CEO at MidLincoln Research
Russia was severely battered in 2014. Yet last year it was one of the best emerging markets, standing pretty firmly whereas most other emerging markets tanked. What will be the dynamics of the Russian market in 2016?
Sentiment towards Russia remains quite grim, and there is no reason to assume that overnight hordes of investors will be piling up in Russian assets. The country is in its pre-election mode. 2016 is the year of elections in the Russian Duma, Russia’s lower house, while customary election years are normally bad for the markets. Dollar is likely to remain strong and it is unlikely that the oil price will be a supporting factor, while the geopolitical risk premium will remain a discounting factor in 2016.
Despite the grim forecast there are investors who will be making bargains while the risk appetite remains at the bottom. They will argue that the ruble devaluation has created significant advantages in some sectors of the Russian economy, that the country remains quite inexpensive as opposed to other emerging markets. These investors will also argue that Russia will eventually lose its pariah state status when sanctions get lifted.
What will international investors be buying?
Most probably there will be a temptation to buy into stocks and sectors of “the new economy”: Internet, communications and technology stocks, consumer names and financial infrastructure companies. There will also be investors favoring companies that are up for privatization as this event could be a significant price-moving factor.
There will also be major shareholders buying back their stock and some will decide to tag along. While it could be quite difficult, it could also make sense to try and catch up the moment when the ruble starts to grow. Finally, somewhat beaten up but nevertheless always relevant is investing in infrastructure.
Browsing through the names in the new economy sectors, investors are likely to start looking for safer names with little or no political risk. Therefore they will attempt to invest in the state-owned stocks in telecommunications and the consumer goods sector, such as the Moscow Exchange, Rostelecom and Aeroflot or looking to position in Mail.ru, Dixy and Megafon where they can enjoy some protection in case of a new asset reshuffle.
Some investors with a slightly different risk profile could go for Magnit, Lenta, or Yandex, companies with no state participation, hence are less heavier regulated. These investments may be just a notch riskier reflecting that their owners are enjoying little political support. Investors particularly favored this class of stocks in the past.
Rosneft, Transneft and Alrosa as well as Aeroflot, the Moscow Exchange and Rostelecom could also enjoy a positive capital flow if another round of privatization happens after all. Privatization has been delayed since 2013, but there is a firmer view now that for some companies, such as Sberbank, VTB and Rosneft, privatization could be the path to escape sanctions. Therefore investors could enjoy double benefits: First, a major price driver in these battered companies could be an expectation that a potential buyer could bid a significantly higher price then is implied by the current market capitalization of these companies. Second, the risk profile of these companies will improve after privatization if the sanctions are lifted.
Buybacks have been a popular theme in the Russian market and it is likely that there will be more companies joining the likes of Mostotrest, Rusagro, Tinkoff and Polyus Gold to support their stocks via buybacks. Lukoil is the one company that has been spotted in the past to use distressed markets to buy back the stock.
Once the Russian ruble starts to grow again it will have an immediate effect on banking or real estate stocks, such as Sberbank, VTB, Tinkoff or LSR. There are many signals indicating that ruble is very close to the bottom. The most powerful of the signals is the decreasing impact of the energy sector on the Russian economy (especially if measured in US dollars) as this sector has been shrinking in line with the oil price. Brent at $30 per barrel is only playing a marginal role for Russia versus oil price at $70 per barrel. If the Russian risk profile improves once conflicts of geopolitical nature gradually die down and the world starts talking about the possibility of removing sanctions, the Russian ruble is likely to positively react to that. The above-mentioned stocks are likely to be the first ones to react positively. On the other hand, strength in exporters’ stocks, such as Norilsk Nickel and Rusal, will be a barometer, signaling that investors are still betting on a weaker ruble.
Russia is being slowly rebuilt and renovated as some of its industrial sites as well as residential real estate and roads are degrading, their use has become at times hazardous and dangerous. Russia is ready to spend lavishly on investments in its infrastructure. In fact on many accounts Russia will ramp up its infrastructure spending to batter the crisis.
Mostotrest used to be the favored investment theme in this sector, but since liquidity in Mostotrest dried up following buyback, Russian steel names, such as Evraz, NLMK and Severstal, as well as real estate names, such as LSR and PIK, will be the ones favored by investors looking into the infrastructure sector.
Glancing back over past crises, Russia has always been able to survive and reward those investors who were faithful. Back in June 1999 a crisis struck when Russia confronted NATO at the Pristina airport during the war in Kosovo. Back then the oil price was a little over 10$ and a lot of investors decided to abandon Russia. It all changed on December 31, 1999, when President Yeltsin announced his resignation. Those Russian traders who did not pay attention as they stepped out for lunch missed a unique opportunity to make money. Just like in 1999, those investors who pay attention to Russia when it is in crisis will be rewarded when the crisis is over.