by Chris Weafer
• Russian equities are now trading at a forward P.E. of 3.0 times. That is by far the cheapest amongst major emerging markets. This is a great entry point for traders looking for a bear market rally and investors looking to build a long-term portfolio. Such cheap valuations cover the risk of earnings downgrades and the timeline uncertainty.
• Currency stability will be key to the start of a rally and Central Bank, after last week’s action, is now a lot closer to finding a more supportable level for the ruble.
• Sberbank will report today and results are expected to be better than VTB presented last week. Both bank shares fell almost 40% over the past five days. Sberbank, the safer of the two, is trading at a very low price to book of 0.3 times for 2009. Polyus and Polymetal are also likely to feature early this week as the price of gold and silver rises along with global financial market uncertainty. Nickel’s 12% rally last week is positive for Norilsk, albeit worries over shareholding and possible minority investor dilution is the dominant driver.
• A busy week ahead for economics in Russia. The cabinet will review proposed 2009 budget changes using $41 p/bbl average oil. December unemployment, wage date and retail sales will also be reported. No positive surprises are expected.
• The big number to be published in the US this week will come on Friday. The advance reading of 4th Qtr GDP is expected to show a drop of 5.7%.
• The annual Davos forum starts Wednesday with Prime Minister Putin delivering one of the keynote addresses. He is expected to emphasise both Russia’s economic potential and role as a reliable energy partner. Russia and China are expected to make the case for the G20 as the main global financial and political forum.
• The price of oil rose 5% last week as OPEC members declare that they are in compliance with the quota and remain determined to bring supply lower to match demand. Urals ended the week at $45.48 p/bbl while the December Brent contracts are trading at close to $60 p/bbl.
• The Central Bank widened the trading basket significantly last week, allowing the ruble greater scope to free float. The implied move is for a further devaluation of up to 11% or to 36.0 against the US dollar. It lost only 1% last week, as ruble market liquidity is currently very tight.
• The yen was the strongest major currency last week with sterling again the weakest. The dollar rose against the euro to close at 1.2969.
• The RTS fell almost 13% last week, twice as much as the emerging markets average. The main drag on performance was the banks (after VTB’s results) and the electricity sector shares as tariff growth worries persist. The oils and Gazprom were amongst the best performing as crude rose and the gas dispute ended – for now.
• US equities fell over 2% last week with the financial sector losing over 7%. 4th Qtr ’08 earnings reported so far are off 60%. Europe’s markets fell over 5%.
• The price of gold is rising along with global market uncertainties. It traded above $900 per ounce on Friday.
• Nickel continues to rise as yet more production cuts were announced. It traded 12% higher last week. Other industrial metals fell over the week.
• Russia funds reported a third straight week of net redemptions last week, albeit a modest $25 mln. All emerging market categories reported outflows in the period.
Russia is cheapest, by far, of BRIC countries. The RTS closed last week just below the 500 level. Equities are now trading with a forward P.E. of 3.0 times. That is one-quarter of the valuation of the Shanghai Composite, one third that of India’s SENSEX and half that of Brazil’s Bovespa. The newsflow from the country’s biggest corporations and that covering the economy is deteriorating and is likely to continue like this until early 2nd Qtr. With the outlook for oil still uncertain and international markets continuing to slide, the Russian markets will remain volatile and could drop a little lower. But at a forward P.E. of 3.0 times, investors are now being paid to take the risk of waiting. Russian equities are a high-beta play on the emerging markets theme.
Currency stability will be key. The RTS has been falling faster than its peers since last June and so far this year the RTS has lost 21% compared to an 11% drop in the emerging markets (EM) average. Russian equities will rise faster than the EM average when investors return to the theme. The ruble is closer to finding a supportable level and, this week, the government will review much more realistic economic forecasts based on $41 p/bbl average oil. That provides for the basis of a rally from these oversold levels. The market is not going to see a sustainable long rally for many months. That is clear. But, entering at this market level, an investor will be handsomely rewarded, whether it is for the bear market rally trade or building a longer-term portfolio. Russian equities, one average, have simply become too cheap.
