Russia’s Risk Variables in 2012

January 26, 2012


Believe nothing, no matter where you read it, or who said it, unless it agrees with your own reason and your own common sense.

Russian equities have started 2012 as they left 2011. The direction and volatility in the Russian equity market continues to be dictated mainly by external events. The Eurozone crisis, although currently the critical global issue, is not the only factor that will determine how Russia and other emerging markets perform this year. In this note, we look at the 12 most important “known” factors expected to have an impact.

Not all of these factors are negative. The next Russian government is expected to adopt a much more proactive strategy to try and attract greater international corporate involvement and more investment in the economy. The government’s response to the recent protests offers encouragement that there will be political reform, while WTO membership at least provides a timeline for companies to become more efficient and competitive. Budget execution and the economy are expected to show relatively positive results.

Our core view maintains that the contagion threat to global growth from the Eurozone crisis will hang over all markets at least through 1Q12 and maybe over 1H12. But, we also assume there will be a resolution that reduces the threat level before summer, perhaps ahead of the G-20 Summit in Mexico in June. Europe is likely to remain in recession through most of 2012, but we also assume that contagion to the rest of the world, and Asia in particular, will be limited.

This should then allow for a much more favorable backdrop for risk asset performance from the summer and through 2H12. This assumed trend, i.e. a split year with all known negatives being frontloaded, is at the core of our market outlook for the next 12 months. There is real danger of further market weakness over the next few months, but we remain confident of our year-end target for the RTS Index of 2,200 – a 50% gain from its current level. The knee-jerk negative reaction to the December protests has expanded the ratings discount at which Russian names trade to global peers. The domestic sector stocks, on average, trade at a 40% discount to the 2013 EM P/E despite having superior growth.

Reflecting that split-year view and the expected volatility in markets over 1Q12, and maybe 2Q12, we again split our stock recommendations into risk-off and risk-on portfolios. The risk-off stocks are mainly those with strong dividend support, e.g. in the oil sector, or whose growth is relatively insulated from external factors. We also add some gold names to this portfolio, as well as NOVATEK, due to its strong domestic growth and the high risk of positive event surprises. The risk-on portfolio mainly contains higher-beta names and those stocks with clear exposure to the global economy, such as commodity exporters.