By Chris Weager, Chief Strategist at Troika Dialog.
“Never permit a dichotomy to rule your life”
Pablo Picasso
A right mess. The dominant issues affecting all global markets this week will again be the ongoing efforts to contain the euro zone debt crisis and news that the US Congress has failed to agree measures to reduce the budget deficit by the agreed $1.2 trillion.
The solutions to both, if they are to emerge, will require new political consensus that seems a long way off on both sides of the Atlantic.
The discussions within Europe are expected to become more intense this week and in the lead up to the next scheduled leaders summit on December 9th. On Wednesday, the European Commission will present proposals on extra economic surveillance of euro states with excessive deficits, and a green paper on euro stability bonds. That may intensify the debate at a political level.
It is very unlikely that any agreement on how to use the ECB or the bonds will be finalized much before the Dec 9th summit. That’s the optimistic version. If anything, the debate is more likely to extend well into the 1st Qtr of next year, albeit pressure will intensify to find the solution long before President Sarkozy faces voters in late April. So, it is likely to be a case of more of the same this week, and through December, with the bond markets reflecting the steadily growing risks and equity funds decreasing activity.
Not much to be thankful for. Against that persistently negative backdrop, however, investors face something of an investment dichotomy.
The improving trend in the US economy provides a significant measure of hope that the previously feared return to recession can be avoided, i.e. provided Europe does not go over the brink and loses control of debt markets. There are several very important indicators due in this holiday shortened week in the US that may add further to confidence. The more important indicator with the greatest impact on sentiment is usually the reports from the major retailers about sales volumes in the days following Thursday’s Thanksgiving holiday. They will come early next week.
MSCI is scheduled to announce the results of a review of its risk-capped 10/40 Indices on Thursday. Speculation is that Norilsk Nickel may be downgraded and wither Novatek or Uralkali promoted.
Asian markets an US Futures are trading lower as the new week starts.
The only positive for Russia is that the price of oil has not extended Friday’s weakness as reports of escalating violence in Egypt, as that country prepares for elections on November 28th, reminds traders of the heightened supply risk premium across the Middle East.
One month Brent is at $107.7 p/bbl at mid-session in Asia. Copper is down almost 1.0% while gold ($1723.9 per ounce) and the euro ($1.3528) are unchanged while investors wait to hear any fresh news from Europe and US investor reaction to the failure of budget talks. Investors everywhere are likely to start the week with a wait-and-see attitude.
Yandex lock-up ends. Against that backdrop, Yandex and Novatek may be active. The lock-up period post the Yandex IPO expires today. The stock was the worst performing of the Russian GDR/ADRs last week with a loss of 15%. The stock is off 13% from its IPO price.
Much of last week’s sell-off was in anticipation of some selling pressure from the previously locked shareholders from today but there may still be further downside risk over the short-term. On Friday, PM Putin said that he supports Total’s ambition to raise its equity position in Novatek. That follows a comment earlier last week that Qatar is also hoping to buy equity in the gas producer. News that Evraz is to sign a five-year deal to supply Russian Railways with rails may provide some relative sector support for the share price.
Russia positive remain. Russia reported generally strong macro indicators for October last week with, e.g. retail sales up 8.8% YoY, capital investment up 8.6% YoY, a YTD budget surplus of 3.2% and a positive balance of payments at $84 bln. All of which confirms a very positive picture for Russia, especially when viewed against most of the rest of the world. While investors are very focused on the extreme risk to the global economy and the “western” banking system, positive pictures such as that in Russia remain sideline issues.
The specific fear being that such a global deterioration might quickly change the currently positive picture. But, when/if, we do eventually get a debt structure deal in Europe and US recovery remains on track, the reasons why Russian equities will again support strong out-performance include:
Strong balance sheet: total foreign debt is less than 30% of GDP and covered with Fx reserves;
Debt is better structured compared to Q4 2008, current foreign debt is longer-dated;
Balanced budget: even with the usual spike in state spending into year-end, the budget should balance;
Politically stable:there is no major question mark over succession;
WTO: a very positive indicator a more pro-investment, pro-business attitude from government;
Earnings growth: ex the extractive industries, Russian companies are expected to see 19% earnings growth in 2012 compared to 10% growth across emerging markets;
Cheap rating: the 2012 average PE for stocks outside of extractive industries is 7.0 times (6.0 times for the total market)compared to 8.5 times for the EM;
Oil is well supported: the price of oil has been relatively very stable in recent months. A tight supply and good Asia demand mix, plus still weak US dollar and Mid East threats should keep the price around the current average well into 2012.
