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Figuring Out Frontier Market Equities

  • A global agricultural commodity crisis could trigger trouble for smaller/developing frontier nations

  • (but) The MSCI Frontier Index is half Financials/Real Estate, so interest rate trends and the wider macro currents are arguably a larger driver

  • FM valuations are decent, but bearish momentum posits a cautious tactical outlook


Global food prices are surging. Overall, the broad commodity index is on course for its best year since 1915 (after leading all asset groups in 2021). The trend could persist in the coming years as supply chains continue to be pressured. Ukraine, the breadbasket of Europe, will be hard-pressed to return to pre-invasion production levels even in an optimistic outcome.


While developed-market citizens may gripe about paying more at the grocery store for our everyday items, food shortages and famines notoriously stir up social unrest in small and developing countries. Perhaps Frontier Markets might feel it the worst in the come years. We all agree that the human impact of the ongoing geopolitical turmoil is most important, but impacts on financial markets matter.


Frontier Markets: Country Composition


IShares MSCI Frontier and Select EM (FM) is the common way to play future economic growth in these volatile areas. The biggest country holdings in the ETF are Vietnam, Nigeria, Morocco, Bangladesh, Bahrain, and Colombia. Clearly, food prices turning parabolic and widespread shortages of some key agricultural commodities could have dire impacts on these nations.


A Value & Financials Play


There’s more to Frontier Markets than just the geographic breakdown, however. What might come as a surprise to readers is that the FM fund is 50% Financials and Real Estate. Perhaps the global interest rate story is a larger narrative than the outlook for commodities. Growth investors should shy away from FM as Consumer Discretionary and Information Technology comprise less than 1% of the ETF.


Our Stance: Neutral


Our flagship Weekly Macro Themes report digs into the latest happenings and a forecast update on Frontier Markets. We turned neutral (from bullish) on the space late last year as technicals showed signs of deterioration. While there have been some improvements in terms of breadth starting to appear washed out, the picture is still somewhat bleak amid broad-based bearish momentum. The MSCI FM Index recently made fresh lows versus USA stocks, while barely holding ground vs DM ex-USA.


Featured Chart: Frontier Markets Hit Fresh Relative Lows vs the USA

chart of frontier market equities relative performance

Valuations: Good, Not Great


On the valuation front, FM has turned a bit cheaper, but there is still a long way to go before the region is downright a bargain. Still, investors can find a nearly 4% dividend yield and a forward PE ratio under 10 on the FM index. We also analyze the FX valuation case in this week’s report that subscribers should check out.


Still Favor FM Long Term


We continue to like the strategic case for owning FM – expected returns looking out five to 10 years are favorable. There are much better FM population growth trends vs developed and emerging markets, and slightly lower volatility compared to DM and EM along with low correlations to EM.


Bottom Line: Frontier Markets should have a spot in a long-term investor’s portfolio, but tactically, we are not excited about the area right now. The technical picture is not impressive amid bearish momentum so far this year. The upside is that valuations have improved, but not enough to warrant a bullish value play on FM quite yet.


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