RSX Is An Emerging Market Outperformer
Summary
- S&P far outperformed emerging market funds YTD. RSX stands out as coming closest to rivaling S&P in terms of performance among major emerging markets.
- Geopolitical views seem to have had a negative impact on sentiment in regards to Russia's economic evolution over the past few years.
- The commodities recovery has been a big part of RSX performance, but there has been a failure in recognizing the foundational work that has been done to expand beyond commodities.
- RSX is set to continue to perform well, not only on the back of strong commodities prices but also because of industrials, retail, and innovation.
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Investment thesis: Bloomberg recently remarked on the poor performance of emerging markets, by focusing on the MSCI Emerging Markets ETF (EEM). It singled out a number of poor-performing countries that led to the overall index losing 5% YTD. The RSX (BATS:RSX) fund only gained about half as much as the S&P index so far this year, but it stands out as an outperformer within emerging markets ETFs. There are a number of developments in regards to the Russian economy, which in my view has undergone a great deal of change in the last decade, which much of the investment community, as well as much of the media, have largely missed. It is still a lot about commodities, which is something we saw before in the last commodities boom cycle between 2002-2014, where Russia's economy did alright for a while, after which it largely stagnated even before the global commodities markets turned sour. What Russia's economy lacked then were the seeds to use the cash from commodities to fuel other sectors. It seems that Russia worked very hard in the last decade to prevent a repeat of that. Now that we have another commodities boom underway, I predict that we will see a lot of those seeds start to pay off, even if there will be a few failures along the way. What we will see this decade will be a significant expansion of Russia's value-added activities, which should be bullish for RSX in the long term.
RSX is a relatively broad and diverse representation of the Russian economy
When we think of Russia and its economy, we tend to think along the lines of President Obama's characterization of Russia as a "gas station". The RSX fund, however, covers a wide range of sectors and companies.
Source: VanEck
As one might expect, nearly two-thirds of the fund is made up of energy & materials, but there is also a sizable part of the fund that represents the Russian consumer market in terms of goods & services. Some of the companies represented within the non-commodities sector are also expanded beyond Russia's borders. Sberbank (OTCPK:SBRCY), for instance, has operations in a large number of countries on three different continents. Ozon (OZON), the online retailer on the other hand is predominantly dependent on the domestic Russian market but is seeing sensational growth in revenues. It has stiff competition from fellow Russian online retailer Wildberries, which is not publicly traded. Unlike OZON, it is expanding aggressively into major markets in Europe. Bottom line is that there is far more to Russia's current economy than just commodities, or products derived from commodities, such as fertilizers.
The one-third of the fund that is in no way related to energy and other commodities is, in my view, set to do particularly well this decade. There are growing signs that Russia's non-resources-based economy, more focused on innovations, services like online retail, and so on can benefit from a robust Russian economy. The commodities rebound we have seen this year may be at the root of an expected rebound in Russia's economy, but unlike the prior recovery it experienced earlier this century, this time, its economy is ready to pick up along most of its sectors.
Beyond the non-commodities business sectors found within the RSX fund, there are sizable Russian businesses, some government-owned, some private that are making strides in Russia and around the world. Wildberries is an example I already mentioned. Rosatom, which currently dominates the nuclear reactor market worldwide, is also a valuable asset, given the likely expansion of global nuclear energy. Emerging aerospace projects, with the MC-21 deliveries set to start within months, are also stimulating Russia's wider industrial base. While these companies do not feature directly within the RSX fund, they can help improve Russia's economic performance, which should help many companies that are featured in the RSX fund.
The reasons behind the RSX's outperformance compared with other emerging market peers, and why it is set to do well this decade
There is no denying that Russia had a tough decade. Even though early last decade energy prices were riding high, its economy started to stall out, given that other sectors of the economy performed poorly. The oil wealth effect seemed to produce very limited broad-based prosperity, with the effect on other sectors of the economy somewhat subdued. Then came the Ukraine crisis, where Russia's previously decent relations with the Western World turned sour, with sanctions and counter-sanctions hitting its economy in 2014. Oil prices also crashed in mid-2014, seemingly providing a one-two punch. Things looked bleak, and the effects lasted for much of the decade.
