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Investment Outlook Second Quarter 2019 Update

Apr 30, 2019

Investment Summary

  • The global economy went through a rough patch in late 2018, but will likely accelerate in 2019 Softer Fed policy and new China stimulus are likely to produce late-cycle re-acceleration. 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 have upgraded our oil price forecasts for 2019 from 45/60/75 a quarter earlier to 55/65/75 USD per barrel (Bear Case / Base Case / Bull Case scenarios, respectively). Our weighted-probability scenario Real GDP growth forecast was upgraded to 1.6% YoY, vs. 1.2% a quarter earlier. Our year-end Russia CPI forecast was downgraded to 4.5% YoY, vs. 5.4% last quarter
  • Easing inflationary pressure may moderate CBR hawkishness. CPI in Russia has reached 5.3% in March 2019 YoY, which most likely be the highest monthly reading in YoY terms for the year. Inflation may slow down toward the end of 2019, because of the base effect, seasonal factors, strengthening of the USDRUB exchange rate, and the exhaustion of the carry-over effect of the VAT hike on inflation. Our baseline scenario now implies one 25 bps cut by the end of 2019, most likely in June. Our Bull-case scenario implies a cumulative 50 bps rate cut in 2019
  • Positive trends have emerged on the Ruble bond market in 1Q 2019. Higher appetite for risk, amid softer rhetoric of major central banks, have opened a window of opportunity for the Government and corporations in terms of primary placements on the local debt market. We have participated in recent placements to capture premiums and increase duration in client portfolios
  • We think that the OFZ market is starting to price in at least one key rate cut by CBR this year. Total returns for Ruble Bonds could be in the 8-9% range in both the corporate and sovereign segments, in the baseline scenario. Corporate credit spreads have gradually started to widen on the back of recovering OFZ prices. Nevertheless, spreads still look moderately tight, compared to historical average
  • Russian Eurobonds are about to deliver low single-digit total returns over the next 12-month horizon. The consensus view is leaning more toward no further Fed rate hikes in 2019. Our scenarios imply a steepening of the UST curve and moderate short-term rate movements. We now see 10Y UST yield at 3.0% as the base case on a 12m horizon, down from 3.2% in our previous exercise. Russian Eurobond total returns could be within the 2-4% range for the next 12 months. Our baseline scenario implies the expected total return of GEM Eurobonds at 5.0-6.5% depending on the segment
  • 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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