CEE Markets Expected to Perform Strongly This Year

Analysis

From left, Tamás Bozsogi, Head of OTP Private Banking, Gergely Tardos, head of OTP Analysis Center, Dávid Sándor, head of the Multi Asset Analysis Department at OTP Global Markets.

OTP Bank experts continue to recommend an underweight in stocks while maintaining some exposure to gold in their investment strategy. Despite the expected continuation of inflation decline, they believe the market has overshot in pricing-in interest rate cuts. As a result, Hungary’s biggest bank anticipates fewer rate reductions in advanced and domestic bond markets than what is currently priced in, making long-duration bonds unattractive at present yield levels.

At a press conference on Jan. 19, OTP experts explained that they foresee the most substantial profit growth in emerging stock markets this year. For the Hungarian forint, a fundamentally stable exchange rate is expected in the first half of the year, although depreciation risks are also perceptible.

To achieve the analyst consensus for this year, including ongoing disinflation, rate cuts, and a soft landing for the economy, monetary policy steps must be perfectly timed. This is particularly crucial for the Federal Reserve (Fed), as starting to ease too late could risk a recession, while doing so too early could undermine the fight against inflation, according to the latest investment strategy from the OTP Analysis Center and OTP Global Markets experts.

While the investor and analyst community generally anticipates a soft landing for the economy, OTP Bank’s experts say they also identify downward and upward risks. Therefore, their investment strategy is designed to offer protection in either a recessionary environment or continued strong growth with renewed inflation risks.

This involves recommending portfolios with a lower allocation to stocks and a higher allocation to bonds (favoring shorter over longer maturities) alongside some gold exposure. This allocation is protective against a recessionary outcome while considering that stocks, at current levels, are relatively more expensive compared to bonds.

The bank says the strategy responds to a potential scenario where economies do not slip into recession (possibly due to new fiscal stimuli), but disinflation slows or temporarily stalls. Accordingly, they have underweighted the U.S. stock market, which typically yields lower returns in election years. Within it, they have shifted towards cyclically exposed, smaller-cap segments that have underperformed.

European Over-weighting

Though the European market, which is significantly cheaper and benefits from stabilization in the manufacturing sector, may profit more, the experts prefer to establish over-weighting within this category through emerging markets and Central and Eastern European stocks.

The most significant profit growth this year is expected from emerging markets, and the end of the U.S. interest rate hike cycle, coupled with the stall in the strengthening of the dollar, could provide a tailwind. The CEE region remains the cheapest globally, disproving many fears last year, with the outcome of the 2023 Polish general elections potentially contributing to the region outperforming this year, OTP says.

Regarding sectoral allocation, the analysts have chosen investment opportunities spanning cycles. For instance, the healthcare sector promises significant profit growth this year, benefiting from its defensive nature and advancements in artificial intelligence. In the event of stronger-than-expected economic growth, the cyclicality of the industrial sector can be well exploited, aided by deglobalization trends, lower investment expenditures in recent years, and fiscal side supports.

While the U.S. economy continues to hold up surprisingly well despite the inflation shock and rapid monetary tightening, the Eurozone has been virtually stagnant since the fourth quarter of 2022. Instead of the anticipated rebound due to lower energy bills, European growth weakened further last year, likely entering a mild technical recession from the third quarter.

“In 2024, the tables are expected to turn, with the U.S. slowing down and the European economy potentially picking up, but growth in both major economies may remain historically low, with particularly strong negative risks in the U.S.,” pointed out Gergely Tardos, head of the OTP Analysis Center.

In Hungary, the overheating before the elections, the energy crisis, regionally high inflation, and monetary and fiscal tightening caused a recession in 2023. However, in 2024, growth is expected to restart, driven by a less hostile external environment, rising real wages, and consumption stimulated by decreasing interest rates. After a nearly 1% recession characterizing the whole of last year, GDP could expand at a rate above 2% this year, OTP believes.

A Stable Forint?

Its analysts predict a fundamentally stable exchange rate for the forint in the first half of the year but also see factors that could lead to depreciation risks in the second half, including the potential realization of external risks, decreasing interest rate differentials, government programs aimed at stimulating economic growth and intensifying tensions with the EU.

The central bank might accelerate the pace of interest rate cuts early in 2024 due to the rapid decline in inflation. Given the high real interest rates and weak domestic demand, a more significant step than the previous 75-100 bp base rate cuts could be conceivable.

However, considering the importance of the forint’s stability, the most likely scenario for Q1 is a return to the 100 basis point steps seen last summer. By the end of the year, OTP believes the benchmark interest rate could favorably decrease to 5.5%, which makes the market’s priced-in 4.25-4.5% value appear overly optimistic. Based on this, it does not find long-duration bonds attractive for the forint at the current levels around 5.5%.

Overall, following the quick recovery in rate cut expectations and significant falls in bond yields, long-duration bonds have lost their appeal. In the bond sector, it is advisable to search for shorter-term securities.

For Hungarian retail investors, special retail bonds remain the most attractive option for forint investments. Regional government bonds offer sufficiently attractive yields with manageable risks for diversification in euros and dollars. This also applies to euro or dollar bonds issued by regional companies, which pay higher yields than their European or American counterparts. Both instruments are additionally suitable for partially hedging the risks of a potential weakening of the forint.

“Gold continues to play a role as a hedge in balanced portfolios,” insists Dávid Sándor, head of the Multi Asset Analysis Department at OTP Global Markets. Gold had an outstanding year last year, appreciating more than 13%, setting a new all-time high in early December (above USD 2,100/ounce) before undergoing a minor correction. Moreover, gold reacted positively to the Fed’s December indication that three rate cuts could come in 2024, with a weaker dollar and lower real interest rates typically having a favorable impact on the price of the precious metal.

This article was first published in the Budapest Business Journal print issue of January 26, 2024.

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