Art of investments


Investment Outlook Fourth Quarter 2017 Update

Oct 20, 2017

Investment Summary

  • An upgrade to global synchronized growth (i.e., IMF upgrade to 3.6%) is leading to higher-than-expected demand for oil,   at a time when OPEC / Non-OPEC production cut agreements have removed excess supply, and the US Dollar is 8.85% weaker YTD, resulting in oil prices in the upper band of the consensus forecast for 2017.
  • EM Equities / Commodities Typically Perform Well when Bond Yields Rise and There Is No Recession. Based on the study of 8 episodes of rising 10-year UST yields since 1999, EM equities stand out as a clear winner with a 32% average return.
  • We have revised our 2017-18 forecasts for Russia across scenarios. We are constructive on growth prospects, lower inflation and lower policy years. In the base-case scenario for 2018, with an average oil price at USD 58/bbl and Ruble at 57.3/USD aop, we expect economic growth at 2.0% and inflation at 4.1%. We expect positive contribution to GDP growth from consumption, fixed asset investment and possibly higher government spending.
  • Russia’s credit impulse is turning positive. Rates for auto loans and mortgages are falling rapidly, in-line with inflation and CBR policy rates. Non-performing loans, which peaked in late 2016, are now gradually declining and may achieve pre-crisis levels as interest rates fall and the economy recovers.
  • Our top-down and bottom-up DCF models indicate strong double-digit equity market returns over the next 12 months. Key points underpinning Russia’s investment case are EPS recovery from a very low base and an eventual re-rating in multiples as geopolitical tensions subside and state-owned enterprises (SOEs) increase dividend payouts. We expect ~14% CAGR over the next three years, based on our bottom-up DCF models, as a result of the low-base recovery effect for cyclical names and contribution from structural growth stories (e.g., retail, internet, banking, real estate).
  • Corporate spreads are tight in hard currency FI space. Ample domestic FX liquidity is likely to stay, supporting the Russian Eurobond market, but there is little room for further corporate spread tightening. Recently, we increased positions in sovereign issues, because of tight corporate spreads.
  • Over the next 12 months, we expect the OFZ curve to gradually steepen due to declining short-term rates. As the disinflationary trend is likely to continue through 2017-18, the full normalization of the OFZ yield curve (i. e., moving to 100-150 bps; 10Y-1Y positive slope) may take 12+ months. Currently, the CBR considers 2.5-3.0% in real terms to be the equitable key rate for the foreseeable future. We expect the key rate of 6.7% by the end of 2018, which is less than Bloomberg consensus forecast of 7.1% for the same time period. We switch to corporates when spreads widen above 80-100 bps for first tier names and move to sovereigns when spreads fall below this level.

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