Slip Sliding Away
Way up is enticing but challenging. Most of Moscow City centre streets are sloped. That makes the city a dangerous place for the unprepared and the unwary during mid-winter months. On Thursday evening, a crowd of people were gathered just outside the exit of a city centre metro station. They were standing at the bottom of the street and pointing upwards. This particular street, with a gradient of about 30 degrees, looked clear and unhindered. But on closer examination, one could see that the neatly laid pavements on either side had a layer of perfectly smooth ice. Occasionally, one or two brave, i.e. foolish, individuals tried to make it up the street only to slide back after no more than a few yards. Sometimes with the grace of a practiced skater but more often ignominiously sliding on their rear-end. And so it is with the local equity markets. The prize of higher valuations awaits at the top of the slope. The way looks unhindered with such a low valuation. But the thin layer of ice that is sending investors reeling, or persuading them to wait, is currency risk. Last week the Central Bank at least gave a signal when the fritting truck is to arrive. It will be when the ruble hits the basket level of 41.0 or approximately 36.0 to the US dollar. It will not be this week because of tight ruble liquidity. It may be next week or within two weeks. Or, if last week’s oil price rally can be extended, investors may not wait for the top end of the basket before the gritting can begin.
Recommended Stocks
Stocks to buy. In terms of stocks, we divided our highest conviction recommendations into two portfolios for 2009. The “Defensive Portfolio” lists those shares that we believe are financially safe and have good business models that can sustain strong relative performance through the expected weak start to the year. Current price levels represent a good entry point, i.e. notwithstanding some recent concerns in the utilities sector over tariffs. The “Phoenix Rising Portfolio” contains both the defensive list plus stocks that we believe are very well placed to lead the markets rally when global confidence – and money - returns to risk assets and to commodity stories. Both portfolios are listed below.
Note: for a list of the best performing and worst performing shares this year so far, review the tables at the foot of this note. The very volatile AFI Developments is the best so far, with a gain of 37%, while TGK-5 just edges out Uralkali and several other utility sector shares, as the worst so far with a loss of almost 50%.
Defensive Portfolio
Comstar
Federal Grid Co.
Gazprom
Gazprom Neft
Magnit
MTS
OGK-4
Polyus Gold
Raspadskaya
Raven Russia
RusHydro
Silvinit Common and Prefs
TMK
Phoenix Rising Portfolio
Dixy Group
Evraz
LSR Group
Mechel
NLMK
Norilsk Nickel
PIK Group
Sberbank
TNK-BP
Vimpelcom
VTB
X5 Retail Group
Trading this week
Cabinet to review revised 2009 budget. This is a big week for economic updates, both in the US and in Russia. It is also the week of the annual economic forum in Davos at which Prime Minister Putin will make a keynote speech on Wednesday. Chinese markets will remain closed for the three day New Year holiday so news flow from Asia (ex Japan) will remain light. In Russia the December data covering the broad range of indicators including unemployment, wage growth and retail sales, will be released. All of the numbers are expected to show a continued deterioration and no positive surprises are expected. That is especially following last week’s industrial production report that showed a fall of 10.3% year on year in December. That brought the full year growth number back to only 2.1% versus 6.3% in 2007. Today the cabinet will review revised 2009 budget proposals based on an average of $41 p/bbl Urals crude. The details should be known over the next few days. The big corporate news will come from Sberbank. It will publish its results today.
US 4th Qtr GDP is the big number. In the US, it will be a busy week for economic reports with the main data sandwiching the five days. Today will see the publication of the leading indicator for the economy plus existing home sales data. Tomorrow it is the turn of consumer confidence and the decision of the Fed’s FOMC meeting due Wednesday. With the benchmark rate at 0.25% no change is expected. Durable goods and new homes sales come on Thursday. On Friday the US will publish the advance reading of GDP growth for the 4th Qtr of last year. The consensus number is for a decline of 5.7%. The earnings season continues and this week the major reports due include American Express, Exxon and McDonalds.
Oil
Oil rose on hopes of OPEC compliance. The price of oil rose last week as OPEC member countries continue to declare that they are in compliance with the new quotas agreed in December. OPEC’s attitude is much more aggressive, and appears much more disciplined, than in previous periods when it tried to stop the oil price falling. That offers the hope that the organisation can more quickly remove the current oil supply surplus when demand stops falling. This week the price of Brent rose by just over 5% to end the week at $48.37 p/bbl. That was despite the fact that US inventory levels were again much higher than expected. The price of WTI was very volatile due to the fact of the switch to the March expiry contract and because storage at Cushing is almost full. The price rose over 6% on Friday on the OPEC comments to end the week at $46.47 p/bbl. December futures are trading at close to $60 p/bbl. Urals ended its trading week at $45.48 p/bbl.
