My Quick Take On Russia

Summary

• Russia is getting hit hard by the news cycle.
• It turns out that this is just more of the same.
• This is a buying opportunity, the article explains why.

They could kiss and make up at any time

The Russian market has been severely punished in the last few days. Yesterday, the MOEX Russia Index was down 8.3%. However, the punishment was compounded by a drop in the Russian Ruble, from 58.1 to the dollar through the weekend, to 63 now, a 8.4% drop. As a result, the Russian RTSI index, which prices in USD, dropped a massive 14.1% in the last 2 days alone.

This drop happened on account of renewed sanctions from the U.S., targeting further Russian individuals and corporations. The effect was particularly pronounced on Rusal and En+, which due to their largest shareholder being targeted, are now in danger of being in default. These stocks dropped in excess of 50% in a matter of days.

The sanctions themselves are related both to:

• The attempted murder (in London, using a chemical weapon) of a former Russian spy.
• Developments in Syria, where Russia sides with the sitting Bashar al-Assad dictator, whereas the U.S. sides with several moderate Islamic groups, in both fighting Bashar al-Assad and ISIS.
• And generic feelings about cyberhacking, U.S. election interference/lobbying, past Ukraine developments, etc.

Leaving aside the weirdness of diplomatic/political sanctions on a country focusing on specific individuals and corporations, the question is on whether all this stock market punishment is warranted from an investment perspective. In my view, it is not. Let me explain why.

Reason #1 – The Type Of Sanctions Isn’t New, And The Economic Impact Is Limited

There are three reasons for me saying this:

• What we saw with the latest round of US. sanctions was an extension of a pre-existing list based on pre-existing rules. The individuals get restricted movement, the entities get frozen assets in the U.S., restrictions on dealing with U.S. entities, restrictions for U.S. investment in them.
• In early 2017 when individuals and entities were similarly added to the list, the Ruble did not react to a similar event.
• The original sanctions did not have a large economic impact on Russia. Russia’s economy did suffer at the time, but basically because crude was crashing at the time (from mid-2014 into early 2016) with Russia’s economy/exports being highly reliant on energy (crude, natural gas). As soon as crude stopped crashing, so did the Russian Ruble, even though sanctions remained in place.

Reason #2 – Russia’s Inflation Is Now Controlled

Russia has had an inflation problem for the longest of times (since the U.S.S.R. breakup). Yet, as we enter 2018, Russia’s inflation is now at record low levels.

Source: Tradingeconomics.com

Low inflation brings economic stability and the ability to have lower interest rates. Those bring investment and sustained economic growth. Low inflation also argues for a stronger currency. These are all in opposite of what we’re seeing due to mostly-irrelevant sanctions (though the Ruble crashing is going to produce some imported inflation).

Reason #3 – With Lower Inflation You Get Lower Interest Rates

The Russian central bank has been cutting reference rates left and right. These now sit at 7.25%, but will likely head lower still. Indeed, rates below 6%, and possibly as low as 4%, are likely. This is so because the Russian CPI now sits at 2.4%, below the central bank's 4% objective.

Source: Tradingeconomics.com

Lower interest rates promote investment (more projects get over the threshold), promotes real estate development (within investment) and consumption. All of this argues for stronger economic growth -- economic growth which can even be free from an energy/commodities boom.

This is not an environment to be dumping Russia. Indeed, it’s nearly the same as dumping U.S. stocks during the early 1980s, at which time a similar dynamic was taking hold in the U.S. (low valuation, high but declining interest rates, high but declining inflation).

Reason #4 – Russia Is Back To Economic Growth

As a result of the much more favorable economic environment, but also because crude and commodities' pricing has improved, Russia has started showing economic growth again:

Source: Tradingeconomics.com

While this economic growth is feeble, I’d say the present environment will call for a broadening of economic growth. More of it will spread to real estate and consumer-driven sectors.

Commodities such as metals will also provide a further boost even as crude’s contribution might stagnate. Natural gas is continuing to rally in Europe (now at 2-year highs) and that will also help.

Reason #5 – The Russian Trade Balance

Russia's trade balance is behaving extraordinarily well. With crude at $70/barrel, the surplus is nearing levels set when crude was higher than $100/barrel.

Source: Tradingeconomics.com

This isn't the trade balance of a currency going down the tubes.

Conclusion

The news cycle might call the attention to a few backwater skirmishes like those happening in Syria or to exciting spy games, along with assorted sanctions. However, the broader reality is one of Russia seeing lower inflation, lower interest rates and renewed economic growth.

These factors argue for a stronger Russian economy and higher, not lower, valuations on Russian stocks and the Russian Ruble. Russian equity yields which previously competed with over-10% interest rates, will mostly remain stable even as interest rates continue downwards. At some point, this will provide a mechanical push upwards to Russian equities.

There are challenges, such as Russia’s demography which is fully stagnated. Or the news cycle, with ever more sanctions and, probably soon enough, a Russian retaliation. But much like Afghanistan or Iraq meant nothing for U.S. stocks, Syria or Ukraine ultimately will mean nothing for Russian stocks over the longer term.

As a result, the current Russian currency and stock crash is a buying opportunity.

The main US-listed proxy for Russian stocks is the VanEck Vectors Russia ETF (BATS:RSX). Hence, for a long term play this ETF ought to be a good candidate for buying.

The RSX ETF does have its weaknesses, though, such as a ~38% exposure to energy-related stocks. This makes it more sensitive to developments in crude, and crude is basically the biggest vulnerability of the Russia/Ruble long thesis. However, this energy exposure doesn’t cover just crude – it also includes natural gas. As I said above, natural gas in Europe has been breaking records … in Euros. And the Euro itself is up strongly against the dollar. Again, that bodes well for Russia and the Ruble.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RSX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.