This article is authored by MOI Global instructor Steve Gorelik, portfolio manager at Firebird Management.

Firebird has been investing in Eastern European equities for over thirty years, and over that time, we’ve learned to take a few things for granted: inflation and interest rates tend to be higher than in developed markets, and local currencies typically depreciate—gradually or abruptly—against the dollar and euro.

This pattern is well documented. Weaker institutions raise perceived risk and elevate inflation expectations. These expectations fuel actual inflation, which puts further downward pressure on the currency. Depreciation then raises the cost of imports, reinforcing inflation and creating a vicious cycle.

But what would happen if the circumstances change and these assumptions no longer hold true?

As noted in a recent FT Alphaville piece, “The U.S. is NOT an emerging market.”^[1] While developed economies like the U.S. grapple with political interference in monetary policy, many of the emerging markets once dismissed as fiscal basket cases are now pursuing more orthodox, credible economic policies. Countries such as Brazil, South Africa, and Turkey are running restrictive interest rate regimes aimed at reining in inflation and restoring consumer confidence.

In our investment universe, in countries like Georgia and Kazakhstan, central banks maintain high interest rates while inflation is seemingly under control and has been coming down for the last two years. Real interest rates in these countries are well over 6%, which is higher than the peak reached in U.S. during the Volcker era. The central banks are run by western educated technocrats who have seen the first-hand impact that high inflation has on the economy and haven’t just read about it in textbooks.

The latest policy rates for Kazakhstan and Georgia are set at 15.25% and 8% respectively, which raises a question: What happens to these economies—and to asset values—if interest rates begin to seriously decline?

The U.S. offers a compelling historical parallel. From 1980 to 1990, real interest rates fell from nearly 6% to under 1%. During the same period, the Fed funds rate dropped from 18% to 7%, and inflation declined from over 12% to under 6%. This shift catalysed a virtuous cycle: declining rates spurred investment, which drove productivity and growth. Between 1983 and 1990, U.S. real GDP grew at an average annual rate of over 4%, compared with just under 1% in the preceding five years.

The effect on equity markets was even more dramatic. While corporate after-tax profits grew at 4.5% annually, the S&P 500 delivered returns of more than 14% per year, thanks in large part to multiple expansion.

In another example from an emerging market, Brazil over the past two decades experienced multiple periods when real interest rates were sharply increased to combat inflation, and later brought down once price pressures were under control. In 2002, with inflation spiking above 12%, the central bank raised its target rate to 25%. This decisive action helped stabilize prices, and both inflation and interest rates declined steadily over the following decade. During that time, equity markets delivered annualized returns of 25%.

Inflation surged again in 2015, prompting the central bank to raise rates to over 14%. By 2019, both inflation and policy rates had fallen to around 4%, and equities once again posted impressive returns of 27% per year. Remarkably, this performance occurred against a backdrop of intense political turbulence—including the Lava Jato corruption scandal, the impeachment of President Rousseff, the imprisonment of former President Lula, and the election of the highly polarizing far-right populist Jair Bolsonaro. This suggests that, in emerging markets, investors often care more about the direction of interest rates than the noise of political headlines—no matter how dramatic they may be.

Looking at interest rates and equity valuations around the world, a clear pattern emerges: countries with higher policy rates tend to have equities trading at lower valuations. The theoretical explanation lies in the Discounted Cash Flow (DCF) model, where the interest rate is a key component of the denominator. In practice, however, it is important to consider not only domestic interest rates but also the discount rates used by the marginal buyers of securities. If the buyers are primarily domestic, then local interest rates and risk premiums apply. However, if the buyers are foreign, their funding costs and risk perceptions may differ significantly—either lower or higher—than those of the domestic audience.

As shown in the earlier examples, high real interest rates often signal that rates are likely to decline once the central bank believes inflation is under control. When that happens, equity trading multiples typically rise, as the discount rate used by marginal buyers falls.

Going back to Georgia and Kazakhstan, we believe that these countries boast some of the bestmanaged companies in the emerging markets universe. Banks such as Halyk Bank and Lion Finance (Georgia) have been in recent years generating returns on equity in excess of 30%. Despite delivering outstanding results—EPS growth of 21% p.a. for Halyk and 33% for Lion since 2019—these companies remain astonishingly cheap, trading at just 3.5x and 6x earnings, respectively. With GDP growth already exceeding 5% in Kazakhstan and 9% in Georgia, a sustained decline in interest rates could provide the catalyst for multiple expansion and a rerating of these stocks.

In thirty years of investing, we saw some of the best opportunities emerge when long-held assumptions began to crack. Markets can be slow to adjust their frameworks, even when the underlying fundamentals have already shifted. This inertia creates pockets of profound mispricing—particularly in regions that are overlooked and where investors have been conditioned to expect certain outcomes. When perceptions finally catch up to reality, the adjustment tends to be substantial.

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^[1] https://www.ft.com/content/a9a9dd1e-36cf-4e2e-81d0-05c64a01871f