Downgrade Polish Equities to Market-Neutrality Pending Result of Autumn General Elections

The upset victory of opposition Law and Justice party candidate, Andrzej Duda, over the incumbent, Bronislaw Komorowski of the governing Civic Platform party, in Poland’s presidential election run-off last Sunday sets the stage for what should be a contentious parliamentary campaign prior to the ballot sometime this fall.  Signaling a possible change in government later this year, Komorowski’s unanticipated loss to Duda imperils Polish sovereign debt’s unique status as an alternative safe haven to US, UK and Swiss bonds for foreign investors.

Polish Real GDP Growth and Warsaw Stock Exchange Price-Earnings Ratio* Trends

Ahead of the initial round of voting on May 10, the mood among investors was unambiguously mixed as a sell-off in the domestic government bond market deviated strikingly from a rally on the Warsaw stock exchange, while the zloty (PLN) appreciated in excess of two percent in both real and nominal effective, trade-weighted terms.  Ostensibly, the credit markets had already been pricing in concerns about Civic Platform’s commitment to disciplined fiscal and monetary policies since the departure of former Premier Donald Tusk last September.

Polish Zloty NEER and REER, and Current Account as Percent of Nominal GDP Trends

After Duda secured the biggest plurality in the first phase of the presidential election – forcing a run-off, both debt and equity markets in Poland fell victim to renewed investor pessimism.  Single-digit losses of 2.1 and 1.5 percent, respectively, denominated in US dollars were recorded by long-term sovereign bonds and the Warsaw exchange in the wake of first-round balloting.  The currency also reacted modestly negatively to the news of the Law and Justice party candidate’s victory, falling a fractional 0.5 percent on both nominal and real effective bases.

Comparative Polish Sovereign Debt Yield Curves

In the immediate run-up to the final and decisive round of voting two weeks later (May 24), with only Duda opposing Komorowski, the zloty depreciated 1.5 percent and domestic stocks accrued a slightly bigger negative return of 2.5 percent in US dollar terms amid growing skepticism of a come-from-behind win by the current office holder.  Credit markets, meanwhile, faded further, but only by 1.8 percent as ten-year bond yields edged up in response to growing investor worries that Duda’s campaign was gaining increasing favor among the electorate.

Following Duda’s slim second-round coup in upsetting Komorowski’s bid for a another term in office, equities have posted losses of 3.0, 2.4 and 2.3 percent on US dollar (USD), euro (EUR) and PLN bases.  The plight of Polish sovereign debt has worsened by roughly similar magnitudes to those of the shares market, registering negative total returns of 3.1, 2.2 and 1.3 percent in USD, EUR and PLN, in that order.  Symptomatic of rising investor uncertainty over the future of policymaking in Warsaw, the zloty surrendered additional ground of 0.5 percent in both real and nominal effective, trade-weighted terms.  Since the end of last year, cumulative losses of government bonds have amounted to 9.7 percent, while the zloty has weakened scarcely fractionally on both inflation-adjusted and money trade-weighted bases.  Even though Polish stocks had appreciated nine percent before the election, a cumulative loss totaling 6.8 percent has diminished the year-to-date total return to 1.6 percent.

Polish Consumer Inflation, Ten-Year Sovereign Bond Yields, Real Industrial Output and Nominal Retail Sales

Of grave concern to domestic and foreign investors alike is the implication of Duda’s upset victory for the lower house (Sejm) election that will take place sometime this autumn.  Ewa Kopacz, Tusk’s handpicked successor, has achieved little in her eight months in office as prime minister and Civic Platform’s leader – exposing the ruling party’s frailties on both the political and economic fronts.  Duda’s presidential campaign effectively portrayed Kopacz’s regime as aloof, a message that struck an acutely sensitive nerve among younger voters especially because persistent double-digit joblessness, although nine points lower than the highest level (20.7 percent) it recorded in February 2003, continues to stagnate social mobility and income advancement across all strata nationally.

While a Duda presidency implies little for day-to-day policymaking prior to the lower house vote this fall since the presidency is largely a ceremonial post, another electoral loss by Civic Platform would transfer control of public policy to the dubious leadership of the opposition Law and Justice party, the strident nationalism and euro-skepticism of which rivals that of the far right of the British Conservative party and contrasts sharply with the pro-European approach of the present government.  Public remarks by Marek Belka, Poland’s central bank president, that allegedly alluded to President-elect Duda as a “joker” appears to have not just poisoned the political atmosphere but ruled out a second term for Belka, putting in doubt the direction of credit policy upon the expiration of his term of office.

The improvement of the Polish economy during the past eight years of Civic Platform’s reign is unmistakable.  Its resilience explains its having escaped the financially-inspired 2008 – 2009 Great Recession owing to strong foreign direct investment symptomatic of increasing overseas confidence in the well-disciplined monetary and fiscal policies of the Civic Platform-led government.  The economic outlook would look even brighter if current leadership were to retain power in the forthcoming ballot.  Inflation-adjusted economic growth is expected to accelerate to 3.5 percent this year and next despite marginal deflationary pressures and chronically elevated unemployment.  Consensus projections of a relatively stable current account deficit to nominal GDP ratio and a modestly lower budget shortfall to money GDP quotient in 2014 and 2015 should enhance the stature of Civic Platform’s campaign.  Yet, its underdog status may encourage Warsaw to cut taxes and increase spending to improve its standing in the polls and ultimately reverse progress in narrowing the fiscal gap.

Warsaw stock exchange’s one-year forward, positive-adjusted price earnings multiple (p/e) of 14.2x exceeds that of most Central and Eastern European, Middle Eastern and African (CEEMEA) shares markets except Hungary (14.4x), South Africa (16.8x) and the Czech Republic (20.5x).  On a relative valuation basis, however, Polish shares compositely appear slightly inexpensive in relation to the Eastern European, Middle East and African (EEMEA) region, as measured by MSCI’s EEMEA index’s p/e (11.0x), at -0.1.

The extraordinary achievements of Civic Platform’s countercyclical fiscal and monetary policies, in having guided the macro-economy past the Great Recession and elevating its bond market to an alternative refuge for investors abroad reinforced by Standard & Poor’s A- rating of Polish long-term, foreign currency debt, are the envy of emerging markets globally and would normally persuade electors to award the incumbent party with, in this case, a third-straight term of office.  Still, Polish voters, in electing Duda president, seem to have grown weary of Civic Platform’s eight years of rule.  While we remain skeptical of Law and Justice’s electoral appeal considering the narrowness of Duda’s win, we are confident Civic Platform can rebound from Komorowski’s loss.  A cautionary reduction of Polish equity exposures to market-weight and a shortening of duration in holdings of Polish government debt are advisable ahead of national elections this autumn.

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