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Photographer: Yorgos Karahalis/Bloomberg Photographer: Yorgos Karahalis/Bloomberg

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While Europe’s equity benchmark is set to record its best annual gain since 2009, it’s been left in the dust by the top stock market worldwide: Greece. The country’s shares have climbed 45% this year, rising from a low base after a decade of crises. As Greek stocks get out of the doldrums, fund managers may start looking at the market again.

You have to go back to the time before the euro replaced the drachma to find higher returns in the Greek equity market, and there are reasons to be optimistic about the coming year, particularly if the economy continues to improve. Momentum for Greece accelerated after the summer election, according to George Lagarias, chief economist at Mazars Financial Planning, as the new government showed its willingness to implement a package of tax cuts and pro-business policies. That has reduced some of the discount that Greek risk assets were trading at, he says.

“The key to unlock further value in Greek equities is the bond market,” Lagarias says, and the current levels of government yields and credit default swaps indicate that the perception is shifting and the country is no longer considered Europe’s “problem child.” It also opens the door for Greece to be included in the ECB’s new round of quantitative easing, usually a catalyst for wider asset reflation, Lagarias adds. There’s still a lot of reform work to be done for long-term sustainability to be achieved, but if this trend continues we could even see more momentum for Greek stocks into 2020, he says. Looking at government bond yields, Greece now borrows money at a similar cost as Italy for five-year terms, while 10-year yields are very close.

“Greece remains one sweet treat for us,” says Emiel Van Den Heiligenberg, head of asset allocation at Legal & General Investment Management. The portfolio manager says despite a 180% government-debt-to-GDP ratio, there’s a lot of positive data coming from the Greek economy. In particular, the nation’s manufacturing PMI is just about the only one in Europe above 50, pointing to economic growth. It’s been resilient to the global downturn, driven by local factors, most notably the sentiment improvement around the new government, he says. Consumer confidence kept improving through the year, hitting its highest level in almost two decades.

Van Den Heiligenberg sees a lot of positives on the debt front, citing a current account deficit remaining close to zero, as well as a few small debt repayments due in the coming quarters, and then nothing until 2022. “As the country’s credit metrics improve, there’s an increasingly realistic chance that Greece will be upgraded to BBB and become eligible for the ECB’s buying program, which would then gobble up at least a third of the outstanding bonds,” the portfolio manager says. Regarding debt, the IMF is still more skeptical about Greece than the EU.

Banks have been at the forefront in the re-rating of the Greek market, and further performance may be closely linked to bank stocks. Dimitri Dardanis, head of institutional equities at Piraeus Securities, says further gains will be dependent on a steady pace of government reforms and on banks’ ongoing efforts to confront bad loans while keeping credit flowing to the economy.

The FTSE/Athex Banks Index has more than doubled this year, with some lenders even posting gains close to 300%. That said, the surge looks almost irrelevant when you look at long-term charts, suggesting that there is still a long way to go before these stocks make a full recovery to pre-crisis days.

Bank of America analysts reinstated their coverage of Greek banks at the end of October, basing their investment case on one single question: can non-performing exposure ratios for loans drop to European standards (in a reasonable time frame) without a capital injection? Things have improved, the analysts said, citing liquidity, sovereign yields and recovering real estate prices.

The government’s Hercules support program, designed to enable lenders to repackage their bad debt, may also help, but they remain cautious overall as domestic and external factors need to keep moving in the right direction. They see long-term structural risks because some Greek banks have limited room to accelerate a clean-up of soured loans due to their poor capital buffers. They see further upside on Eurobank (buy), while NBG and Piraeus remain at underweight. Alpha Bank is rated neutral.

In the end, it remains to be seen whether the Greek stock market can finally become attractive again for most investors, instead of being a playground for hedge funds. After all, despite the 45% rally, the total size of the ASE Index is less than 55 billion euros ($61 billion), smaller than the market cap of Adidas.