EM promotion for Saudi and Argentina – Good or Bad?
MSCI announced yesterday that both Saudi Arabia and Argentina will be promoted to Emerging Markets status. In theory this should be a good thing for both markets but the recent history has shown that promotion may actually end up in tears. Pakistan, UAE and Qatar have for different reasons experienced a sharp sell-off post promotion.
A lot has been written on these two countries but to share our thinking, we believe that most of the good news is already priced in Argentina but not yet in Saudi Arabia.
In the case of Argentina, we believe that the stock market may on the short term go up but that EM inclusion will be a non-event over the mid-term. The only thing that really counts in the case of Argentina is whether they will be able to move away from a consumption driven economy financed by international investors.
President Macri is sincere in his reforms but his policies are not yet delivering on the necessary economic transformation. As a firm we will stay underweight until at minimum we see a reduction in the account deficit. The fact that Argentina has not been able to improve their trade balance after two rounds of dramatic currency depreciation, is a clear sign of the challenges ahead. Add to this rising inflation and interest rates of 40+% in local currency terms.
In the case of Saudi Arabia, EM inclusion will not have a big impact on the short term but will be a major factor going forward. Saudi will have around 3% weight in the EM index and all signs are there for it to become one of the major constituents in the index.
The Aramco listing will be a major catalysts but even beyond this, local companies have a lot of room to increase weights by e.g. increasing their free float. As importantly the EM inclusion is part of a bigger economic and social transformation that has been slowly but surely gaining momentum. Investors are not really yet taking this into account and we believe that the Saudi market may become one of the star performers in the coming years.
As a final note, we believe that the major index providers should rethink their index criteria. Countries with small weight in the EM index including Argentina and the likes of Egypt, Pakistan and UAE should be classified differently…Frontier Markets?
Their small size and intrinsic volatility has in the past resulted in a cycle of promotions followed by relegation. More consistency would be good for all.