Eurozone Growth Boosts Emerging Europe Stocks

Emma Wall: Hello and welcome to the Morningstar series "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Chris Colunga, Manager of the BlackRock Emerging Europe Trust.

Hello Chris.

Chris Colunga: Good morning.

Wall: So we're running an Emerging Markets Week this week and today we are focusing on emerging Europe. One of the questions I wanted to ask you is that actually we have seen great growth in the eurozone, and we've seen a return to favor European equities among retail investors. I was wondering how much did that impact positively or negatively emerging Europe going east?

Colunga: Well as you can imagine, it has quite a significant impact, for multiple reasons. One being that clearly with growth in the eurozone, you would expect an increased demand for manufactured goods, materials, energy, and these are all things that Eastern Europe tends to provide for Western Europe given the lower wage growth and in many cases higher productivity than their western peers.

So as a result, you kind of get this pull of demand and an increase in growth within Eastern Europe. And on top of that you have a second layer and one is, with the ECB starting to tighten rates given how interlinked these economies are you have a situation where the Eastern European banks where all those economies are already growing faster than Western Europe need to start to raise their rates as well. And what this will allow is the banks to start having slightly higher margins going forward.

So, for the last eight years we've been talking in Europe about negative rates, slowdown in loan growth, slowdown in economies. As Europe accelerates, Eastern Europe accelerates even faster. They've already got underlying growth, coupled with restoring rates. You could see significant re-ratings in those banks especially in Eastern Europe, especially relative to peers in Western Europe.

Wall: And of course, we are grouping all those countries together for that particular point. But they are a heterogenous group. What are the other drivers of eastern emerging Europe?

Colunga: Well, you've got a couple of different, I guess I should distinguish here. Especially when we are talking about Central and Eastern Europe. Poland, Hungary, Czech, Romania, these are the guys that are really plugged in to Eastern Europe.

You still get a benefit out of Greece, out of Turkey, out of Russia from what's going on in Europe. But that leverage really comes in the eastern CE4 bloc if you will. The other drivers there, is that these economies are still playing catch up with Western Europe. You are still seeing significant investment into their infrastructure, increases in their productivity, and many of the governments have been able to run fiscal policy that is actually very helpful for the consumer.

So, Poland, for example, has enacted a lot of fiscal spend recently that benefits the consumer directly, putting increased money in the lower mass segment pocket, which increases the consumer spend within Poland, accelerates the economy even faster. This is happening not just in Poland, but in Hungary and to a lesser degree in Czech and Romania.

Wall: One of the things that is negative, that's levied against this bloc though is that they are more volatile than Western Europe. Partly because the stock markets are made up of more cyclical sectors. Do you think that’s a fair accusation?

Colunga: We need to be careful when we say that about distinguishing which countries we are talking about. Some are naturally more volatile than others, Russia, Turkey, do have a higher volatility, say, than Poland or Czech. But the thing within these economies, within this grouping there is actually a greater diversification when the E7 as we call them--if we take those central and Eastern European CE4, add in Turkey, add in Russia, compare that with the G7 you've got such a greater diversification available to you. Meaning that the markets move in their own ways and separate from each other. 

So, whilst one or two countries may be extremely volatile, they don’t tend to move in the same direction as the other economies at the same time. And so, as an active manager what we get to do is pick and choose where we think we are going to get the highest return for our investors and that’s something that this grouping really allows us to bring to the forefront.

Wall: Chris, thank you very much.

Colunga: My pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching.