The Russian Eagle. December 2019 - Rise of the Ugly Duckling

> The best performer by far, and not overheated yet. The Russian equity market has delivered a 47% total return in 2019 versus 12% for emerging markets. Still, it would be a stretch to describe the market as an investor darling. The growth has come from a very low base following the events of 2014-15 and is well backed by fundamentals. We calculate that only a third of the market's 2019 return can be attributed to improved sentiment, while two thirds is down to pure fundamentals, such as earnings upgrades and lower interest rates.> We set our end-2020 RTS target at 1,800 points. Rapid disinflation is set to bring down the cost of debt. The CPI plunging to around 2.5% in early 2020 is likely to push the CBR to deliver more rate cuts in an attempt to meet the 4% inflation target. The key rate could fall to 5.5% or even lower. We also expect the equity risk premium to continue normalizing toward the historic average of 6%. Thus, we project some 250 bps of contraction in cost of equity, which translates into a P/E expansion from 6.7 to 8.0 (+20%). A 7% dividend yield increases the anticipated total return to 27%.> Global disinflation provides ample room for stimulus. Russia's disinflation trend is not at all unique. Developed and emerging economies alike are witnessing very low inflation by historical standards. Meanwhile, the global economy is going through a synchronized slowdown, with countries producing 90% of global GDP seeing lower growth in 2019 than in 2018. In such an environment, policymakers could launch new stimulus programs without fear of meaningful negative side effects. However, with near-zero yields in many developed markets, the hunt for yield should support EM local currency bonds and equities.> Political risks are the key threat to an otherwise benign picture. An unusually eventful US presidential election - and the ongoing impeachment process preceding it - could see anticipation of changes to US economic or foreign policy spark volatility in global markets, as could the trade war with China more generally. Meanwhile, the US Congress is still threatening new sanctions against Russia, though we see the passage of such measures as doubtful without a new geopolitical catalyst. Domestically, the Russian government will likely be looking to improve approval ratings ahead of the 2021 Duma elections.> Top picks. We believe that the main topics for next year will be dividend yields and risk premium compression. Cheaper stocks with strong free cash flow generation and rising payouts are set to benefit more than others. Our top picks include Lukoil, Tatneft, Nornickel, Yandex and LSR Group.