By Chris Weafer, Chief Strategist, Sberbank Investment Research.
It does not do to leave a live dragon out of your calculations, if you live near him.
J.R.R. Tolkien, The Hobbit
US budget worries have balanced out macro optimism. Markets have been in something of a zero-sum game in recent weeks as the lingering concern over the unresolved US budget negotiations has been counterbalanced by mainly positive macro indicators in the US and China. The case for slightly higher optimism at the start of this week has been fulfilled by the better US payroll report published on Friday and the improved Chinese November macro update released over the weekend. The higher than expected Chinese inflation number may cause some concern, but the focus will likely be on the better industrial production and retail sales data for now. We should therefore see a better global market context for the Russian market at the start of the week, although gains everywhere will remain modest as the focus remains firmly on the continuing budget talks in the US. Investor confidence will not be unconditional until the risk of a negative economic impact in 2013 is removed.
The main events will come Wednesday and Thursday. The list includes US Federal Reserve Chairman Ben Bernanke’s press conference late Wednesday and a hectic Thursday that includes the EU summit, the final decision on the Greek bailout, bond sales from Italy and Spain and the US November retail sales. Surprises are definitely possible, and the unknown risk factor will keep most investors sidelined again and ready to close their books for the holiday season early next week. We keep our short-term tactical view slightly in the bullish segment as we believe modest positive momentum can be maintained, especially within emerging markets, driven by Chinese momentum and the continuing strong inflow into EM retail funds. Over $3 bln was added last week, almost exclusively to GEM balanced and China-focused funds, bringing the total YTD figure close to $20 bln.
The Fed may comment on QE, and OPEC may try to cool the oil price. The two big risks for Russia investors this week, apart from an unexpected positive breakthrough in the US budget talks, are external. First, the Fed could boost quantitative easing, or at least make provisions to do so. If that were coupled with a boost in euro optimism, we could see the dollar weaken in the latter half. A falling dollar would support the gold sector (one of last week’s main laggards), the oil price and oil producers, and EM currencies including the ruble. However, that remains a speculative call for now as no clear promise has been made regarding QE and political divisions at the EU summit would see the dollar strengthen and thus weaken gold and EM currencies. The second risk is a more bearish assessment of the oil market (for purely political reasons) from OPEC when it holds its semiannual production meeting Wednesday.
The best theme this week will likely be the steel sector. Evraz and Mechel moved up 3.5% and 2.5%, respectively, last week while MMK lost 2.7%. Any further market catalyst, even a modest move in Chinese economic growth, would provide short-term support for the steel sector and further support for Norilsk Nickel. The real estate sector is, in our view, unreasonably out of favor, with LSR Group, PIK Group and AFI Development among the laggards last week. We like this sector for 2013 as we consider the concerns over the economic outlook affecting the sectors’ shares to be overdone. Our preference is for LSR Group and Etalon Group, but we also have BUY recommendations on AFI Development and PIK Group. TMK is also one of our top picks for 2013, and it also underperformed last week. See our table below for further details on our top stock picks for companies with over $1 bln in market cap, including valuation and performance statistics as of Friday’s close.
Politics dominate on Putin address, street protest anniversary. Politics will dominate the headlines from Moscow this week as President Vladimir Putin is set to deliver an annual address to the Federal Assembly on Wednesday, while next weekend sees another Moscow street protest. While the protests organized since last March have attracted much lower numbers than seen in December-February, this next event comes on the anniversary of the first big march last year, and the organizers hope that this will encourage a bigger turnout. Either way, expect a lot of discussion about the state of the political opposition during the week.
Putin’s policy speech on Wednesday. Putin’s increasingly active schedule has deflated the rumors about his health, so now attention will shift to his address on Wednesday. This is the speech in which he usually sets out his policy priorities for the coming year. The hope is that he will reinforce the message about corruption and promise broadened efforts to tackle the problem within the government. A sustained and visible effort to reduce corruption is one of the catalysts that could cut the current high risk premium investors apply to Russian equities and help the expected re-rating in 2013.
Note: we plan to issue our comments after the speech on Wednesday.