Russia rebounds despite problems
Stocks finally showing signs of life, but recession is expected to linger
Last year was absolutely catastrophic for Russian assets, with the country’s ruble, stocks and bonds suffering their worst declines since Russia’s 1998 financial crisis.
The market carnage made sense given that it seemed Russia’s economy was heading for a collapse. But even though there are still plenty of questions about the country’s future, investor optimism about its prospects has apparently returned.
In a surprise turnaround, the country’s stock market has been one of the best performers among emerging markets this year. Russia’s MICEX Index, which tracks 50 of the country’s most liquid companies, is up more than 15 per cent so far this year, topping stocks in Japan and Europe, which have been boosted by quantitativeeasing efforts.
An easing of tensions between Russia and Ukraine and a pause in the free fall of oil prices have helped the country’s beleaguered assets recover some of the wealth lost by investors.
The question they have now, though, is whether the rally can continue?
Fund flows show that foreign money is finally coming back into the country, after spending much of last year exiting it. But analysts are less quick to accept Russia’s turnaround.
Many say the current rally is simply a reversal trade, with rock bottom prices for Russian assets attracting those willing to take a risk. But the longer-term picture, they say, still looks bleak.
“Russian equities have been in a bear market pretty much since the end of 2011, ever since President Dmitri Medvedev and Prime Minister Vladimir Putin decided to announce to the world that they would switch jobs,” said analysts at BCA Research Inc. in a report.
“This convinced foreign and domestic investors that pro-market reforms, corporate governance, and a business-friendly climate were not at the top of the Kremlin’s policy agenda.”
Russian asset prices collapsed last year following fears that the country was heading to war with neighbouring Ukraine. Covert support of ethnic Russian rebels in eastern Ukraine led to sanctions from the United States, which hurt the country’s financial institutions and exporters.
The country’s stocks subsequently tanked and they declined even further after global oil prices fell more than 50 per cent over a period of six months, crippling Russia’s oil-dependent economy.
The losses extended beyond stocks: Russian bond prices sank to their lowest level in five years and the ruble retreated 45 per cent against the U.S. dollar.
This year’s bounce is largely due to the easing of both economic and political pressures. Ceasefire negotiations in Ukraine have brought Russia back from the brink of war, oil prices, while still volatile, are stabilizing, and the economy received a boost in the form of central bank interest rate cuts.
Fund flow tracker EPFR has noted that Russian equity funds have been one of the top destinations for capital flows this year, with $400 million US being poured in after a massive exodus last year.
There are plenty of reasons for investor interest. Russian stocks remain among the cheapest in the world, while companies listed there have among the highest dividend yields.
Russian bonds also remain cheap, especially when compared with developed market economies in Europe, where German, Italian and Spanish bond prices sit near record highs. “Russian bonds are both cyclically and structurally under-priced,” noted Goldman Sachs analysts in a note earlier this month.
But the prospect of high rewards that has drawn investors back to Russia this year also comes with high risk.
Russia remains mired in a recession, with few indicators that the country’s economy can bounce back this year. TD Economics notes that the collapse in oil prices and a massive decline in government revenues means that it is possible the Russian economy could remain trapped in recession for years.
“The country’s near-term prospects will be largely determined by the evolution of the conflict in Ukraine, political relations with the West and oil prices, but it is likely to remain in recession next year as well,” TD’s economists said in a report.
But that does not mean investors can’t find returns in Russia in the near term. Analysts at BCA Research said Russia remains a top choice for investors if oil prices begin to climb this year.
“Investors should buy Russian equities from this point onwards only if they think oil prices are about to take off,” the analysts said. “This may be the case by the end of the year, but headwinds exist in the short term.”
But longer term, they, too, remain bearish. They note that Russia requires a plethora of freemarket reforms in order to fix the country’s fundamentally broken economy. The current regime under Putin has shown it is resistant to such reforms, making it hard for anyone to put together a true investment case for Russia.
“Our long-term thesis on Russia remains bearish,” BCA analysts said. “Without significant reforms and a change in policy toward a pro-investment/market outlook, Russian equities will remain in a bear market.”