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Investment Outlook 2019

Feb 11, 2019

Investment Summary

  • There was virtually no place to hide in 2018. As at the end of 2018, less than 20% of asset classes showed positive returns, others were in red. Though, there were no dramatic drawdowns on asset class level. Defensive strategies turned out to be the winners last year, against the backdrop of increased volatility caused by global risks. However, this challenging year is over, and capital markets kicked off 2019 with an encouraging optimism.
  • The global economy is going through a late-cycle expansion phase in 2019. The later stage of the cycle is not yet a recession, and almost all assets usually perform well. Russia is well positioned to benefit from the robust demand for hydrocarbons and other commodities as well as better supply-demand balance, because the current economic cycle is extended beyond earlier expectations. Russian equities tend to perform well in a late-cycle environment.
  • We downgraded our forecasts for crude oil prices from 55/70/90 a quarter ago to 45/60/75 (Bear Case / Base Case / Bull Case scenarios respectively). The revised forecast resulted in the downgrade of the 2019 Real GDP forecast from 1.6% to 1.2%, while the industrial output forecast was downgraded from 2.0% to 1.5% in a probability-weighted scenario. The CPI forecast has risen from 5.3% to 5.5%, YoY.
  • The Central Bank of Russia (CBR) continues to be hawkish. The longest period of monetary easing – since Elvira Nabiullina was appointed as the head of the CBR in mid-2013 and the CBR began transitioning to the inflation targeting regime – has probably ended. Save marginal scenarios, the CBR may keep the key rate at the current level until the end of 2019, which is presently our base-case scenario.
  • We remain moderately defensive in the Russian fixed income space. We prefer liquid, shorter-duration, high-grade issues, both in Ruble and Hard Currency debt. Nevertheless, we do not rule out investing in high-yield bonds to generate additional alpha when proper opportunities materialize.
  • We think that the OFZ market is pricing in a flat key rate. Total returns for Ruble Bonds could be in the 8-9% range in both the corporate and sovereign segments, in the baseline scenario. Corporate bond credit spreads still look moderately tight compared to historical average after the sell-off in OFZs in 2018, which has affected corporate segment to a lesser extent due to low foreign investor participation factor.
  • Russian Eurobonds are about to deliver low single-digit total returns over the 12-month horizon. Our base-case scenario implies a moderate narrowing of credit spreads over US Treasuries, 1-2 Federal Funds Rate hikes and higher 10Y UST yields with the shape of the yield curve remaining close to flat. Given the abovementioned conditions, Russian Eurobond yields may hover in the 2-4% range within the next 12 months.
  • Russian equities could deliver double-digit returns over the next 12 months. A combination of high dividend yield on mid-cycle profits, supported by strong FCF generation, low leverage, and expanding cash distributions look like a recipe for further outperformance. With high implied cost of equity, companies are likely to put equity issuance on hold and opt for dividends and buybacks.

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