Brent-WTI spread narrowed. The oil price reflected the general uncertainty last week albeit the main event was the sharp closing of the WTI-Brent gap mid week when the operator of a pipeline feeding oil into Cushing said that it will reverse that flow. The WTI contract is a strictly speculative betting chip for Nymex traders but, because it is widely reported by financial news agencies in the US, it can have a disproportionate sentiment effect towards oil themes, such as Russia ETF and stocks. The WTI-Brent discount had reached a record of $27.88 p/bbl on Oct 14th. On Wednesday it closed at a discount of $9.28 p/bbl. On Friday it closed at $10 p/bbl. That discount is more likely to widen this week because the pipeline to be reversed does not have enough capacity to solve the Cushing bottle-neck problem.
This Week: Little to be thankful for
EU debt and US deficit. The primary drivers of markets again this week will be the euro zone debt crisis and the return of the US budget stand-off.
Against the background where rating agencies are now warning threatens the US as well as Europe’s banking system, dialogue between the leaders of the main EU countries is now at a constant level so newsflow and commentary can appear at anytime and influence all asset classes and investor risk perception.
The US Congress is expected to announce later today that it has failed to agree mechanisms to cut the agreed $1.2 trillion from the budget deficit.
US holiday, and shopping, season. The other major factor this week will be the Thanksgiving holiday in the US on Thursday. That usually means a drop off in market activity from early Wednesday for the remainder of the week. The results of the shopping days just after Thanksgiving, including so-called Black Friday which is the busiest shopping day of the year in the US, will be very closely watched by the markets as a key indicator for the overall economy.
US GDP and FOMC minutes. Before that, however, there are several very important macro updates in the US which investors hope will also confirm the positive trend in the economy that has observed in other updates in recent weeks.
The most important will come on a very busy Tuesday and Wednesday. The 2nd reading of US 3rd Qtr GDP (Tuesday) is expected to show last quarter growth of 2.5%. The Fed’s FOMC minutes will also be released on Tuesday and will be closely scrutinized for evidence of the Fed’s view of economic prospects into year end.
Before that, later today, the October existing house sales update and the Chicago Fed index are amongst those reports that usually affect investor sentiment.
On Wednesday, all reports normally issued on Thursday and Friday will be released ahead of the holiday.
October durable goods, the weekly jobless claims report and the University of Michigan sentiment survey will be amongst them.
Thursday and Friday will avoid a news vacuum as Germany and the UK are scheduled to release 3rd Qtr GDP reports and the lfo survey of business sentiment in Europe will be released.
Inflation watch in Russia. In Russia, this will be a much quieter week for economic updates after last week’s busy schedule. The inflation update will be the most closely watched indicator after the Economy Minister said she expected a full year figure of between 6.7% and 6.8% while the Central Bank Chairman said Friday that the full year rate may exceed 7.0%.
Those forecasts certainly look high when compared with the year to date inflation growth of 5.5% as at last week and with the weekly rate back to a normalized 0.1%.
The ruble-euro rate trend will be the key factor (weak ruble drives inflation) but we expect a full year outturn of not much higher than 6.0%.
MTS results Monday. Several Russia companies will update numbers this week, starting with MTS today. It will issue 3rd Qtr US GAAP numbers. Tomorrow AFI Group (3rd Qtr IFRS) and Acron (9 mth IFRS) will issue and AFI will host a conference call for investors on Wednesday.
October macro report:
Industrial production +3.6% (YoY)
Retail sales Rub 1,693 bln ($55 bln), + 8.8% YoY
Capital Investment Rub 1,097 bln ($35.5 bln), +8.6% YoY
Nominal average wages Rub 23,350 ($755) p/m
Real wage growth + 5.0% YoY
Unemployment rate 6.4% (from 6.0% at end September and 6.5% at end July)
Income per capita Rub 20,691 ($670), + 7.5% YoY
CPI +7.2% YoY, +5.3% YTD
PPI +17.5% YoY, +12.6% YTD
Agriculture production Rub 592 bln ($19 bln), +51.8% YoY
Cargo, bln tons/km 420.5, + 0.9% YoY
Railroad cargo, bln tons/km 183.0, +4.8% YoY
Residential construction 5.0 million square meters completed in Oct, +6.9% YoY
Completed construction Rub 523 bln ($16.9 bln) in October, + 8.2% YoY
Source: Federal Statistics service
Other data released last week:
GDP grew 4.8% in Q3 YoY, up from Q2 growth of 3.4% YoY
Budget surplus at end October was Rub 1.4 trillion ($45 bln) = 3.2% of GDP
net capital outflow year to date at end October was $64 bln (Central Bank Chairman)
bank lending to companies is up 23% YTD at end October (Central Bank Chairman)
bank lending to consumers is up 31% YTD at end October (Central Bank Chairman)
balance of payments at end October is $84 bln, + 38% YoY
Trading last week:
World markets fell 4%. Global markets only managed one positive closing this week as equity investors took their lead from the European bond markets. 10 year bond yields reached the critical 7.0% level in Italy and came very close in Spain while the CDS spread between French and German bonds expended mid week before the ECB intervened as a buyer to calm markets. Set against the euro zone debt fears, US growth indicators have continued to improve and have substantially reduced previous fears of a recession. The net result for the past five days was a loss 4.0% for the MSCI World Index. The measure is down 9.6% YTD.
