Frontier Markets Semi-Annual Outlook

February 2024*

Backdrop More Favourable for Frontier Markets

The prospect of Federal Reserve (Fed) rate cuts, lower bond yields, and a softer US dollar point to a more supportive environment for frontier markets (FM). The FM universe is diverse, and we prefer markets exposed to trends like friend-shoring (Vietnam) and decarbonisation (Kazakhstan).

The environment for FM has improved and is more favourable than six months ago. Developed market (DM) central banks, led by the US Fed, have signalled the end of their tightening cycles and the prospect of rate cuts as inflation continues to edge down. Historically, a fall in bond yields has consistently followed the last Fed rate hike, which should temper US dollar strength. Meanwhile, timely surveys suggest that global growth has slowed but is still resilient. The US economy keeps defying expectations, while policymakers in China continue to introduce stimulus measures to stabilise the domestic economy.

Focusing on FM, a softer US dollar, easier DM monetary policy and falling commodity prices mean that most of the key headwinds of the past few years are set to fade. There are still some downside risks to FM, ranging from an eventual US slowdown to ongoing El Niño-related disruptions. Additionally, Sri Lanka and Ukraine are in the midst of a sovereign default and war respectively, rendering them uninvestable for the time being. But overall, we hold a constructive view on FM equities. Market-friendly reforms are underway in countries such as Kazakhstan and Bangladesh, while Argentina’s new president attempts to address the country’s macroeconomic imbalances. Climate change is a perennial risk, and FMs are projected to be more vulnerable to the fallout. The IMF’s Resilience and Sustainability Facility, which has so far administered financing to Morocco and Bangladesh, is one way that countries prepare their economies for climate change. Relatedly, the push to decarbonise the global economy presents opportunities for Kazakhstan and Morocco, who are endowed with uranium reserves and green hydrogen production feed respectively. 

Market Strategy

FM equities, as measured by the MSCI FM 100 Net TR Index, outperformed emerging market (EM) equities (MSCI EM Net TR Index) by 5.7% points over August-January. Both underperformed DM equities (MSCI World Net TR Index) over the same period as US equities rallied following the Fed’s perceived pivot at the December FOMC meeting. Despite outperforming EM, FM equities still screen cheap in relative terms. The 12M forward P/E for the MSCI FM100 Index is at a nearly 40% discount to EM, wider than its five-year average discount of 20%. 

In terms of country allocation, we continue to prefer Vietnam and Kazakhstan. In Vietnam, we seek to gain exposure to friend-shoring trends. Our overweight in Kazakhstan reflects our slightly optimistic view on oil and uranium prices, the latter being driven by decarbonisation demand. We stay underweight in Argentina as legislative delays and hurdles reduce the chance that the new administration’s key reforms will succeed. Nigeria was removed from the benchmark S&P Extended Frontier 150 in November due to market liquidity issues.

We only make one change to our allocation:

  • Downgrade Romania to underweight. Relatively expensive valuations vs its historical average, ongoing twin deficit problems, and the economy’s close connection to beleaguered eurozone economy mean that we reduce our position to underweight.

Chart 1: S&P Extended Frontier 150 Net Total Return USD, Aug 23-Jan 24

Source: S&P

*The publication reflects asset performance up to 31 January, 2024, and macro events and data releases up to 8 February, 2024, unless indicated otherwise.

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.