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Investment Outlook Fourth Quarter 2019 Update

Nov 18, 2019

    Investment Summary

  • Capital markets remain sanguine amid rising global recessionary risks. According to Bloomberg polls, the probability of a recession in the global economy within the next 12 months is currently ca. 25%. In response to rising recessionary risks, global central banks are easing monetary policy. The base scenario is that, through their actions, central banks can extend the late economic cycle and reduce the realization of recessionary risks by a few more quarters.
  • We are keeping our 2020 oil price projections at 55/65/75 in the bear / base / bull case scenarios, respectively. On a probability-weighted basis for 2020 we expect real GDP at 1.6% YoY, headline inflation at 3.9% YoY, key rate at 6% eop with USDRUB exchange rate at 63 eop.
  • Monetary policy is becoming more accommodative. The Central Bank of Russia (CBR) made a number of statements regarding monetary policy in October. In particular, the head of the CBR stated that lower inflation makes it possible to ease monetary policy at a faster pace than previously thought. Given the slowdown in inflation and new statements by the regulator, we revised our key rate forecast up until the end of 2020, depending on what level the CBR will evaluate the neutral key rate in real terms. Depending on the scenario, the key rate by the end of 2020 may fall in the range of 5.75%-6.25%, closer to the lower border (6%-7%) of the previously announced key neutral rate range in the base case.
  • We expect the OFZ yield curve to steepen on the 12-month horizon and its 1-15Y slope to normalize to the historical level of ca. 80-100 bps. Long-term OFZ yields have already priced in the scenario of 3 more CBR rate cuts (to 5.75%). A 20-30 bps decline in yields is expected in OFZs with a 1-2 year maturity, following the CBR’s monetary policy easing. The OFZ market offers buying opportunities in the shorter segment of the curve. BB/BBB-rated corporate bonds with 2-3 year maturity also look attractive: they could provide the highest returns of 7.0-8.0% p.a during the CBR’s rate-cutting cycle and credit premium shrinking.
  • Russian Eurobonds are about to deliver low single-digit total returns over the next 12-months. The Fed’s monetary policy easing in 2019 (3 cuts amounting to 75 bps in total) triggered a revision in our estimates for the USD interest rate trajectory. We now see the 10Y UST yield at 1.8% in the 12M base case, down from 2.3% in our previous estimate. Our base scenario implies no more rate cuts by the Fed, which is in line with the Bloomberg consensus, and suggests Russian Eurobonds’ total returns at 3.0-4.3% for the next 12 months, depending on the segment. Our base scenario also implies the expected total return of GEM Eurobonds at 2.9-5.6% for the next 12 months, depending on the segment.
  • Russian equities could deliver double-digit returns over the next 12 months. As the market rallied, EPS estimates and payout ratios were revised up as well and the risk premium is still there. Russia’s sovereign bond yields just made fresh lows while the dividend yield is still close to historical highs. Russia is not yet at the top of the corporate profits cycle, SOE payouts have some more upside in select names, leverage is low and declining. With high implied cost of equity, companies are likely to put equity issuance on hold and opt for dividends and buybacks.
  • We prefer RUB debt and domestic plays in equities to Eurobonds among Russian asset classes. Local rates are likely to trend down over the next 12 months while USD rates may bounce up from historical lows. We expect Russian equities to continue outperforming Eurobonds as long as EPS estimates do not decline to far.

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VTB Capital Investment Management