Higher Interest Rates, The Real Russian Roulette

by: Elliott Auckland

Bonds have been in an unparalleled bull market over the last 10-30 years. The process has gone from a starting point of ultra high inflation, waning economic (nominal) growth to recession. It seems, now that this period is coming to an end. But who stands to be comparatively stronger in an era of higher interest rates? Quite simply those countries who are lower indebted.

There are two major themes to look at; the well discussed Government (public sector) debt to GDP and the Private sector or perhaps more importantly, the household sector. Countries who have financed GDP growth through excess government and consumer expenditure will no longer have it so easy. Most of the western world stands to lose, and horribly so:

Using the latest Economist data:


Country Government Debt
(as a % GDP)
Household Debt
(as a % GDP)
(as a % GDP)
U.S 80% 90% 170%
Canada 68% 92% 160%
UK 78% 98% 176%
Spain 65% 85% 150%
Italy 110% 47% 157%
Germany 83% 60% 143%
France 87% 48% 135%
Switzerland 64% 118% 182%
Japan 215% 65% 280%
China 33% 13% 46%
Brazil 65% 15% 80%
India 65% 10% 75%
Russia 5% 10% 15%

The figures from the table should be taken with some pinch of salt, as this is only the liability side of things. It is certainly true that Western consumers (governments and individuals) have more on the way of Assets too, but certainly not enough to cover the vast amounts of debt.

The trend, however, is clear. Western Countries are over indebted both on a public and private level, and higher interest rates globally will have a sizable effect on the ability to re-finance and the size of disposable incomes, both of which will hurt consumer demand.

While it is true that interest rates don't rise of their own accord, there has to be excessive aggregate demand/economic growth (generally) for this to occur. There will be a competitive advantage for countries lower indebted, and who will consequently be able to enjoy stronger and more natural economic growth. The two I would like to highlight are India and Russia. So if everyone were to benefit regardless of higher interest rates, some will perform better than others.

India, unlike their BRIC counterparts have fantastic demographics, that will bless them with an expanding workforce for the foreseeable future. Unfortunately the same cannot be said of China who will see their workforce shrink in 2017, and the proportion of workers to pensioners will change dramatically (much like it is in the western world at the moment). Russia has a problem far worse; a declining population.

Russia though for its demographic problems has the sweet spot in everything else. It has the lowest debt profile of top nations globally, while having the worlds richest resources and not just in the well known oil and gas. But in the likes of fertilizers, grains, timber and even fresh water - consequently all assets that will more than hedge inflation, if there is a lack of interest rate rises. Quite simply, Russia is poised for perfection.

Brazil is also an interesting play, somewhere in the middle of India and Russia. However, Brazil's major downside is their inability to control inflation and hot-money causing erratic policy shifts that can create difficulties for a foreign investor with FX risk.

Of the three of these I feel Russia is best poised to outperform due to their valuation against Brazil and India, that being said both Brazil and India should beat the Western world. I have highlighted for geopolitical reasons why Russia is a strong play going forward in my article. But I feel even, in spite of the potential rise in commodity prices, Russia will outperform globally because its economy is so much healthier than the rest.

A good way to buy the 6x PE Russian economy from the US is the ERUS, which essentially maps the Micex index. A more targeted play would be Sberbank (SBRBF.PK), Russia's leading bank that is poised to take market share on the international stage as it is in healthier shape than its European counterparts, while having the influence and ability to pick up market share that other international banks do not.

Russia is a land of strong fundamentals, a place that will see the fastest growth in the developed world over the longer term, on the cheapest valuations. It does not take a "Warren Buffett" to win in Russia. A well known fact in Russia is that the Private Equity world suffers, due the ease of the private investor to find returns, in names like Gazprom (OTCPK:OGZPY).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.