So you want to buy Russian stocks? Perhaps you hadn’t really considered it, but you’re now tempted by the recent dips based on the crisis in Ukraine?
Your temptation is understandable. Russian stocks are, from most outward appearances, a great deal. In February 2013, Forbes quoted Financial Times estimates that Russian stocks were trading for only 5.6 times their earnings, and recent reports suggest the number is down to 4.6. This is a relative bargain given world market averages are closer to 15, and US stocks are closer to 17. General emerging markets trade at 10.5.
The significant drop in the market has been tempting investors for some time, regardless of the risk. According to MSCI (Morgan Stanley Capital International, home of the MSCI Emerging Market Index), in terms of US dollars, the Russian stock market is down 59% from its record high in 2008, and small caps are down a staggering 78% from their peak. Reuters is reporting that Russian stocks are winding up their fourth consecutive month of losses, as the separatist activity in Ukraine appears to be increasing.
According to analysts at Standard and Poor's, investors have pulled approximately $60 billion out of the Russian market during 2014 – a greater exodus of funds than in all of 2013. Yet the chairman of Templeton Emerging Markets Group, Mark Mobius, recently stated that the rewards of investing in Russia and Ukraine outweigh the risks, and they will continue with Ukrainian and Russian investments. Currently, their holdings are at $500 Million in Russian equities.
The Russian equivalent of the Dow Jones is the MICEX, composed of 50 large-cap stocks. As of early March, thirteen of them are below 10 on a price-to-equity ratio and were selling below book value. Among those are the well-known energy companies Gazprom (MCK: GAZP) and Lukoil (MCK: LKOH), with P/E ratios of 3.7 and 5 respectively. For comparison, European emerging markets are nearer 6.3 and Asian markets are at 10.5 based on information from Credit Suisse.
Good grief! Why would you not invest in Russian equities given this information?
Maybe you should, but you should ask yourself two questions first: have they hit bottom, and why would you expect them to rise anytime soon? The fundamentals of the Russian economy were not in the greatest shape even before the Ukrainian crisis.
Keep in mind that most Russian ETF's are energy stocks. All it takes is one good boycott or some real targeted sanctions, as opposed to the toothless ones that are in place as of late April 2014.
Washington has recently ratcheted up the rhetoric and threatened deeper sanctions against energy and financial firms, but investors are trying to answer the same fundamental question as Vladimir Putin – is Washington likely to follow through with deeper sanctions, in the apparent absence of EU support?
The U.S. may increase sanctions, but the EU is not likely to play along. According to an article in Bloomberg, three-quarters of the direct foreign investment in Russia is from the EU, and conversely, Russia supplies one-third of the petroleum imports into the Europe.
In essence, Russian stocks are a bargain, but they are likely to stay that way for a while, and may fall further if sanctions are imposed. What forces are in place to make them rise?
If you are going to dive into Russian stocks now, it might be best to treat it as a lottery ticket. They will eventually rise – and probably rise significantly – but if you are buying now, you are presuming it will be sooner rather than later. And just like buying lottery tickets, don’t invest more than you can afford to lose.