CHRIS WEAFER COMMENT: Russia in context – as unwelcome as the person from Porlock

By Chris Weafer, Chief Strategist, Sberbank Investment Research.

Boarding this vessel is an act of war. Ergo we surrender.

Rimmer (Red Dwarf)

Nervous wait for Wall Street is most likely. Equities and the ruble have opened moderately weaker today after US markets closed near the session low on Friday. This came about as investors became more nervous about the growth outlook and prospects for further progress in efforts to solve the Eurozone crisis. But fears that we may be heading into another big selloff in risk assets look excessive. Asia’s markets are off only slightly this morning, while commodity prices have rallied a little from the Friday weakness. Brent crude traded up $0.3/bbl to $110.5/bbl in early Asia trade. Still, investors will adopt a very cautious stance this morning until they see how US markets follow though at the opening today. If there is a bounce later today, then the stocks that fell the most on Friday will lead it, e.g. Evraz and Mechel (both off 4.1% on Friday). However, these are still the stocks most at risk in the event that Wall Street falls further.

Google and a poor EU summit result. For most of last week it seemed that equity markets were comfortably drifting into another phase of the rally that started in early June. US and China macro numbers were at least in line with consensus and a majority of the 3Q12 earnings updates from reporting S&P 500 companies were close to or above what had been expected. The generally positive rhetoric from EU politicians over the previous week suggested that progress would be made at the ThursdayFriday summit. Then, like the “Person from Porlock” interrupting Samuel Coleridge while writing Kubla Khan, the early release of Google’s bad numbers on Thursday also came as a reality check. The lack of any real progress at the EU summit only added to the concerns on Friday. The question now is whether the markets’ progress has merely been interrupted or, like Coleridge’s opiuminduced inspiration, has evaporated?

Day of reflection to start the week. We have been here many times over the past years; a critical few days when investors may regain confidence and push ahead to the November rally that was expected before Google’s results or markets may give back a lot of the summer’s gain. How markets follow through today will of course be critical, especially in the US. There is no news of significance scheduled for today in major economies and little tomorrow. The main indicator mid-week will be the flash manufacturing indicators across all major economies on Wednesday, the same day that the European Central Bank (ECB) president makes a presentation to a German parliamentary committee. Investors will be very sensitive to both of those events. The US 3Q12 (advance) GDP reading will likely have less impact than previously, as any weakness will be discounted because QE3 started after the period.

Russia is once again a bit player on the world stage. The main drivers of where the Moscow bourses trade this week will all be external. In Russia this week, the negotiations between Rosneft and BP over the former’s expected purchase of the latter’s 50% stake in TNKBP will continue to dominate the headlines. Judging by the weekend media headlines, it seems that a deal has been agreed but the terms are still unclear. It does, however, seem as if BP has finally managed to snatch victory from the jaws of defeat, reversing a trend that has dogged the company for many years in many parts of the world. Once the terms of the deal are announced, the speculation will be far from over as attention will then turn to Alfa-Access/Renova Group (AAR)’s position in the company.

Economic concerns are growing. Apart from the oil industry, the other talking point will focus on Deputy Economics Minister Andrei Klepach’s comment on Friday that the economy likely only grew 2.5% yoy in September (2.8% in 3Q12). This is well below the 4.5% growth recorded for 1H12 and raises concerns as to whether the economy is slowing much faster than had been expected. If that is indeed the case, then assumptions used in the earnings models for companies active in the domestic sectors may have to be revised downward, and it will also raise a concern over the market valuation. Still, given the valuation discount at which Russian equities (total, excluding commodities) trade relative to GEM peers, there is still a comfortable safety cushion to protect the market on a relative basis.

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