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Frontier Markets Semi-Annual Outlook

February 2022*

Virus in Rearview Mirror, but Challenges Abound

Virus developments are likely to play a smaller role in determining the economic outlook for frontier markets (FM) as new variants become less deadly. Nevertheless, FM are still set to face a number of challenges, from slowing economic recoveries to heightened inflationary pressures, leaving central banks with a tough balancing act.

Like the rest of the world, frontier markets have been grappling with an Omicron-driven surge in virus cases. But unlike previous outbreaks, restrictions have been light-touch, even as vaccination coverage in FM has lagged the rest of the world. Looking ahead, unless a more deadly variant emerges, further outbreaks are unlikely to require economically damaging restrictions.

That said, frontier markets still face challenges. First, some economic recoveries are losing steam. Slowing economic growth will likely put pressure on governments to keep fiscal policy accommodative, further delaying progress on sorely needed fiscal consolidation, chiefly in Argentina and Kenya. Second, higher energy costs and food prices are set to keep inflation elevated this year, prompting central banks to resume or start tightening policy. But FM assets are likely to be under pressure this year as the global tightening cycle picks up pace in H2. In contrast, the economic outlook for Vietnam, Romania and Slovenia is bright. In Vietnam, growth will be driven by exports and the reopening of the tourism sector. Growth in both Romania and Slovenia will be supported by the Recovery and Resilience Plan.

Market Strategy

FM equities have moderately outperformed emerging markets (EM) over the past six months, with equity prices for the former flat compared to a small decline in EM. But valuations offer a more mixed story. The 12M forward P/E of FM has improved from a 4.2% premium to EM six months ago to a 5.9% discount. This is in line with the five-year average. But 12M trailing FM dividend yields have dropped back, narrowing the gap to EM. Indeed, FM offer a dividend yield of 2.8%, a touch higher than the 2.5% for EM, albeit still significantly above the 1.8% for DM. Meanwhile, 12M forward EPS for FM are expected to be only 27% higher by end-22 compared to their pre-pandemic levels, softer than the 40% expected in EM.

Bringing this together, in our view, FM equities in general do not look particularly cheap relative to EM, especially when considering sluggish growth prospects. Therefore, we have become more selective with regards to country allocation in this environment. Taking into account the economic, policy and political outlook as well as valuation, we make the following changes to our allocation:

*The publication reflects asset performance up to 31 January, 2022, and macro events and data releases up to 10 February, 2022, unless indicated otherwise.

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The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.

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City of London Investment Management Company Limited (“CLIM”) is authorised and regulated for the conduct of investment business within the UK by the Financial Conduct Authority (FCA) and is registered as an Investment Advisor with the United States Securities and Exchange Commission (SEC). Registered in England and Wales No. 2851236. Registered Office: 77 Gracechurch Street, London, EC3V 0AS, England.

© 2022 City of London Investment Management Company Limited. All rights reserved.