- The numbers make Russia the cheapest global market.
- However, most of the market is made up of energy and financials, while normal companies are fairly priced.
- Long term economics in Russia aren’t positive as the country is completely dependent on oil prices.
Russia As An Investment Opportunity
Russia has been the best performing market year-to-date and is up 50%. However, it’s still considered by many in the financial environment as one of the cheapest global markets as it’s still far from the pre-sanction and higher oil prices levels of a few years ago.
Figure 1: MSCI Russia Capped ETF. Source: iShares.
In today’s article, we’ll discuss the risks and rewards for investing in Russia.
Low oil prices and the sanctions imposed on Russia by the European Union and the U.S. as a result of the situation in Ukraine, have led the Russian economy into a prolonged recession.
Figure 2: Russian economic growth. Source: Trading Economics.
The country’s economy is recovering as oil prices increase and domestic demand picks up. The IMF expects the Russian economy to grow at 1% in 2017. However, the economy remains extremely dependent on oil, with oil and gas having accounted for about 50% of the Russian budget revenue for the past decade.
Figure 3: Distribution of Russian budget revenue. Source: Bloomberg.
In addition to the high dependency on oil and gas, Russia doesn’t have a positive demographic outlook. The median age is 39.3 years, and the population is slowly declining.
Lower oil prices have increased budged deficits and spurred inflation. This has, in consequence, lowered the value of the Russian ruble by about 50% in the last two years.
Figure 4: RUB to USD. Source: XE.
As things settle, inflation has been lowered and is close to historically low levels.
Figure 5: Russian inflation. Source: Trading Economics.
From an economic and country perspective, an investment in Russia is a pure bet on oil. If oil prices increase further, so will economic activity in Russia and vice versa if oil prices decline.
Russia doesn’t have positive demographics, nor is it diversified in natural resources or highly advanced technology that could increase industry competitiveness. For a bet on oil, it’s better to look at domestic oil and gas producers due to country, currency, and political risks, especially now that Russian stocks are already up 50% in 2016. Even with relatively high oil prices in the last decade, Russian GDP is now at the same level as it was in 2008, indicating a lost decade for Russia.
It seems that economic growth isn’t the most important thing for Russian politicians. They are more interested in some other values like annexing territory or building huge infrastructure projects with questionable economics. Also, Russia lacks the entrepreneurial spirit we are used to in the western world. Therefore, we can conclude that Russia will always be Russia.
In any case, we are going take a more detailed look at the investing opportunities in Russia.
Investing Opportunities In Russia
By investing in the iShares MSCI Russia Capped ETF (ERUS), you’re again depending on oil as 6 of the 10 largest holdings are in the energy sector. Energy companies account for 50.6% of the Russian ETF.
Figure 6: Russian ETF components. Source: iShares.
By taking a look at other sectors, we can see that the Russian market isn’t that cheap after all. A grocer and retailer, PJSC Magnit (MGNT) has a PE ratio of 22, Rostelecom has a PE ratio of 15.9, while Mobile Telesystems (MBT) has a PE ratio of 12.7. So, the story that Russia is the cheapest stock market in the world isn’t true when you exclude the energy sector and the closely related financials that are extremely exposed to currency risks. Domestic retailers and telecommunications corporations have better PE ratios, so there isn’t a need to look to Russia for such investments.
Therefore, the common perspective that Russia is the cheapest market and will average to the mean has to be carefully analyzed. The fundamentals might look good with a PE ratio of 8.1, a cyclically adjusted PE ratio of 5.1, and an average price to book value of 0.9, but I see those fundamentals as fair in relation to what Russia has to offer from an economic and development perspective.
Figure 7: Russian fundamentals making it the cheapest market in the world. Source: Starcapital.
Investing in Russia isn’t really investing, but rather betting. Betting on the price of oil and the hope that international investors will push Russian asset values higher. With slow economic growth perspectives, a questionable political system, and declining demographics, there are far better places to invest your money globally.
However, the current rally may continue, but I simply don’t like the risks attached to investing in Russia at this moment. Finding a single undervalued stock is possible, but then you’re still running the risk of a crazy Putin day or a war and increased sanctions. Just an example of the trouble Russia is in is the fact that the finance minister proposed freezing civil servants’ salaries for the next three years. That’s a red flag if ever I’ve seen one.