Head - Equity Strategy
June 21, 2018
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Estimated flows into Argentinian equities are between $2bn-$3bn with $8bn-$9bn expected to flow into Saudi equities
Results at the 2018 Fifa World Cup have so far not gone according to plan for both Argentina and Saudi Arabia, but both countries managed score a big victory on 20 June by being promoted to Emerging Markets (EM) status by index provider MSCI. Estimated flows into Argentinian equities are between $2bn-$3bn with $8bn-$9bn expected to flow into Saudi equities.
Following a 9-year absence, Argentinian equities will retake their place in the main EM benchmark in May 2019, having been upgraded from Frontier Markets status. Saudi Arabian equities will be included into the EM benchmark for the first time, bypassing the Frontier benchmark altogether.
The MSCI Argentina is likely to have 11 constituents while the MSCI Saudi Arabia will have 32. Expectations for Argentina’s weight in the EM index center around 0.5%, putting the market on par with Colombia and Peru. Saudi will initially command a weight of around 2.6%, but this could rise substantially depending on the valuation and inclusion of the much discussed Saudi Aramco IPO.
MSCI will initially only include foreign listings of Argentinian companies, such as American Depositary Receipts (ADRs) and has said it will monitor liquidity conditions on the Buenos Aires Stock Exchange and reevaluate this decision as needed. MSCI also stated it will review its reclassification decision should Argentinian authorities introduce any sort of market accessibility restrictions, such as capital or foreign exchange controls.
Based on the experience of other markets upgraded to EM status by MSCI, the period of greatest performance comes in the 11-12 month period between the reclassification announcement and actual inclusion. The UAE and Qatari indices rallied 94% and 48% respectively between the upgrade announcement in June 2013 and their reclassification to EM status in May 2014, while the MSCI Pakistan rose 32% between its June 2016 upgrade announcement and its May 2017 EM index inclusion.
While clearly supportive in the near-term, in the longer-term policymakers in both Argentina and the Kingdom need to maintain the positive momentum which earned them the upgrade in the first place. Between their respective inclusions and today, UAE, Qatari and Pakistani equities are all down around 40% in USD terms.
Chinese A-shares, whose gradual inclusion into the MSCI EM index was announced in June 2017 were up 9% in dollar terms by the time implementation began last month, but are down 10% since mid May. While this pattern is consistent with the UAE, Qatari and Pakistani experiences, we believe the recent sell-off has more to do with Chinese authorities’ tackling of the shadow banking system.
The PBOC has been among the most hawkish Central Banks in the world over the past year, but now looks set to relax policy in response to softening growth data and as an offset to the potential ramifications of recent trade tensions (see China eases policy to offset trade risk and liquidity concerns). We believe that Chinese equities stand to benefit from this.
Argentina’s recently announced IMF agreement, coupled with its cheap valuations and year-to-date underperformance (MSCI Argentina is down 37% in dollars) suggests that the potential upside appears greater for Argentinian equities than for Saudi equities, which are among the world’s best performers this year (+19%).
The Citi Private Bank Global Investment Committee is positive on Latam equities, expecting regional markets to be supported by valuation multiples of just 10-12x forward PE, thereby compensating investors for potential medium term risks.