2012: The Undiscovered Country

December 13, 2011

 

As investors face a new year, rarely has the outlook been so uncertain and the possible scenarios so extreme. Confidence is deteriorating in Europe’s ability to avoid an even more serious debt crisis and economic recession in early 2012. Such events would almost certainly lead to contagion in the US banking system and a lowering of growth expectations in that country and in China. The hope for investors in Russian assets is that the crisis does come to a head in early 2012 and that a new base of valuation and risk reference can then be established. Until that happens, none of the traditional “reference points of relative valuation” can be trusted because current assumptions, e.g. earnings growth, will certainly change. To a large extent, 2012 is the undiscovered country.

In this 2012 preview report, we look at sectors and stocks vulnerable to a further global deterioration and highlight stocks and themes well placed for the expected recovery in optimism in 2H12. Our top stock picks are therefore divided into two parts: a risk-off portfolio for the early part of 2012 and a risk-on portfolio for the latter half.

All markets will remain volatile in early 2012, providing plenty of opportunities for traders. Investors with a near-term risk tolerance and a long-term performance horizon will have plenty of opportunity to acquire quality assets cheaply. They should not hesitate. Just as there has been a steady stream of surprising, and mainly negative, news in 2011, the solutions and optimism may come equally quickly in 2012.

To some extent, the Russian domestic story is also entering undiscovered territory, as the government is set to embark on a more proactive and pragmatic journey to try and generate higher growth and achieve greater economic diversity. The oil price, even at $100/bbl, is no longer sufficient to deliver that. But until there is some post-crisis global economic and investment roadmap for the future, Russia is expected to remain a sideshow or a derivative theme in global markets.

We expect the generally positive macro picture to continue in 2012 with 4% GDP growth and 6.0% inflation. WTO entry in 2Q12, while not having any significant short-term impact, will nevertheless establish an increasingly important timetable for companies to become more competitive.

The wild card for the Russia investment case is the oil price. The Brent price, and therefore Urals, has outperformed other commodities and equities in 2011. This is due to tight supply, demand skewed toward the still-robust developing world and a higher risk premium as a result of instability across the Arab world. Oil will not be able to avoid a decline with the EU recession and slower global growth in 1Q12. But the same factors that held the price relatively well in 2011 are still in place. This will not prevent Russian market weakness in 1Q12 but should still ensure a favorable domestic economic platform for 2H12.