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Dmytro Kulakovskyi
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Recent Finance graduate passionate about equity and fixed income research seeking to acquire experience in the fields of his interest.
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  • Emerging markets: case for Russia
    Why Russia?

    I get the impression, that, in spite of the tremendous growth in attention towards emerging markets observed over the last decade, the informational coverage of some of the largest emerging markets remains far below the level, which the recent performance of those markets would suggest. Since 2000 leading Russian stock indices rose twice as fast, as NASDAQ rose in the 90’s, but attention to Russian market and other emerging markets as a whole pales in comparison to the media coverage of a single industry, IT, a decade ago. Not that Russian market deserved as much attention, but still, it appears somewhat unreasonable, that there are twice as many mentions of Google on seekingalpha than there are mentions of Russia.

    Two indexes most commonly used to track Russian stock market are RTSI and MICEX. On the graph below you can see the above-mentioned performance and how it compares to that of other emerging markets and S&P500:

    Of course there are numerous reasons for the poor informational coverage: Russian market is not as liquid, not as transparent and, as implied by pricing on money markets, not as stable, as OECD markets, and, hence, not as attractive to a wide range of investors. Below we will examine what essential implications those factors have from a stand point of individual investors.


    Every major sector on Russian market has numerous companies publicly traded at more-than-sufficient volumes (at least as far as individual investing goes). With total market cap exceeding $700bln Russian stock market provides more investment opportunities than any other Eastern European market (for comparison, total market cap of publicly traded Polish companies is $150bln). Average trade volume for the companies listed on MICEX toped in 2008 at $24mln. But what’s worth mention here is that it’s significantly skewed towards resource-intensive industries. In fact, oil and gas industry alone accounts for about 50% of the total market cap. But with the total market capitalization of $700bln the remaining half of it still provides you options to choose between. Specifically, the rest is broken down as follows:


    The list of stocks with highest trade volume also reflects the skew:

    Obviously, the skew towards mineral resources imposes excessive market sensitivity to commodities prices, which leads to higher volatility.

    As there is no way I could cover every sector in this post, for detailed information on weights and performance of particular sectors I would forward you to (

    Macroeconomic outlook

    Over the decade both macroeconomic and political outlooks of the country have been steadily improving, causing drop in the values of national risk metrics.  

    I don’t expect my readers to be deeply familiar with economic history of the region, so I would start with data on some of the basic macroeconomic indicators:

    As indicators attest, performance of Russian economy in terms of GDP growth, inflation, external trade and exchange rate stability has significantly improved since 2000 compared to that observed in the 1990’s. These trends were taken into account by credit rating agencies resulting in improvement of Russian sovereign rating (S&P ratings):

    According to S&P BBB rating is an “investment” grade (as opposed to speculative BB+) and suggests “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.

    That being said, Russian economy still does exhibit several troubling trends, which I will try to outline:

    1. Overreliance on natural resources: according to IMF research soaring oil prices and increase in oil extraction account for up to 80% of federal budget revenue increase (“Budgetary Impact of Oil Prices in Russia” by Goohoon Kwon), which obviously imposes significant market-wide sensitivity to oil prices. O&G- exports-to-GDP ratio between 1998 and 2006 increased from 0.1 to 0.2. In 2007 73% of exports fell at fuels and metals. Although officials seem to realize the problem and do embark on various diversification programs, no material result has been attained so far.

    2. Unstable capital flows: in spite of investment grade S&P rating institutionainvestors still treat Russian economy as highly speculative, which translates into volatile cycles of net capital inflows and outflows.

    External shocks have severe effect on Russian economy, since possible internal demand deterioration is likely to overlap with capital outflow, which would lead to financial markets being sucked out of cash dry. It was exactly what happened in 2008, which led to sharp decline in stock prices and spike in interest rates.

    Such conditions contrast with what we can see in OECD economies, where global recessions are usually accompanied by capital repatriation and interest rates decrease.