Source: Trading Economics
Perhaps no data point symbolizes the rough time that Russia's economy has had than the average wage data for the past decade. While wages nearly doubled in ruble terms, in US dollar terms, wages actually declined slightly because, since the beginning of 2012, the ruble went from about 32 to the dollar, to 74. The drop in the buying power of the Russian consumer in FX terms made it tough for all domestic companies to thrive.
The situation in regards to Russia's poor economic performance has been well-covered by analysts and the media, providing for a very well-defined view of Russia's economic situation, that has been predominantly negative in regards to its present as well as its future prospects. In the process, much of the positive outlook for Russia's non-energy economy has been ignored. For instance, there is very little coverage about Russia's agricultural revolution that happened since 2014. In 2020, Russia became a net food exporter for the first time since the collapse of the Soviet Union. Russia's food production gains were accompanied by growth in Russia's support industries such as fertilizer production, agricultural machinery manufacturing, food processing, and so on. In other words, it was a broad-based gain. By comparison, the last energy boom period, characterized by the roughly one decade period that started in 2002 and ended in 2014, saw Russians mostly spend their money on food products imported from the EU and from other parts of the world. Russia's counter-sanctions against EU food products worked wonders in this regard. I personally doubt that Russia wants to see its mutual sanctions regime with the EU be dropped, given the positive effects it had on its economy.
As we are now entering a new era of higher commodities prices, Russia's economy is set to improve, with consumer demand likely to take off. This time around, it will not lead to the same unhealthy trends we have seen in the 2002-2014 period, where Russia's broken post-Communist economy failed to sustainably absorb the windfall from energy exports. It was similar to the Spanish gold wealth effect problems, where all the gold flowing in from the new world actually led to its own economy faltering, as the wealth inflow started chasing goods imported from England or Netherlands, rather than stimulating economic activity in Spain. This time around, the financial inflows will end up circulating through the Russian economy to a much greater extent, with a far more broad-based stimulative effect, given that the period since 2014 saw the seeds planted for it to take place.
With a P/E ratio of 8.55, based on the past 12 months, the RSX fund is providing the value that most Western markets no longer have to offer. The S&P is currently trading at a P/E ratio of nearly 30. The great disparity is supposed to be a reflection of emerging market risk premium versus the safe-haven status that the US and to some extent EU, Japanese, and other mature economy assets historically tend to enjoy. I would argue that the safe-haven premium is fundamentally overdone at this point, and it is increasingly sustained by a herd mentality. As the developing world economies continue to grow in global prominence, especially the Asian ones, it makes increasingly little sense to continue to follow the decades-old established trading path of rushing into developed markets whenever there is some global economic or financial uncertainty.
The Bloomberg article I cited at the beginning of the article points to other factors such as an inferior earnings outlook for emerging markets. For the RSX fund, in particular, it may not be the case. Looking at its top two holdings, namely Sberbank and Gazprom (OTCPK:OGZPY), earnings are looking rather healthy. Gazprom just announced record earnings for the latest quarter. Sberbank also saw some significant improvements in its Q3 financial performance. For the reasons I cited throughout the article, I expect Russian companies represented in the RSX fund to do relatively well on average, not only on the back of higher commodities prices but also due to a more balanced, healthier Russian domestic economy.
The geopolitical risk factor
The greatest worry on most investors' minds tends to be the ongoing COVID issue. The latest scare with the Omicron variant, which is apparently highly mutated and spreading quickly, just recently hammered the markets, due to fears that it will lead to further lockdowns, border closures, and so on, which might significantly dampen the global economic outlook for next year. In the case of Russian assets, they started selling off on the back of lower oil prices, as well as the recent tensions at the Ukraine border, where it is alleged that Russia is amassing an invasion force before the Omicron worries began.
