Russian market to gain 39% by end-2012. Our end-2012 RTS index target of 1,980 implies 39% upside. This was derived from our base case scenario which projects the Russian economy to expand 2.8% next year and continue growth at a slow rate afterwards. We forecast a 5.3% EPS decline for the index next year, which sharply contrasts with the consensus, calling for a 6.5% expansion. Still, EPS are forecast to grow 9.7% in 2013, exceeding the record 2011 levels.

Multiples set to expand, but no decoupling just yet. We expect a sustained expansion in equity multiples as the negative economic momentum loses steam, likely to take place in 1Q12. We expect the lack of a large domestic investor base to prevent the Russian market from decoupling with global markets.

Strong gains in the long term. The outlook is brighter for the longer term, because when faced with a similar situation in the past the Russian market returned an annualized 26% on the 12-18-month horizon, while for 3-6 months the return was only 4% and was substantially more volatile.

First defensive positioning…. A defensive countercyclical positioning is warranted until the economic slowdown reaches its bottom. We like the telecom sector, electricity generators, strong retail operators and inexpensive commodity producers that promise high dividends in 2012. Utilities would be an obvious bet for the post-election period.

… followed by overweighting cyclicals as the slowdown ends. As we move closer to the turning point for the economy, when growth may regain speed, we would turn to more cyclical sectors, namely depressed steel and banking stocks.

Only 19% downside in the event of a mild recession. A mild recession scenario implies the RTS will end 2012 at 1,170, which corresponds to 19% downside. EPS would decline 35% in 2012 and recover a marginal 2.5% in 2013. The natural resource sector, including oils, would be a key loser, however, we see this scenario as already 70% priced in.