    3. Institutional concerns: the country is well known for its corrupted government, lack of business ethics, and power of special interest groups. According to recent research (Le Monde) bribes and kickbacks amount up to 50% of GDP. Transparency International places Russia at 146th position in its Worldwide Corruption Perception ranking (on par with Sierra-Leone and Kenya). As a result, due to the unpredictability of regulators and courts’ bias any investment bears additional unquantifiable structural risk.
    As follows from the above, just as any emerging market Russian market is, without a doubt, riskier than those of developed economies. But the risk itself doesn’t say much, since it’s balance between risk and expected return, that differs attractive investments from potential disasters. We can illustrate this relation using quarterly coefficient of variance (calculated for weekly changes in the index) as a measure of risk and quarterly change in average (arithmetic) value of the index as a return measure.

    Charts above show that being more risky Russian market has demonstrated (on average) significantly better performance, which suggests that at least for some risk-tolerant investors exposure to Russian market may lead to improvement of risk-return profile. Another point worth mentioning here is correlation between Russian and American stock markets, which amounted to 73% for years 2004-2010 (calculated for weekly changes). Imperfect correlation yet again suggests attractiveness of Russian market for the purpose of portfolio optimization.

    Trading Russian stocks

    Trying to spark some interest towards the topic, it’s necessary to expand on how individual investor can access Russian stocks.

    Most popular options include:

    1) Trade Russian companies listed on American Exchanges. Those include: Michel steel (MTL), Mobile TeleSystems (MBT), Vimpel-Communications (VIP), Wimm-Bill-Dann Foods (WBD), CTC media (CTCM) and numerous companies traded OTC;

    2) Trade Russian-oriented ETFs:

           a. RSX: mostly exposed to Russian O&G industry;

           b. RBL: industrial materials and energy make up more than 60% of the holdings;

    3) Theoretically, you can find either a Russian broker licensed to work with non-residents, or an American broker licensed to work on Russian exchanges. Practically, this option seems to be beyond typical investor’s reach, since high transaction cost and Russian non-resident capital gains taxes will dramatically affect your performance.

    In the view of above, in subsequent posts I will probably focus on telecommunication industry and metal producers, as those stocks are relatively easy for American investors to get exposure to and are largely uncovered by English-speaking media.

    Below you can find sources used in this posting and internet portals, which might come in handy to those looking to analyze Russian market by themselves.


    Comprehensive resources in eng:

     Related articles:

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Dec 10 5:10 PM | Link | Comment!
  • Case-Shiller 10 via UMM/DMM funds. First glance at trading perspective.
    Recently I’ve found myself interested in such a new option as investing in Case-Shiller 10 Index via leveraged trusts. Clearly, prior to taking any action of investment nature sane prospective investor certainly has to perform at least some sort of analysis on the matter. Not claiming ultimate truth, objectivity or significance, I’ll try to present my findings, hoping someone find them useful.

    What is Case-Shiller index and how do I invest in it?

    In this entry by “Case-Shiller index” I mean S&P/Case-Shiller Compisite-10 Home Price Index (not seasonally adjusted), designed to track changes in the value of the residential real estate market in 10 metropolitan regions across the United States. This index uses the repeat sales pricing technique to measure housing markets. The S&P/Case-Shiller Home Price Indices are calculated monthly and published with a two month lag.

    Just to picture it:

    Since June 30th 09 one can invest in national residential real estate market by purchasing shares of MacroMarkets’ UMM trust or go short with the real estate market via DMM trust. The whole idea is quite simple and is fairly visualized on the company’s website ( In short, buying a UMM share at a given price you purchase a conditional right for a relevant portion of funds of the DMM trust and conditional obligation to the DMM trust – if for the date of final distribution (late Fall 2014 for shares circulating by now) Case-Shiller index doesn’t exceed/exceeds the value of index, that corresponds the price you paid, you’ll lose/gain an amount derived from the index value divergence. Obviously, in case you buy shares of DMM you will be entitled to a portion of UMM funds, if the value of Case-Shiller index published by the final distribution date is below the one supposed by the price you paid, and vice versa.