Currency
Ruble allowed to free float within wider band. The Central Bank called an end to the process of salami slicing the value of the ruble this week when it announced that it is extending the lower end of the basket to 41.0. The basket was trading at 37.2 at the time, i.e. implying further weakness of 11%. Effectively the bank took a big step towards allowing the ruble to free float, albeit still making it clear that it will intervene again when/if the ruble hits the 41.0 level. That also implies an upper limit of 36.0 against the US dollar. The ruble did not move appreciably after the news because liquidity in the ruble market is extremely tight right now and the Central Bank has made clear its displeasure at any bank activity that could be construed as speculating against the currency. Still, the consensus view is that the ruble will move to the lower end over the next few weeks. Where it trades after that will depend on where the price of oil is trading, i.e. as that remains the main influence on sentiment. Lat week the ruble lost 1.4% against the dollar to close at 33.01 while gaining 1.7% against the euro (42.39). Year to date the ruble is off 11% and 2.3% against the dollar and euro respectively.
Yen is the haven bet. Amongst the world’s major currencies, the yen was again the strongest while sterling was the weakest. The dollar rose against the euro. The yen is in demand as a haven currency while sterling fell again after the country confirmed that it is the latest country to officially enter recession. The Bank of England is also expected to cut its benchmark interest rate when it meets next week. The Dollar Index rose 1.7% last week and ended at 1.2969 against the euro.
Trading Last Week: Domestic
Banks and electricity were the worst. The local markets continue to be driven by the trend in global emerging markets with the extra kicker coming from currency worries. Last week the MSCI Emerging Markets Index fell 5.7% while the RTS fell 12.1% and MICEX ended 9.0% lower. That was despite a 5% gain in the price of oil. The RTS is now trading at a level last seen in the middle of 2003, i.e. when the YUKOS case was kicking off. The worst sector was the financials, losing 18.6% as a group. That was partly because of the contagion from international markets but with the main damage inflicted with VTB’s results that missed consensus forecasts. Both VTB and Sberbank shares ended the week down almost 40% each. The electricity sector was not far behind, losing 17.1% as a group, as worries over tariff growth. The table of worst performing shares from last week, littered with electricity sector names, is at the end of this note. The oil stocks and Gazprom provided the best sector performance as the price of crude rose and the gas dispute with Ukraine ended – for now.
Trading Last Week: International
Financial sector losses pulled markets down. US equities fell for a third straight week as earnings continue to reported much worse than expected. Investors also worry that the problems of the financial sector are far from over. The S&P 500 closed down 2.1% last week with technical indicators pointing to further significant weakness unless the Index can close above the 850 level. It ended last week at 832. The Dow fell 2.5%. The main loser was the financial sector, down 7.1%, as losses continue to mount. GE ended a miserable week for earnings, badly missing it’s expected number and pushing it’s share price down 14%. So far this earnings season, earnings are down 60%. European markets fell to a two-month low with a loss of 5.4% for the Euro Stoxx 600 Index. Bank sector problems were the main drag. In Asia, the MSCI Asia-Pacific Index fell 5.2% for much the same reasons and because traders closed their books ahead of this week’s Chinese New Year holiday.
Commodities
Nickel rose with production cuts. Commodity prices ended the week with a bounce but the main trend continues to be downwards. Nickel was the best of the main metals, rising 11.8% over the five days (to close above $12,000 per tonne) after yet another announcement of production cuts. Copper rose over 5% on Friday after news of an earthquake in Chile, the world’s biggest producer. But the trend remains weaker as global demand slips. Over the five days the metal fell 3.6%. Zinc last 10.4%, platinum ended down 3.4% and palladium lost 0.4%.
Gold continues to rise. Gold traded above $900 per ounce on Friday as financial market uncertainties increase. It closed the session just below that at $895.8 per ounce, the highest since early October. That is a gain of 6.9% over the week. Silver was also in demand, rising 6.5% last week.
Agriculture commodities had a mixed week. Wheat rose earlier in the week, after the US government reported strong export numbers, only to lose that again later in the week as the value of the dollar rose. It ended the five days up 0.8%. Corn fell slightly (-0.2%) last week despite a gain on Friday. The price rose on news that production in Latin America will likely fall this season due to very hot and dry weather conditions.
Funds Flow: No Love for Russia
Third straight week of Russia outflow. Investors unsurprisingly withdrew money from most asset classes in the week to last Wednesday. GEM Balanced funds reported outflows of $483 mln; BRIC theme funds lost $15 mln and East Europe funds an additional $82 mln. The country specific funds also all reported outflows, albeit still relatively modest. Investors in China funds redeemed $377 mln, they took $35 mln from Brazil funds and $14 mln from India funds. Russia funds reported redemptions of $25 mln. But unlike the other country funds, i.e. that have reported inflows over the previous two weeks, this is the third straight week of outflow from Russia funds. The total taken out so far this year is $90 mln. Still, however, a relatively modest sum. Through 2008 investors placed almost $1.5 mln of new money into Russia funds that report their flows to EPFR Global on a weekly basis.
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