By Tim Seymour
Going into today’s Presidential elections in Russia there has been an avalanche of political analysis in the press and the brokerage community. We thought we would provide a quick note to briefly summarize our views, tactical approach, and also to discuss the Russian market and the investment opportunities therein.
Russia is an important market for us and a place where we feel we have an investment edge. Part of our edge comes from not only having deep corporate, local and institutional relationships, but also from the fact that we have lived and invested through the last four Presidential and Duma election cycles with an approach of both caution and respect for the market forces.
However, as an investor, some of the greatest investment opportunities in Russia have emerged from the market overreactions, rooted in a fear and mistrust of these “market forces." This election is no different, and we would argue the stakes have never been greater in Russia. The next three years will see far more asset transfer and transition from the state to the private sector than we saw in the now infamous privatizations of the 1990s and the “loans for shares” schemes that set Russia back under Yeltsin.
Market Sentiment: In the last six weeks, there has been a bizarre role reversal between “nondedicated” and “dedicated” Russian investors with regard to the prevailing risks in the market surrounding elections. Surprisingly, since the fireworks that followed December’s Duma outcome, we see more apathy from the “uninformed," “casual," “non-specialized” or dare we say, “global” investors who have historically overreacted to Russian politics.
Instead of taking a sell first and ask questions later approach, or an almost “cold war view” on the political -- and thus market -- environment in Russia, these folks have bought Russia in recent weeks. This group has made a macro allocation to Russia within EM, based on valuation screening (incredibly cheap vs. peers, and relative to its history), and an allocation to oil exposure.
Russia is a clear global winner with $125 Brent, and this is the investment overlay applied. Conversely, the “dedicated," “local," “smart," and “old guard” Russia money, while not panicking, is taking a more cautious, reserved view on the potential for an outcome that will spell volatility for the Russian market.
Few fear blood in the streets, but there is this sense that people are being a little cavalier. We would put ourselves in that camp and that is how we have positioned our Russia book for the last six weeks. We have chosen to avoid investing or maintaining positions in companies we feel have heightened or potential transition risk.
Organically grown companies, especially in the retail sector, have less risk and the most to gain if Putin makes an appeal to the masses. We have run Russia net long for the last eight weeks, but tighter and smaller than typical positioning, and we do hold tail protection through the end of March.
Election Scenarios: What is good for the market is not necessarily what is good for Russia and vice versa, in terms of the development of the society and evolution of the Russian economy.
What has transpired in Russia, not only from the Duma elections, but back to the day in September when Putin announced he and President Medvedev would be switching places after this election is a profound positive moment in Russia’s post-Soviet society.
Markets, however, may find this transition uncomfortable at times.
Scenario 1. Putin wins with 50-58% of popular vote, no run off, but no landslide victory for Putin. (Best case)
Scenario 2. Putin wins with more than 60% but less than 66% of the popular vote; based upon recent polling announcements from the Kremlin, this is where expectations are being managed
Scenario 3. Putin wins 45% of the vote and is forced into a runoff on March 25 against Zyuganov, the Communist leader who will be clear runner-up in this round, and Putin wins convincingly.
Scenario 4. Putin wins more than 66% of the vote, meaning either absurd stuffing of the ballot by his own United Russia Party or, as he has stated, by the opposition in order to give them a strong foundation for a claim of voting manipulation. Both sides will claim the other is at fault. (Worst case)
The most interesting part of the election setup and outcome may, in fact, be the appointment of the prime minister, followed by senior government and ministerial appointments.
While Medvedev has been already named by Putin, this is one source of significant public frustration. Making a change from Medvedev could actually indicate a real response to the protest movements.
Replacing Medvedev with former Finance Minister Alexei Kudrin would be cheered by markets and would constitute our “home run” election outcome when added to scenario 3 above.
This scenario would create short-term market uncertainty, but offer the highest re-rating effect for Russia. Currently, all other players in the government are on hold and await a reshuffling of the deck that will pose additional risk but also may augur exciting change.
Bottom line, however, is that despite all the rancor and foment in Russia, Putin still has the majority, and the majority in Russia still need the government.
Two questions to confront:
1. History says in Russia all major revolutions and political uprisings have taken started in either Moscow or St. Petersburg. March 5 (Election Day) is the day of Stalin’s death and a very symbolic day for Russian citizens. The Duma elections highlighted massive voter fraud in Moscow where Putin’s popularity is not what it is in the regions or heartland. How do Russians react if they find that Moscow and/or St Petersburg results were in the mid-30s and that the total election victory was achieved through landslide voting support from ethnic republics like Dagestan, Chechnya and so on?
2. After a Putin victory, will the newly emboldened Kremlin take a more authoritative, violent response to protestors? It would only take one poor response to trigger greater conflict.