    Relation between trusts shares prices and Case-Shiller index is shown in the table:
    If CS-10 exceeds 216.23 or goes below 108.11 prior to the final distribution date, trusts will be terminated and either UMM or DMM investors will receive all the funds raised by both trusts. As proceeds from shares placing are held in form of T-securities, apart from money from final distribution investor may also be eligible for interest payment, provided the amount T-securities generate exceeds trusts management’s expenses. The amount of interest investor is eligible for depends not only on the settled interest rates for T-securities, but also on preceding changes in CS-10 index. For the sake of simplicity, I guess, it’s reasonable to consider interest payments from T’s always equal management’s expenses.
    Why trade Case-Shiller via UMM/DMM?

    > With average total trade volume for UMM and DMM of 30k a day market for these securities might be quite inefficient as of yet. Less then 2 months (see graph below) ago UMM/DMM shares were priced at the levels, that suppose, that real estate markets in 10 largest metropolitan areas were to experience another major prices decline just to return to something around -10% from current levels by late summer 2014 – clearly, it was not the likeliest scenario, but as trade volumes haven’t grown significantly ever since it’s feasible, that market will repeatedly deviate from common sense, thus, offering opportunities for promising bargains. In the same time, unlike most of stocks with comparable daily trade volume and volatility, residential real estate market is well covered in media and there can be found a plenty of relevant data for research.


    > Such investment may be used as a sort of insurance against decline/increase in real estate prices.

    First glance at CS-10 and particular real estate markets.

    As otherwise CS-10 index would have been less adequate, metropolitan areas it features are given different weights, according to the sizes of their real estate markets. As a result, the index appears somewhat skewed towards the largest metro areas – almost half of the weight falls on NY and LA, making analysis of these two local markets crucially important for forecast of the index future value.


    It’s important to find out, how homogeneous these markets are and whether extrapolation of conclusions reached on one of the local markets to the whole index would be acceptable.

    Although some similarity in price trends does persist among the areas, graph below suggests degrees of development of these trends differ significantly from area to area.

    Inflation-adjusted CS indices:
    Based on this graph, I guess it would be appropriate if these 10 areas were split in two groups: those with moderate bubble (peaking at +60% to +80% since 1987 – namely Boston, New York, Denver and Chicago – 47% of the index weight) and those with serious bubble (peaking at +120% to +180% since 1987). Some questions arise: what was that something, that pushed prices for the second group that high, but didn’t spread on other areas to the same extent? Of course the thesis about effect of lowered mortgage requirements can be recalled, but, as long as requirements were eased all around the nation, it doesn’t explain the difference observed between the areas.
    One may assume, that the difference in rate of price increase was caused by difference in pace of socioeconomic parameters improvement. Grounds for such assumption are obvious: the faster number of employed and/or per capita income increase – the more money is absorbed by the area to fuel additional demand for the real estate. It this case, once again, we need to learn, whether there were some specific patterns of socioeconomic improvement among areas of the second group not observed among other areas.

    First, let’s look at such an important indicator as unemployment rate:


    Although Washington D.C. metropolitan area shows some remarkable dynamics, I guess, no sound conclusion is apparent in case of this indicator, as long as there appears no essential divergence between groups’ averages.

    Another way to gauge employment dynamics is that by using relative change in number of employed. Grounds: even with growing/stable unemployment rate and stable per capita income local real estate market still may experience demand increase, if absolute number of employed and, thus, aggregate metropolitan income increase.


    And yet again, despite remarkable dynamics on some markets, particularly on that of Las Vegas, Denver, Miami, San Diego and D.C., divergence between groups’ averages is not significant enough to draw a feasible conclusion.

    Next socioeconomic indicator is average income growth (measured as nominal per capita gross metropolitan product growth since 2001; for years 2007 and 2008 nation average GDP growth rate was used). Here we can see some quite intriguing trends:
    As seen, not only average rate of per capita GDP growth was higher for the second group, but also no area of the first group ever exceeds any area of the second one, no exemptions. Preliminary conclusion seems obvious: personal income growth was a necessary, if not determining, prerequisite for bubble inflation in a given large metropolitan area, whilst unemployment dynamics didn’t affect demand significantly.

