For investors, Russia has long been the forgotten child of the four BRIC emerging markets (Brazil, Russia, India and China). Five years ago, US$100-a-barrel oil propelled the Russian economy to nearly 4.5-per-cent GDP growth, and yet many Western investors still shied away from the country for any number of legitimate reasons: Russia was too politically volatile, too hard to do business in and just too risky.
Meanwhile, the “BIC” countries became staples of emerging markets portfolios and investors' attention. China has dominated financial headlines; India has become the world's fastest-growing large economy; and Brazil has foundered in deep recession, but seems on the path to recovery with a new government committed to economic reform — the benchmark Brazilian Bovespa stock index is up nearly 50 per cent this year.
And Russia Well, it's still a basket case. It remains off the radar for many investors, and with good reason. But that might be about to change.
Now, that's a big “might.” The November 2014 collapse of oil — which accounts for a hefty portion of Russia's GDP and most of its exports — along with Western economic sanctions over President Vladimir Putin's aggression in Ukraine and the Middle East, plunged the economy into a deep recession (-3.7 per cent in 2015). The International Monetary Fund expects GDP to shrink by 1.2 per cent in 2016, and to rebound anemically next year to one-per-cent growth. Inflation is running at more than seven per cent.
Meanwhile, Putin has reportedly shown little interest in relinquishing state control of the economy, and has rejected or ignored pleas for market-friendly reforms. He's more interested, apparently, in cementing Russia's position as a bully on the geopolitical stage.
Yet, rather quietly, Russia has provided one of the world's best-performing stock markets this year. Moscow's large-cap MICEX index is up more than 12 per cent year-to-date; the MSCI Russia Capped Index, which includes mid-cap companies and is replicated by a handful of ETFs, was up more than 30 per cent YTD at the end of September. Despite this uptick, however, Russian stocks still look cheap; the MICEX P/E is about 9, compared to nearly 20 for the S&P 500. In short, from a valuation perspective, Russian stocks might have considerable upside.
The ruble, meanwhile, has been soaring against the U.S. dollar for months, up about 30 per cent since its mid-January low. Yet at US1.6 cents, it's still only about half its value before the oil crash and the sanctions — which, if you're an optimist on Russia, means the currency still has a long way to rise.
I use the notion of “optimism” advisedly, of course, since what's good for Putin's Russia is quite likely bad for much of the rest of the world. But putting ethics aside for the moment, there are several factors that support the case for a Russian revival.
The rise in oil prices this year has no doubt helped the country's GDP, currency and stocks, and at this point placing a bet on Russia would in large part be a bet on that recovery continuing. As the world's second largest producer, where oil and gas once accounted for nearly 70 per cent of government revenues, Russia clearly has a lot riding on the pending output limits the Organization of Petroleum Exporting Countries will try to confirm at its November meeting.
Putin has already declared that non-OPEC Russia will be onside with OPEC's caps. Whether it will actually stick to any of its commitments is another issue — it has broken such promises before. But from Putin's perspective, OPEC caps are a win/win. Russia is already at record production, and even the illusion of real production cuts is likely to maintain higher prices, if only for a while.
Another “optimistic” factor is the possibility that Donald Trump becomes the next president of the United States. This may benefit Russia in a couple of ways.
First, in the short term at least, there's the potential a Trump win will be a major destabilizing force in global markets — hardly an unlikely occurrence, given that he has promised trade wars, has an economic plan that would add billions to the deficit, has openly contemplated a default on government debt, and has flip-flopped on a fairly countless number of issues.
If markets respond with panic, we can expect a run on the greenback à la the hammering of the British pound post-Brexit. That would provide another boost to the ruble, as well as to oil producers like Russia, because crude is priced in U.S. dollars. We caught a glimpse of the potential last Friday, with news that the FBI was once again looking into the Hillary Clinton email scandal: the ruble gained half a per cent against the greenback.
Second, there's Trump's openness to friendly relations with Putin. If America becomes Russia's friend (some might characterize it more as a “stooge” relationship), then that raises the prospect of the reduction or elimination of sanctions, not to mention freedom for Putin to more aggressively pursue his economic and geopolitical interests.
In short, investing in Russia now might be a great hedge against a Trump presidency. That might be enough to put the “R” back in “BRIC” for investors willing to live with big political risk — and to hold their ethical noses.