Despite eye-popping returns, emerging markets managers think Eastern European markets still have lots of room to rise.
Privatizations of state-owned companies will broaden these markets and sop up foreign assets without batting an eyelash, some money managers believe.
The Czech Republic, Hungary and Poland promise annual growth rates of 6% to 9% a year through the decade, labor costs are extremely low compared with Western European neighbors, and workers are highly skilled and literate.
Eastern Europe is offering "Asian-type growth rates on Europe's doorstep," said Glenn Wellman, executive director of CS First Boston Investment Management Ltd., London, and portfolio manager of its new $200 million Central European Growth Fund PLC.
Some investors, however, remain a bit more cautious, although are optimistic for the long run.
"Now, a rising tide lifts all boats, but in the future we will have to be more selective," said Steven Bates, director, Fleming Investment Management Ltd., London.
After strong performances in 1993, these markets still are roaring. In dollar terms, through March 25, the Warsaw Stock Exchange has returned 44%, while the Prague and Budapest markets have returned 50% and 46%, respectively.
"Prices generally are much, much higher than they were a year ago," said Jonathan Passmore, director of marketing at Creditanstalt International Advisors Inc., New York. But conventional yardsticks, such as price-to-earnings ratios, are not the best ones to use when evaluating emerging markets, he said.
If there's any great caution in the short run, it's with regard to Poland, whose stock market skyrocketed 875% in dollar terms last year. Some believe Polish stocks - now trading between 28 and 40 times earnings, based on varying estimates - have become overvalued, but the risk essentially is short term.
Polish stocks are "somewhat dangerous at this level, particularly because no one is sure about valuations," explained Arnab Banerji, chief investment officer of Foreign & Colonial Emerging Markets Ltd., London. He said a 25% to 50% correction would not surprise him, but he remains "bullish on Poland in the medium to long term."
Gross domestic product growth hit 3.9% last year and higher rates are expected. Annual inflation has plunged from a peak of nearly 600% in 1990 to 37.5% in 1993. And Poland just restructured its commercial bank debt, relieving payment pressures.
But the 38 million Poles still have to recover from the effects of radical restructuring started in 1990. Unemployment has risen to 15% and threatens to reach 18%% to 20%, according to research by Morgan Stanley & Co. International, London.
The resulting social expenditures have driven the budget deficit to nearly 5% of GDP, although down from 6% in 1992. These factors "could weigh heavily on the market later this year," said James Lister-Cheese, Eastern European analyst for Morgan Stanley.
In the long run, the key to Poland's economic growth is expected to come from its delayed mass privatization. Some 400 companies will be sold off.
Also, later this year the government is expected to issue licenses to about 20 new stock exchanged-listed investment companies, which will provide a new investment opportunity, said Gary Ballard, emerging Europe analyst for Baring Asset Management Ltd., London.
Many experts believe the Prague Stock Exchange will provide one of the best emerging markets in the world in 1994.
Already up 50% in dollar terms, although price-earnings ratios range from only 15 to 18 times earnings.
The country has virtually no budget deficit and unemployment is only 3%. The Czech Republic enjoys a trade surplus and has reoriented its trading patterns to the West: now 60% of trade is with the European Union and other Western countries.
Inflation is running in the high teens, but experts said that's because of the introduction of a value added tax this year, and the inflation rate should settle down to 10% next year.
Like the other Eastern European states, the republic's 10 million citizens are nearly all literate and highly skilled. Average wage rates, however, are $1.23 an hour; wages in neighboring Germany are $15 an hour.
The biggest vulnerability is nearly total dependence on Russia for energy supplies. Any disruption to the flow - such as a rift between Russia and the Ukraine, through which the Russian oil and gas travel - could hurt Czech industry.
Prague's stock market is the best developed. There are 980 companies eligible for over-the-counter trading, with about 330 to 350 companies trading actively each session, according to a preliminary prospectus for the Morgan Stanley European Emerging Markets Fund Inc., New York. Eight stocks are officially listed. But a second wave of privatizations will add another 700 stocks later this year.
Hungary has proceeded with privatization more cautiously than anticipated, but some experts think the pace is quickening.
The top four or five stocks account for 80% to 90% of total turnover, Mr. Lister-Cheese said. Elections slated for May should help accelerate privatizations, he said.
Hungary has attracted a greater degree of foreign investment than the other European states: Foreign investors bought 80% of privatizations in 1991, 60% in 1992 and about 40% in the first seven months of 1993, according to Morgan Stanley Asset Management. A wave of 70 companies should be privatized this year.
"Hungary is stepping up privatization a bit," said Baring's Mr. Ballard.
The market is by far the smallest of the three nations, at $1.5 billion, while the average p/e is about 20.
Fundamentals are looking better. Economic growth dropped by 9.3% and 4.5% in 1991 and 1992, respectively. It declined an estimated 2.8% in 1993. Inflation, after peaking at 32.2% in 1991, has dropped to less than 22%, although the budget deficit as a percentage of GDP has climbed to 6.9% from 4.4% in 1991.
Meanwhile, new investment funds are cropping up. Besides the CS First Boston fund, Baring has raised $124 million for the Baring Emerging Europe Trust PLC, a closed-end fund traded on the London Stock Exchange. The initial target is to invest 40% in Eastern European markets and 60% in the Greek, Portuguese and Turkish markets.
The closed-end Morgan Stanley fund will be listed on the New York Stock Exchange. It will invest in Poland, the Czech Republic, Hungary and Turkey, plus various other small states. Isabel Knight, a London-based portfolio manager for the fund, said Morgan Stanley has set a minimum investment of $60 million, but she is hoping the fund will raise $100 million to $150 million.