Retain Slight Overweight of the Polish Stock Market Given Domestic Economic Resilience

The US dollar-denominated performance of the Warsaw Stock Exchange index (WIG) had already been flirting with negative territory several times in the first six months of 2014 before a full-fledged rout overpowered it and thrust Polish shares into a single-digit, year-to-date loss. Capital flight stemming from Russia’s annexation of Crimea, subversion in Eastern Ukraine and air space violations over the Baltic nations has dampened foreign financial enthusiasm toward many, if not most, Central and Eastern European (CEE) equity markets – either eroding gains or compounding losses they have accrued during the course of the past ten and a half months.

In spite of the departure of Prime Minister Donald Tusk for the presidency of the European Council in Brussels, his hand-picked successor (Ewa Kopacz) to the premiership telegraphs no immediate changes to policymaking for the foreseeable future. Local elections held on November 16 reportedly experienced some malfunction that required the state electoral commission to revise the vote tallies and restate the outcome. Nonetheless, the ruling center-right Civic Platform captured the most seats in provincial assemblies (or mandates), 179 of a total of 555 and winning eight of the sixteen provinces.

Meanwhile, its coalition partner – the Polish Peasant Party – captured 157 mandates, fourteen shy of the 171 seats secured by the opposition Law and Justice Party. The victory of the center-right alliance in the provincial balloting earlier this month not only reinforces Kopacz in her leadership position but also – together with its triumph in the European parliamentary vote last May – validates the liberal, pro-market policies of the incumbent regime ahead of the next round of national elections that must be held no later than October 2015.

Stability in the political climate generally tends to imply steadiness in public policy development and execution. The pro-liberalization predisposition of the state’s agenda is not expected to change anytime soon no matter which party wins the 2015 lower (Sejm) and upper chamber (Senate) ballots come eleven months from now. Even so, Kopacz will encounter inordinate pressure from within her party to pursue an expansionary fiscal policy to safeguard the re-election of Civic Platform next year. Still, Global Markets Intelligence (GMI) expects Kopacz to hike spending in a restrained manner as a means to forestall a run-up of the budget deficit, but resist a comprehensive rise in government expenditures in conformity with her party’s commitment to fiscal discipline.

The National Bank of Poland (NBP), meantime, is expected to remain on high alert to the downward tendency in price pressures. Having already transitioned from disinflation to deflation since last July, the nation’s cost of living is spurring the Polish monetary authorities to press ahead with its accommodative credit stance in order to avert consumer and business psychology from becoming overly accustomed to declining prices, which would – in all likelihood – pose devastating long-term consequences for domestic consumption and investment by instilling a self-reinforcing mindset that encourages households and businesses to postpone spending and capital formation, respectively, in anticipation of further decreases in the cost of goods and services.

Looking forward, lower credit costs and rapid zloty depreciation should foster a gradual improvement in inflation-adjusted economic activity. Comparatively low borrowing rates will give rise to increased consumption by households and higher investment by businesses as exports regain upward momentum owing to currency weakness. In sum, Poland’s economic growth rate could accelerate steadily to the four percent mark by 2016 provided the country does not sustain any adverse exogenous shocks.

The WIG’s one-year forward, positive-adjusted price-earnings ratio (p/e)[1] of 14.4x may seem expensive on an absolute valuation basis vis-à-vis its historical average (13.2x) and record low (6x), but appears to have plenty of room to eclipse its present level by expanding in the direction of its all-time high (25.8x) if trends in macro fundamentals prove correct. From a relative valuation perspective, the WIG appears marginally overvalued by about 0.01 point in relation to its bellwether (MSCI Eastern Europe, Middle East and Africa). All the same, GMI is convinced the WIG’s p/e has substantial leeway to expand in light of the economy’s resistance to downside pressures.  Compared with other markets in the region, the WIG’s p/e is justifiably overvalued versus those of every shares market in Eastern Europe. However, its undervaluation relative to South Africa looks curiously understated, requiring an eventual upward adjustment to reflect fundamental differentials in Poland’s favor. In view of the foregoing, an overwhelming case still supports our retention of an overweight on Polish equities compositely in spite of geopolitical factors that have been weighing deleteriously on them since June.

[1] MSCI Poland (MXPL) positive-adjusted price-earnings multiple data proxy those of the Warsaw stock exchange index.

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