Signs of risk aversion subsiding. Over the past month or so global markets have been advancing and there are several indications that risk aversion is subsiding: bad news is being ignored (implying that it is already priced in), volatility and yields are falling, small caps have started to outperform large caps, and cyclical stocks are outperforming non-cyclicals.
Greater appetite for risk should be supportive for emerging markets, CEEMEA and especially Russia. Russia has tended to outperform in previous recoveries and we believe that the country, which was a major underperformer in 2H11, for the first time since Nov 2010 now looks attractive on valuations. As a result, we believe Russia is currently in a sweet spot to receive rotation of funds out of CEEMEA’s two other major markets, South Africa and Turkey, and hence relatively outperform.
Valuations finally in Russia’s favour. We believe Russia’s standing against Turkey and South Africa is key. Currently, MSCI Russia trades at discounts of 45% and 52%, respectively, to MSCI Turkey and South Africa on 12M fwd P/E, 45% and 61% on P/B, and 26% and 50% on 12M fwd P/CF. This, together with the cyclical nature of the Russian market, as well as its high beta, in our view justifies rotating out of South Africa, given South Africa’s defensive characteristics and that it was a major recipient of funds in 2011. A key competitor for fund flow could be Turkey. However, Turkey is facing a major deceleration in economic growth and while at first glance it is cheap on multiples, it is trading close to its long-term average on 12M fwd P/E and trailing P/B.
Russia’s macroeconomic picture is near-term supportive, but long-term problems persist. In our report A Road Map for Russia (29 Nov 2011), we highlighted that the economy is currently facing significant medium and long-term structural problems which have severely intensified Russia’s dependency on the oil price. However, we feel that if the current market sentiment holds, Russia’s relatively strong near-term macro footing could also support equity prices.
Equity screening for underperformance, high beta and decent liquidity identifies a selection of stocks, predominantly materials and financials. This is to be expected given that these two sectors have consistently outperformed in previous recoveries. The stocks that meet these criteria and hence may find support include Mechel (commons and prefs), Evraz, Yandex, MMK and the less liquid Bank St Petersburg, and Integra.
This is not a call for 2012 but rather a momentum idea based on what we view as a temporary improvement in sentiment and risk appetite, supported by improved fundamentals for Russia. However, the Russian market is already up 20% YtD. With the European debt saga still in play, the Chinese economy showing signs of slowing and rising tensions in the Middle East, our top picks reflect our caution that we may have to close this call at short notice. In addition to external risks Russia is in election mode, and while we believe that Vladimir Putin is likely to be Russia’s next president, we cannot rule out any market destabilising surprises. As a result, our current preferred stocks are liquid names, to facilitate an easy exit should we need to recommend reducing Russia exposure.
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