Of the BRIC quartet, Russia sticks out like a sore thumb. You can’t ignore it, but can you really back up the truck to buy Russian stocks?
Because of this hostility towards foreign capital, Russian stocks receive the biggest BRIC valuation discounts. At some point, stocks get so cheap that it is almost silly not to buy. Also, because Russian equities started the last decade from very depressed levels due to the Russian debt default of 1998, they ended up beating other BRIC markets by a factor of two and three.
Even now, after the economy has improved tremendously in the past 10 years, it is still the most volatile of any BRIC nation. The Russian central bank has had to cut interest rates 14 times in 14 months to spur lending and stabilize the economy — while the Indian, Chinese and Brazilian central banks are already taking steps to tighten monetary policy as economic growth goes into overdrive.
Most observers lump Russia together with Eastern Europe, but this is really in name only. Churchill once called Russia “a riddle wrapped in a mystery inside an enigma” as he often had difficulty understanding the Russians. However, he did come to the correct conclusion that predicting the Russians’ actions would likely be based on their national interest; this is true for nearly any government.
The Russian strategy is to keep riding the boom in natural resources, while reforming the economy in order to reduce their dependence on the oil prices. And while Brazil is also geared towards natural resources, it is not nearly as dependent as Russia. In fact, the Brazilian stock market nearly matched its 2008 high of 73,800 on the Bovespa when it traded at 72,000 in April. Russia, however, is still very far off those 2008 highs; and I see this as an opportunity.
Looking at the performance of the price of oil and the Russian stock market speaks volumes because of the significant leverage of the Russian economy based on the price of oil.
The Russian RTS index declined from nearly 2,500 to under 500 as oil went from nearly $150 to a hair above $30. In hindsight, those were silly prices, but few investors are ready to buy “when there is blood on the streets” in classic Warren Buffett fashion. In my experience, the hardest buys turn out to be the best in many occasions.
Currently, we are experiencing a normal correction in Russian equities after the RTS index more than tripled off of its 2009 lows. Since I am of the opinion that this $150 oil price will ultimately be taken out — oil is headed north of $300 and gold north of $3000 in the next five to 10 years — the Russian market will be very rewarding to patient investors. Given the current leverage to the oil price, it pays to be a buyer of Russian equities as oil has seen a nearly $20 correction from its April highs.
If I had to pick between the S&P 500 SPDR (SPY) or the Market Vectors Russia ETF (RSX) for the next 10 years, I will make my decision in split second — the choice is the RSX, Putin in charge or not. While it is unheard of to see two back-to-back negative decades from the S&P 500, I can assure you that it is possible. Japan’s Nikkei 225 index did so and the S&P 500 can do the same. My opinion remains that you should focus your investments in natural resources and BRIC markets.
There are 46 Russian ADRs, but only four that are listed on major U.S. exchanges. This is because listing on the NYSE or the NASDAQ raises the reporting requirements as the companies have to conform to U.S. GAAP. While Chinese companies often choose to conform to GAAP — giving us a lot of ways to take advantage of that market — Russian companies generally prefer to trade OTC without GAAP compliance. Also, it is cheaper to trade OTC as companies save on the listing fees.
Trading OTC is not a problem per se. Nestle (NSRGY), one of the highest-quality companies on the planet, also trades OTC, so having Gazprom (OGZPY) and Lukoil (LUKOY) trade over the counter is not an issue. As a reminder, Gazprom and Lukoil have the number-one and number-two worldwide reserves of hydrocarbons of any publicly trades companies. At $120 billion and $40 billion, respectively, their market caps do not adequately reflect the current values of those reserves. To boot, Lukoil trades at less than 6 times earnings after the recent correction, where for Gazprom the P/E has never been a relevant metric.
The four listed Russian ADRs — Wimm-Bill-Dann Foods (WBD), Mechel Steel (MTL), Mobile TeleSystems (MBT) and Vimpel-Communications (VIP) — all also offer growth opportunities for investors. They have rallied a lot in the past year, but the recent correction should be bought, in my opinion.
The next time oil trades north of $150, the RTS index should be a lot higher than 2,500 due to the reforms being carried in the Russian economy at present.