This article is part of the Morningstar's Guide to Emerging Market Investing. Click here to find out just what an emerging market is and which regions hold the potential to boost your investment portfolio.
Emma Wall: Hello, and welcome to Morningstar. I am Emma Wall, and here today to give his three sector picks is Chris Colunga, Manager of the BlackRock Emerging Europe Trust.
Hello, Chris.
Chris Colunga: Hell. How are you doing?
Wall: Good. Thank you. How are you?
Colunga: Very well. Thank you.
Wall: What's the first sector pick today?
Colunga: Well, today, I really want to focus on the financial sector and primarily in Central and Eastern Europe; so, if we talk about Poland, we talk about Hungary and we talk about Czech, the reason being is that these economies are closely tied to Western Europe, therefore the interest rates have been closely tied to what the ECB is doing.
Negative rates, slow loan growth in the West has been reflected in these economies as well. And as they start to reach a situation where those rates can rise, the banks are very much levered into earnings growth with a rising interest rate. And so, this is one of the sectors where if you start to see interest rates move up over the next 12 to 18 months, you could see a significant up-rating in earnings; 30% to 50% would not be unheard of for most of these banks.
Wall: And now, the banks in Western Europe have been very beaten up over the last decade because they behaved so badly in the global recession. Was the same true to those in Eastern and emerging Europe?
Colunga: Well, there was definitely a correlation. But I would not argue that our banks have been as beaten up given the heights of valuation that we saw in the West and then the lows thereafter. We've had actually a much less volatile data series within our countries in the Central and Eastern Europe relative to the West. But they still are going to have that levered play on what's happening in Western Europe because of those sensitivities and the starting points of those economies.
Wall: And what's the second sector pick today?
Colunga: Well, the second one, I would also stress people to look at is consumer, the reason being that a lot of these economies, especially in Poland and Hungary, have been putting through fiscal policies that help stimulate and put money in the pocket of the average man on the street in Budapest, Krakow, Warsaw.
These policies have been going on for about 12 months now. So, we've seen already the initial impact of people paying down their high-cost debt and now they are starting to spend money. And as they start to spend, you should start to see an uplift obviously in the sales and the margins across the board with those companies that interact with that segment.
Wall: And now, consumers have been squeezed in this country in particular by rising inflation. Is that a concern in the countries you are looking at?
Colunga: Inflation is definitely rising within the Central and Eastern European economies. But what we are noticing is that the wage growth is rising even faster. Unemployment is at 10-year lows or 20-year lows in many of these countries. And so, the wages are just starting to push up. They can't get enough labor. As a result, again, given the stimulus the government is putting into it, the consumer sector looks like a fantastic place to be.
Wall: And what's the third and final sector pick?
Colunga: The third pick is a little off-piece and that I would recommend materials, the reason being that these stocks clearly are cyclical and they go through their highs and their lows, but with a rise in what's happening in growth in the West, the continued growth of the inflation and also the GDP growth within the rest of the economies, we're seeing an increasing demand and that excess capacity that was in the system is being used up. And we are seeing some of these Polish, Russian, Turkish producers start to put out very high profits, strong operating cash flows and as a result, good dividend yields and that always looks attractive to us.
Wall: Chris, thank you very much.
Colunga: My pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