    As per capita GDP data has shown such interesting results, it might be worth comparing it with paces of bubble inflation. The graph below shows cumulated excess of nominal per capita metro GDP growth over local CS index growth (for years 2007 and 2008 nation average GDP growth rate was used), i.e. if above 100 – per capita GDP was growing faster than local real estate prices, and vice versa.


    Although, most of areas have already returned to levels of 2001, the major ones – Los Angeles and New York – are still around 20% below the 2001st’s income-price ratio. Are they necessarily going to 2001 levels? It depends, clearly, on whether U.S. economic system is to restore pre-bubble regime for real estate market or bubble levels will be considered to remain a normal by market participants. In case, when future state of nature largely depends on hardly predictable actions of a relatively small group of people (fiscal and monetary policy makers in regard to bubble prevention, names having essential power over investors’ views in regard to definition of “normal”, etc.), no strict deterministic approach can be employed, i.e. there’s no data that allows you to predict with high accuracy, e.g., when, for how long and to what extent lending standards will be tightened and how market’s common sense will develop. I doubt, that in such case there is an approach leading to a forecast more accurate than plain comparison with previous bubble developments would suppose.

    Japanese assets bubble and dot-com bubble usually cross investors’ minds as the most relevant recent examples real estate bubble may be compared to. These examples share some important peculiarities with recent U.S. real estate bubble inflation and burst: they largely affected the whole national economy and their developments involved direct participation of broad ranges of investors, thus, drawing media’s active attention. The bottom line of the comparison is that investors do not tend to re-inflate massive bubbles – the ones market considers to be the prime cause of economic downturn or slowdown – once they burst.

    At this point my conclusion would be:
    There is no reason to expect a rapid uptick in real estate prices towards bubble levels, unless slow recovery is replaced by economic boom, accompanied by fast paces of income growth, unemployment rate decline and credit standards conservation. Considering poor effects fiscal and monetary stimulus programs have had so far in the context of consumer spending acceleration and concerns about credit standards in regard to assets rapid inflation prevention monetary policy-makers seem to share, economic boom and demand for real estate soaring are doubtfully around the corner. Meanwhile, taking into consideration essentially slowed paces of economic contraction and relatively stable investors’ and consumers’ sentiment, another major decline in real estate prices doesn’t seem likely as well, thus, UMM/DMM shares do not appear interesting as long-term investments, unless they at least leave $20-30 price range.

    Aspects to analyze later: plausible effects of delayed demand emergence and inventory disposal.
    Tags: Real estate
    Sep 11 12:41 PM | Link | Comment!
  • Big Lots, Inc

    Big Lots, Inc (BIG) – the largest broadline closeout retailer in the United States.

    Current key statistics:
    Market Cap – 1,78B
    P/B – 2 (comparable to sector average)
    Debt to equity – 1.2 (better than sector average or comparable if one company excluded from average)

    Miscellaneous pluses:
    -Nation-wide coverage (1300 stores in 47 states);
    -Broadly diversified merchandise and vendors;
    -In March 2007 Board of Directors authorized massive (30% of current M.Cap) share repurchase program (average share price for March 2007 was about 33% higher than current);
    -Straightforward management strategy.

    Miscellaneous minuses:
    -No attempts to enter foreign markets;
    -No dividends;
    -Revenue growth rate over last 7 years worse than those of competitors and prospective competitors;
    -No intersectoral diversification;
    -High stock price volatility

    Stock target price evaluation:
    1.Over the last 7 years average P/E ratio for non-dividend companies of comparable market cap within the industry was around 15.
    2.As there appears to be no structural problem with the company and uncertainty related to its prospective earnings doesn’t appear extraordinary, average P/E can be applied;
    3.In the nearest future company’s management, whose forecasts have over recent years proved their adequacy, expect no essential earnings deviation from those observed in 2006-2008, so I extrapolate average earnings for 2006-2008;
    4.Considering all the above for me target price would be 26 (=Average EPS for 2006-2008 multiplied by average P/E of 15);

    Additional data:


    Disclosure: No positions

    Jul 19 6:15 AM | Link | Comment!
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