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Investment Outlook First Quarter 2018 Update

May 18, 2018

Investment Summary

  • Global economy continues to run smoothly, with 2018 and 2019 GDP growth estimates seeing modest upgrades both for DMs and EMs. Emerging markets are a high beta play on global growth. Russia is well positioned to benefit from continued higher demand for energy and commodities as well as better supply-demand balance, as the current economic cycle is extended beyond earlier expectations

  • In April 2018, Russian markets experienced severe pressure caused by external factors. A geopolitical discount, tied to the risk of further Western sanctions targeting Russia, is once again reflected in prices. The current situation resembles March 2014, when certain risks had materialized. Although there are a few differences. We see more resilient Ruble money market rates, given the floating exchange rate and ample RUB liquidity

  • We remain constructive on growth prospects and inflation this year. We see positive surprises on the budget side with the oil price in RUB recently marking new historical highs. In the base-case scenario, with the average oil price at USD 65/bbl and USDRUB exchange rate of RUB 58.8/USD, we expect the growth rate of real GDP to be 2.1% and inflation rate to accelerate to 4% YoY

  • There is less room for further rate cuts as the CBR comes closer to switching to a neutral monetary policy. We expect a pause in rate cuts until the response of consumer prices to the new exchange rate level becomes clear. We believe that FX developments in the coming months will determine the space for further easing: a return to the USDRUB 57-58 range would make it possible to reach a key rate level of 6.75% by YE18, while current exchange rate levels would mean a much narrower easing space

  • We expect the OFZ curve to continue steepening in 2018. Total returns on OFZ bonds could be around 7-8%, and 8-9% for corporate bonds in the baseline scenario. Corporate bonds currently look more attractive compared to OFZs

  • Commodity exporters are poised to benefit from high commodity prices and the weaker Ruble. Russian commodity exporters have a RUB cost base and USD revenue streams. We believe that the recent sell-off has provided a good buying opportunity for certain names

  • Russian Eurobonds could deliver low single-digit total returns over the 12-month horizon. We assume a ~50bps upward drift in benchmark UST rates and a modest contraction in credit spreads, as a base-case scenario

  • Our top-down and bottom-up DCF models indicate 30%+ equity market returns over the next 12 months. Russia is in the midst of a cyclical recovery in earnings. With high implied cost of equity, companies are likely to put equity issuance on hold and opt for dividends and buybacks

icon_pdf.gif   Full version of the report could be found attached.

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