More Russia Sanctions, And Putin's Endgame

by: Charles Lewis Sizemore, CFA

The United States leads another round of Russia sanctions... and Russian stocks enjoy a nice bounce. The Market Vectors Russia ETF (NYSEARCA:RSX) is up more than 2% today following the news. This seems to be something of a recurring theme.

It's not difficult to see what is happening here. The new Russia sanctions - which cover visa bans and asset freezes on seven new Russian officials and asset freezes on 17 companies linked to close associates of Putin - are not strong enough to have a meaningful impact on Russian President Vladimir Putin personally or on the Russian economy. President Obama, in an odd admission that raises the question of why the U.S. is bothering to impose Russia sanctions at all, acknowledged as much by saying "we don't yet know if it's going to work."

The Russia sanctions are more noteworthy for what they do not include rather than what they do. Vladimir Putin was not targeted personally, nor were Russian energy majors like Gazprom (OTCPK:OGZPY) or Rosneft (OTC:RNFTF). If Obama's goal is truly to "change Putin's calculus," then it's hard to see these new sanctions meeting that goal.

Meanwhile, Putin is not the type to sit back and play the victim. He's striking back with a May 7 deadline for Ukraine to pay its outstanding debts to Gazprom. If Ukraine does not pay - and without financial aid, that cannot happen - Russia will require prepayment for future gas flows, which means that Russia would have a legal basis for simply turning off the tap, starving Europe of nearly a third of its imported gas. Ukraine has $2.2 billion in overdue debts to Gazprom and Russia recently invoiced Ukraine for an additional $11.4 for breaching the "take or pay" clause in its contract.

What's the endgame here?

It is not entire clear what Vladimir Putin really wants. But we can speculate on what he doesn't want.

Putin doesn't want to invade and occupy Ukraine. By one estimate, doing so would require 500,000 to 800,000 Russian troops - or substantially the entire Russian armed forced.

But Putin also does not want a Western outpost, via EU or NATO membership, at his immediate doorstep. My best guess is that Putin is stirring up trouble in Ukraine to improve his position at the bargaining table. If he gets guarantees that Ukraine cannot join NATO or the EU, then the unrest in eastern Ukraine will probably dissipate in a hurry.

While the sanctions have not bitten Russia hard enough to warrant a change of course, a prolonged financial war with the West would be costly for Russia. Already, Russian bond yields have risen, and the decline in the rouble has caused the price of imports to rise.

Of course, Russia sanctions are costly for the West as well. Europe cannot afford higher energy prices at this stage in its recovery, and the UK and Germany both profit handsomely from economic ties to Russia. No one has a vested interest in this crisis dragging out much longer.

How do I see it ending? Ukraine is partitioned into a federal republic. Russia has said that this is what it wants, and the West has no compelling reason to object.

Does any of this make RSX a buy? Not in a vacuum. Russian stocks are, however, among the cheapest in the world, trading at a cyclically adjusted price earnings ratio of about 6. At that price, they are worth buying on dips.

Disclaimer: This site is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results.

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