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Will the Party in Russian Shares Continue?
Russia's RTS index was the world's top performing emerging market in 2009, up an incredible 140 per cent. Yet I believe the spectacular bull market in Russia will continue in 2010, albeit in a more muted fashion. Why? One, Russia goes ballistic when GDP growth swings from an 8 per cent contraction to 5 per cent growth.
- PUBLISHED: Mon 4 Jan 2010, 11:59 PM UPDATED: Mon 6 Apr 2015, 10:23 AM
- By:
- Matein Khalid (Money Maze)
This is happening now. The last time this happened was in 1999 when the rouble MICEX index trebled. I know. I was there.
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Two, the Russian Central Bank has regained the world’s confidence in the rouble, even though it spent $200 billion to avert a catastrophic post-Lehman shock devaluation that would have awakened the demons of August 1998.
Three, the Russian Federation is the cheapest major emerging market on the planet, at 9 times earnings on the index. China and India trade at 18 – 20 times multiple (depending on whose numbers you believe. In BRIC investing, statistics are what Churchill branded terminological inexactitude). Even Brazil is now expensive at 14 times earnings as the Bovespa is all about low multiple, cyclical Vale, Petrobras, the banks and miners. Russia trades at a one third discount to the MSCI emerging markets index even while EPS growth is estimated at 60 per cent this year. Paying nine times earnings for 60 per cent EPS growth? Yummy.
Four, the Russia banking system was successfully bailed out by the Kremlin with $100 billion in state funds. This is the reason I am long Sberbank and VTB, who control an incredible 50 per cent of Russian deposits, whose share prices have both quadrupled since last January. Sberbank profits, for instance, will rise 600 per cent this year as loan loss provisions peak, corporate debt spreads compress, loan growth surges after the credit squeeze, net interest rate margins rise to 700 basis points, the highest in BRIC or even GEM. Owning Russian banks is a license to print money as earnings surge, cost of equity falls, funding cost decline, deposits swells and rouble capital markets new issuance reopens. Foreign banks in Russia will retrench (Unicredit, Raffisen, Citi) and the oligarch/pocket banks have lost the faith of the public. The last time I recommended a monopoly in this column over the summer, the monopoly traded at 15 times book value. Yet is Microsoft shares surged 50 per cent since I pleaded the bullish case for MSFT in Khaleej Times ad infinitum. But Sberbank and VTB trade at 1.5 – 1.7 times book value. As me, homeboys in Southall croon, goodness gracious me!
Five, Russia was the world’s most profitable petro-currency play in 2009. One third of the Russian GDP is oil and gas. The double headed eagles of the Tsars can boast gasfields in Yamal-Nenets Arctic ice floes and the Siberian taiga in the Far East. Rosneft is increasing production at a time when the Kremlin will cut taxes to boost FDI and capex. Meanwhile, Gazprom’s gas and volume woes are over. Notice that the spreads on the new Gazprom five year bonds have fallen 200 per cent since they were issued in the Eurobond market in August.
Six, Russian sovereign Eurobonds have been spectacular winners. The 2030 dollar bond yield has fallen from 10 per cent last March to 5.4 per cent now. The Russian CDS risk has collapsed. The world’s smart money loves Russian risk. And why not? The Kremlin earns 700 million dollars a day in oil and gas exports. The Russian central bank has $437 billion in hard currency and gold reserves. Incroyable!
Seven, Russian allocations are being raised by EM fund managers, though as a Pavlovian contrarian, this gets me worried. Yet Putin wants to attract FDI, not just hot money. Finance Minister Alexei Kudrin even tried to dampen the animal spirits in Moscow by stating that the markets were overheated, President Medvedev decried the “primitive structure” of the economy and vowed to wage war on corruption and vodka (a recurrent theme in Russian politics since Tsar Peter the Great!) If Russia embraces a market economy and the rule of law to attract foreign capital, if it unleashes the vast purchasing power of 140 million people, if the oligarchs repatriate $100 billion in flight capital? Take real estate. I have researched Russian property plays where NAVs will rise fivefold as they will not in, say, Palm Jumeirah, let alone International City. I claim no emotional neutrality on Russia but I feel in my soul that Moscow will be the epicentre of history’s next spectacular bull market, the El Torro to beat all torros. Yet, sadly, if anything in finance sounds too good to be true, it never is.
As a trader in Russian equities, the rouble and Gazprom debt for the past decade, I am all too aware that black swans emerge traumatically from the Siberian permafrost, the risk rollercoaster in Moscow must never discounted, that the politics of the Kremlin clans is as secret and unpredictable as the conclaves of successive Soviet Politburos from Lenin to Andropov (the real ruler of the USSR for three decades even though Uncle Leonid was General Secretary). Russia’s political bombshell were, tales of vengeance and sorrow straight from the pages of Doestovski and Tolstoy. The rouble devaluation and banking collapse of August 1998, the rigged oil auctions of the Yeltsin era that created a new tribe of oligarch-billionaires, the meteoric rise of ex KGB lieutenant colonel Putin from obscurity in the St. Petersburg mayors office to ultimate power in the Kremlin, the second Chechnya war, the Moscow bombings and terrorist carnages in Beslan, the fall of Mikhail Khodorovsky, judicial strangulation of Yukos, the gas spats with Ukraine, the war with Georgia, the steel price fixing change against OAO Mechel, the murder of an ex KGB dissident in London and Russia’s oil concession disputes with BP and Shell. These were all events etched in my nervous system as I navigated the financial souks of the Rodina, the Russian motherland that bewitched me so long ago with its surreal pantomimes of ice, blood and tears.
Yet, bizarrely enough, I believe that the real risk to a Russian equities portfolio will emanate from abroad, not the Kremlin Putin and Medvedev have learnt the lessons of 2008. Russia, for all its $435 billion hard currency reserves, cannot develop or diversify if it is blackballed from the international capital markets. Russian politics can, be definition, not be captured in any model or Gaussian curve fits or mathematical algorithms that presuppose even an iota of rational predictability. Yet both Putin and Medvedev will do their best to minimise policy risk and capital flight. So what could go wrong? A lot. The Chinese property bubble could blow up. Something is dangerously wrong when the price of the Beijing apartment is 80 times average income, when factories make more phantom money flipping land than making widgets, when billions of yuans in bank loans to state companies and provincial Communist Party bosses end up in glitzy condo projects and concrete Xanadus. When property bubbles burst, debt deflation ensures kaput GDP growth and bank failures, as the experiences of Japan, Latvia, Southeast Asia and even now the Gulf attests. This could be a catalyst for a brutal correction in oil, gold, gas and emerging markets (EM). I can easily imagine a ghastly 50 per cent fall in EM if the grizzlys run amok in Shanghai as the Middle Kingdom’s credit and property bubble deflates. Other than China, I am convinced that the financial chain reaction of sovereign debt defaults is inevitable in 2010. This means emerging markets debt credit spreads surge even as the Uncle Sam Treasury note yield spikes to 5 per cent as the American economic colossus accelerates to 6 per cent GDP growth and the Federal Reserve exits from the Bernanke’s Wall Street life support packages. Gold is a classic case of the Greater Fool Theory of investing, which saved me from the madness of paper condo flipping or credit note arbitrage when tulip mania was the rage all over town. What happens to crude oil if Superdollar surges to 1.25 euros? Black gold at 25? Sometimes Russian roulette seems a lot safer to me than Russian equities but when the stars, dear Brutus, are aligned just right, the mythical firebird soars above the fairy tales spires of the winter palace. For me, it is from Russia with love.
