The Latest Putin Dustup Could Sink the RSX ETF

Vladimir Putin is a man who is invariably addicted to the political limelight, pushing the boundaries of international patience in spite of U.S.-led sanctions that have negatively impacted Russian stocks and the Eastern European country’s economic stability.

RUSSIAOn March 6, 2014, U.S. President Barack Obama responded to the Russian military incursion into sovereign Ukrainian territory by issuing a series of executive orders targeting individuals within Putin’s inner circle as well as key industrial centers — all part of a concerted effort to economically stymie Russia.

New concerns are now being raised with Moscow’s latest action, where according to a Reuters report, Russian troops in the embattled region of South Ossetia have allegedly installed border signs about a mile deep into Georgian territory. This intrusion essentially places part of an international pipeline critical to European oil supplies under Russian control.

Future implications from this latest geopolitical flare-up for Russian stocks, via the popular exchange-traded fund Market Vectors Russia ETF (RSX), are quite obviously bearish.

Back when the Ukrainian crisis first erupted, the RSX ETF lost roughly 24% of market value between January and April of 2014. Russian stocks made a bit of a comeback in May, but the rally was short-lived. All in all, the RSX ETF was roughly halved last year.

However, not everyone shares a bearish view on the RSX and Russian stocks in general, with InvestorPlace‘s own Jeff Reeves offering an insightful contrarian argument. Reeves’ premise is that under most metrics of fundamental analysis, Russian stocks are trading in the markets at a discount. In addition, normalization of currency exchange rates and commodities prices would offer a bullish tailwind for future growth in the RSX ETF. In fact, the RSX is up an astounding 22% year-to-date, whereas the U.S. benchmark S&P 500 is piddling along at 3%.

The assessment that Russian stocks are cheap isn’t under dispute. The more pertinent question is why they are so cheap.

It’s telling that the financials for Gazprom (OGZPY) — the RSX ETF’s largest holding — demonstrate an unwinding of top-line demand. For fiscal year 2014, net revenue declined nearly 9% against the average revenue for years 2011 through 2013. This was only partially offset by a 3.5% reduction in cost of goods sold using the aforementioned framework, leading to a relatively poor gross profit margin of $2.34.

As Reeves rightfully cautions, the RSX ETF is weighted heavily toward the energy sector by 43%, while another 17% is allocated to Russian stocks involved in the materials sector. This is a fundamental vulnerability.

The U.S. Energy Information Administration notes in their Annual Energy Outlook 2015 that increased domestic production of energy resources combined with modest growth in American consumption will lead to the U.S. becoming a net exporter of petroleum products after the year 2020. As time passes, Russia’s oil leverage will likely diminish, and with it so will the incentive for investing in the RSX.

RSX ETF, technical chart
Source: Source: JYE Financial, unless otherwise indicated

Technical indicators, too, do not offer solace for potential long-term speculators, as the problem is one of recidivism. Since the middle of 2013, the RSX ETF has charted a weekly series of bearish head-and-shoulders patterns, with each formation culminating in a precipitous drop in the markets.

Interestingly, each drop coincided with a major fundamental catalyst. For the first pattern, it was the initial invasion of Ukraine. For the second pattern, the RSX was slammed along with the crude oil markets. And now, in the third pattern, Russia has been found antagonizing Georgia.

Vladimir Putin has achieved a level of behavioral consistency that can only arise from genuine mental illness, which spells doom for Russian stocks and means another trip down the elevator for the RSX.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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