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Investment Outlook 3Q 2013 Strategy

Jul 22, 2013

Investment Summary


  • We continue to see a strong case for the Central Bank of Russia to ease monetary policy. From a monetary supply standpoint, all the prerequisites for inflation deceleration are in place on a 12-16 month horizon. Secondly, based on previous experience, it is natural for the newly appointed CBR Chairman to lower rates during first six months of tenure. The Central Bank of Russia has room to lower interest rates 50-100bp over the next 12 months.
  • The scenario-weighted upside for the RTS index is over 60% according to our estimates. Dividends and share buy-backs remain the key forces for unlocking fundamental value. Russian equities must more than double in order to close the accumulated five-year performance gap with fixed income.
  • Russia equities offer deep value as they are priced the cheapest of all GEMs. Russia‚Äôs discount to GEMs by P/E forward twelve months is approximately 60% vs. 25-30% historical range.
  • Russia remains hostage to weak investor sentiment with respect to BRIC and EM equity markets in general. A deterioration in the relative ROE and economic growth momentum is likely to be the key reason behind the EM underperformance. We think that both measures are currently depressed cyclically, not structurally. Outflows from EM equities give rise to market dislocations.
  • The Russian rouble has tactically retreated to the 32-33 range versus USD. We think that RUB is oversold versus USD. Our scenario probability-weighted exchange rate for 2013 year-end is 31.3.
  • Russian local government debt was sold off during 2Q13 on the back of international portfolio outflows. Anticipated CBR easing in 2H13 as well as a more attractive valuation could drive back both international and local investors.
  • Global growth and inflation momentum has trended down over the second quarter of 2013. China and the euro-zone remain the key areas of weakness. Only Japan shows a considerable cyclical improvement.
  • Speculation about Fed policy normalizing intensified in 2Q13. At the same time, economic conditions (employment, inflation) develop in a way that makes any significant change unlikely, at least until late 2014. Nevertheless, speculation about Fed tapering has made a lot of fixed income investors feel uncomfortable. US fixed-income mutual funds have seen a record outflow in June.

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