Haters gonna hate. But hating Russia as investment story this year might prove as unproductive as it did in 2016, when the Russian small to mid-cap index rose over 95%. And now that Russia has become the world’s leading producer of hydrocarbons, surpassing Saudi Arabia, and the new administration of Donald Trump has signalled and end to anti-Russian belligerence, there are even more reasons to invest in Russia.
By country, Russia reported the most inflows of foreign portfolio money than any other global emerging market fund. More than China. More than India, Brazil and Mexico. Global emerging market funds saw a second straight week of inflows last week, hitting $476 million, according to EPFR Global.
So far there has been net inflow of $472 million into Russian stocks, compared with $837 million all last year.
Russia is now the most popular emerging market in terms of foreign investor inflows as a percentage of market cap. Last year, investor flows were the equivalent of 1.6% of Russia’s stock market capitalization, after three straight years of declines. The only other country that greater inflows as a percentage of market cap was Colombia. Investors were betting on a peace deal with the Revolutary Armed Forces of Colombia at the time.
As money flows in, holders from 2016 are selling. Newcomers to the Russia story are losing money as they place their bets on a more friendly Washington-Moscow relationship that could ultimately end economic sanctions later this year. The Market Vectors Russia (RSX) exchange traded fund, the main way investors buy the ole bear in the woods, is down 0.5% this year while the MSCI Emerging Markets Index is up 4.9%. Investors who can tolerate less liquidity are turning towards the Russia Small Cap (RSXJ) ETF, also owned by Van Eck Global’s Market Vectors. That fund is still killing it, up 6.96% this month and 137.5% over the last 12 months. There has not been a better emerging market fund than this one.
American “regime change” is worrying some investors. Meanwhile, many pundits have expressed concern of Brexit-like contagion spreading to France later this year. This would be the trifecta of political disruption. France is set to decide on a new president on April 23.
Russia, like other emerging markets, may also benefit from changes in monetary policy in the core economies.
Consensus on Wall Street is that the Fed and other core central banks have reached the practical limits of monetary policy. Japan has ended its experiment with negative rates. Europe will follow. Investors are cautiously optimistic about changes in fiscal and regulatory policy in the U.S., less optimistic about trade, though they will adjust to new realities.
The impact of democratic regime change will also be felt on emerging market asset prices, market liquidity and emerging market capital flows in the months ahead. Russian inflows this year will be a fluke, rather than a constant.
Thanks to the oil price rebound and lower interest rates, the Russian recession is over. The market has performed well so many 2016 holders are taking profits. But on Monday, Renaissance Capital in Moscow reiterated their overweight recommendation for Russia’s stock market.
Real wages having turned positive, and a further 200 basis point rate cut is likely to come in 2017.
Any market that is up 57% in dollar terms over the last 12 months, as registered by the Market Vectors Russia fund, will be vulnerable to profit-taking. Investors shouldn’t take this as a negative sign.
“We are still meeting investors, particularly in the U.S., who are underweight Russia and we believe that global money…continues to be absent,” says Daniel Salter, head of global equity strategy at Renaissance in London.
“In an uncertain world of Brexit, Trump, Italian, French and German elections we find Russia well placed within emerging markets,” Salter says, adding that Russia only looks good if oil holds at current levels.
Russia continues to take a licking and keep on ticking.
Western sanctions and the onslaught of negative headlines has not turned off investors. A relaxation of sanctions is expected if France and Italy voters choose anti-establishment candidates later this year.
Washington will remain a tough call as many Republicans, not enamored by Donald Trump, will try to increase sanctions on Russia for allegedly hacking the emails of the Democratic National Committee and Hillary Clinton campaign boss John Podesta. Russia says it did not hack those entities, but the U.S. intelligence agencies say it did. The stand-off gives ammunition to anti-Putin congressional leaders like John McCain and Lindsey Graham who promised this weekend to give Trump a list of new sanctions to punish Russia for interfering in November elections.
Outside of political soap operas, progress is being made on the economic front. This is what makes Russia a money magnet this month.
Progress on bringing down inflation has been impressive. Expectations are for a 50 basis points cut to interest rates in March.
The ruble remains stable and there has been a marked decline in capital flight.
Russia is also seen as resilient to Fed rate hikes given the current account surplus there, coupled with the fact that most Russian companies have been shut out of low rate U.S. and European lending markets anyway due to sanctions. Higher interest rates are not going to matter. Russia companies have been focusing on local sources of funding, and rates are double digits and declining.
Consensus earnings forecasts from Russian investment banks have all been rising. Russia is still a clear beneficiary of a Trump presidency, at least as far as perception is concerned.
Renaissance recommended non-ETF investors to look at Sberbank, Aeroflot, Gazprom, Lukoil and PhosAgro to name a few.
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