No one can predict what can happen in regards to a possible conflict. It may be the case that there will be a new conflict between Ukrainian government troops and rebel forces supported by Russia in the East. It may escalate, with Russia providing open support to the rebels. In that case, further economic sanctions are likely to be leveled against Russia and Russian companies in response. Such an event will surely lead to a steep selloff in Russian assets, with the RSX ETF being no exception.
We should take a step back however and contemplate current realities as they stand. The EU will likely face calls to action, with the "tough on Russia" stance has become a sign of righteousness in the current Western political environment. The problem is that the EU is currently facing a dire situation in regards to its natural gas inventories going into winter. Inventories are currently 18% below their five-year average. Russia is the only actor that can provide some relief, even though its own spare capacity is somewhat limited and it will involve some re-direction of natural gas that would have otherwise been sold as LNG or utilized on the domestic market, where demand has been growing. Before the 2020 COVID crisis, Russia's domestic demand was in fact at record highs, in part because it expanded its domestic petrochemical industry. It will be hard for the EU to push severe sanctions and at the same time resolve its energy issues for this winter, as well as going forward beyond the immediate energy problems it is facing.
US calculations have also changed since the last decade. The shale boom that pretty much met all global demand growth for oil & gas for the past decade is now done. Meanwhile, we are facing a significant rise in inflation, which increasingly risks taking on a life of its own, in other words, it could become self-sustaining. With global oil demand set to reach a new record high next year, it is imperative that all major oil producers and exporters produce at their maximum potential next year and beyond. Based on the latest OPEC monthly report, at some point starting next summer, we can potentially see a situation where daily average demand will surpass supplies on a sustained basis. It could become a major factor in sustaining high inflation rates beyond current expectations that it may still be just transitory. Russia is the world's second-largest net oil exporter, rivaling Saudi Arabia in importance in this regard. It currently has the power to plunge the world into an oil price crisis, with no immediate remedies to counter such a move aside from global demand destruction. It could also lead to a stagflation crisis. For most of the last decade, Russia would have had to cut its oil exports very deep in order to negatively affect the global economy. Given how tight the situation looks going forward, it will not take much of a cut at all to throw the world into economic chaos. No government wants to deal with that.
If there will be some form of conflict between Russia & Ukraine, it will not lead to a sustained or economically devastating sanctions regime. No one can afford it at this junction. The news of such a conflict would therefore be detrimental to the RSX fund and its holders in the short term, but it would present a buying opportunity rather than a reason to fret for long-term investors. I added to my RSX position in response to the recent pullback, on the back of lower oil prices as well as talk of another Ukraine crisis. Both issues are temporary, therefore, the pullback is only temporary. Any short-term pullback due to temporary events should be taken as an opportunity to buy because I believe the RSX ETF will continue to outperform most emerging market ETFs for the foreseeable future. It may even outperform many developed market stock indexes.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of RSX, OGZPY either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (26)
thank you for your thoughts. Because of such thoughts I am able to collect 10%+ dividend yearly.
Russia has been reactive in geopolitics since 1980 (war in Afghanistan). In all these times between then and now, US and UK were very proactive, making Russian empire shrinking to borders of Russia. Not only that. NATO has expanded itself and in some places came to direct contact with Russia, like in Baltics, where German tanks are stationed 160 km from Sankt Petersburg. Ukraine is important only as a NATO platzdarm for threatening Russia militarily. Unfortunately, very few Ukrainians find this fact disturbing. The right question would be: Is the new military block AUKUS of US, UK, Australia strong enough politically to escalate military confrontation between European NATO countries and Russia? In other words, can US and UK start another war between European countries?
I think we need to be honest here, and expect tensions between NATO and Russia as long in future, as both will exist as parts of geopolitical setup. For this reason I prefer to have Russian dividend stock with wight of 85% and 10% growth stocks. 5% for Surgut to hedge USD growth.
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