Most markets fell by same amount. In the US, the S&P fell 3.8% (-3.3% YTD) despite managing to scramble back to almost flat for the Friday session as the Leading Economic Indicator came in better than expected (+0.9% versus +0.6% expected). The S&P Financial Index was the worst sector performer, falling 5.6% for the five days as Fitch Ratings warned that the euro crisis may affect US banks also. The benchmark Stoxx 600 index in Europe lost 3.7%. The MSCI Emerging Markets Index moved in line with other indices with a loss of 3.8% last week (-18.9% YTD).
Moscow fared little better. Moscow’s bourses also followed the global markets trend last week albeit the local indices fared a little better than the higher-beta GDR Index. That was mainly due to a Friday session loss of 1.9% for the latter as it overlapped for longer with a weak US morning session. The RTS ended the week off 2.3% (-15.5% YTD), MICEX fell a creditable 1.6% (-13.5% YTD) and the IOB GDR Index lost 14.7%.
Novatek was best. Few stocks showed strong relative performance last week, albeit two blue chips, Novatek and Sberbank, did feature amongst the best performers. Novatek is the best performing Russia name year date with a gain of 25%. Uralkali is next with a gain of less than 10% and Magnitogorsk is worst with a YTD loss of close to 60%. Qatar confirmed that it is interested in acquiring an equity position in the Yamal LNG project and in Novatek. On Friday, PM Putin said he supports Total’s ambition to increase its stake in Novatek. At the other end of the weekly performance table, Yandex lost 15% and is now down over 13% from its IPO issue price. The lock-up period ends today.
The table with the best and worst ADR/GDR performances of last week is at the end of this note.
Ruble also moved with EM trend. The ruble moved mainly with the trend in developing market currencies rather than for any domestic reason last week. It ended the week off 1.1% against the dollar (30.863), a similar level to the decline in the Korean won while India’s rupee fell by 2.4%. The euro managed a rally on Friday after the ECB bond purchases but, over the week, the dollar rallied 1.6% against the euro ($1.3525). Gold fell 3.5% ($1,725.1 per ounce) and silver was off 6.5% as investors continue to shun even traditional haven assets in the midst of so much uncertainty.
Commodities ended lower. Industrial metals also fell with copper, the most active contract, down 1.8%. Brent fell 5.8% last week, although some of that was because of the arbitrage between WTI and Brent as the WTI discount closed very sharply. Brent finished Friday at $107.56 p/bbl and WTI was at $97.67 p/bbl. Soft commodities lost between 4.0% and 5.0% each last week.
Equity Fund Flows: EM stalls – Russia remains net positive
Investors pulled back to neutral. Investors adopted a more wary approach to emerging markets last week as concerns about Europe’s debt crisis escalated. After four weeks of positive flows, during which $8.8 bln was invested into funds in the asset class, last week a modest $181 mln was taken out. The Asia region bore the brunt of the redemptions with an aggregate loss of $223 mln.
Russia picture mixed. Russia country funds, the smaller fund category, reported a net inflow of $56 mln (0.45% of AUM in this category) with 80% coming via ETF flows. This follows an inflow of only $1.7 mln the previous and, for this country fund category, that was the third straight week of net inflows.
But, looking at the much bigger pool of Russian money in the aggregate country category, the net inflow for the week fell to $25 mln (0.05% of AUM in this category), down from $75 mln in the previous week.
This broader category has seen net inflows for the past four straight weeks. The fact that the EM fund allocations were negative last week, albeit just slightly (the difference between the $56 mln country funds and the $25 mln total) is a bad sign as EM allocations are usually a good indicator of the trend in sentiment.
On a year to date cumulative basis, the aggregate country flows to Russia are minus $1,224 mln or 2.7% of the AUM. Looking only at the country fund basis, the year to date cumulative flow is minus $373 mln or 3.4% of the AUM in this category.
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