How I went wrong in Russia

Vladimir Putin is once more cast as the bogeyman

Watching the news from Crimea last week, I couldn’t help but be reminded of my days as a fund manager back in 2008. I was managing an Eastern European fund at the time. So you can imagine how I felt back then when I saw footage of Russian tanks rolling across the border into Georgia.

That was Russia’s last adventure in its ‘near abroad’. The Georgian war in early August 2008 was a major distraction. It knocked sentiment towards Russia and sent an already weak Moscow stock market tumbling.

I judged that this was all political noise, that it would blow over quite quickly. I decided not to panic sell, but to look on the nervousness as a buying opportunity.

I was right about the war, which was over in five days. But it distracted me from the bigger picture, which was about to get very ugly indeed.

Our job as investors is to figure out what’s important and what’s just noise. Often that noise can be deafening and drown out our ability to get to the truth.

Right now, the Russian market is looking incredibly cheap, but many investors are voicing concern over potential risks. So is this all just noise? Or has Russia become the ultimate value trap?

Never a dull moment

By the time Russian tanks rolled into Georgia in 2008, the Russian market was already unsettled. A couple of weeks earlier, Putin had launched a verbal attack on Igor Zyuzin, the billionaire CEO of a steel and mining company called Mechel.

Putin offered to “send him a doctor” after he failed to attend a summit meeting, claiming illness. The sinister overtones of this “medical assistance” helped Mechel shares fall 37% on the day and more than halve over a week.

The market had hit its all-time high in May. But by early August, following Mechel and Georgia, it had fallen by 30% and looked very cheap. So as a fund manager, my view was clear.

Russia had come down a lot further than other markets (the FTSE was down about 11% over this period), and it would be quite wrong to sell on the back of two events that I thought would only have a temporary effect on the market. I believe I was right in this analysis. But I had been distracted from the big picture.

The oil price had spiked up to almost $150 per barrel in early 2008, great news for Russia as the world’s biggest producer. But by summer, it had dropped by 20%. That was probably the real reason for the stock market’s weakness. Not the war, or the threat of a ‘visit’ from Putin’s physician.

Then a month later, Lehman Brothers collapsed and the financial world imploded. Oil plummeted and hit $35 by the end of the year. The Russian RTS index fell by 80% from that May high. And the invasion of Georgia caused me to miss what was really going on.

The Russian value trap

How would I apply those lessons in today’s market? Russia yet again appears to be very cheap and has fallen further than most markets. Sentiment is similarly negative and Mr Putin is once more cast as the bogeyman.

My instinct is that events in Ukraine will have very limited economic impact. But you need to look at the long-term picture. And this has been getting worse.

The oil price is stable, but Russia now needs about $10 more than the current $107 per barrel to balance its budget. The economy will barely grow this year, which compares with the 7% clip it achieved during the previous decade. Governance is every bit as bad as ever. The golden opportunity to modernise and reform during those past times of plenty has long gone.

And then there’s the ‘cheap’ valuation. The giant gas producer Gazprom is indeed on a price/earnings (p/e) ratio of about 2.6. But it’s still an arch destroyer of value, and I can’t make a fundamental investment case for it.

My favourite Russian stock, supermarket company Magnit, trades on 18 times 2014 earnings. Magnit is as good a company as Gazprom is bad. It looks reasonable value to me… but I couldn’t say it’s cheap.

So if you fancy trading against the political noise and buying Russia for a rebound, you might catch it just right. But do keep your eye on what’s really important – Russia’s fundamentals are a lot worse than they were. Russian stocks are a value trap.


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  • IJ1

    Good article. As someone who was also working in Russia back in the boom years and got similarly injured catching the falling knife, I share many of your sentiments. Please tell your Moneyweek colleagues to stop using the CAPE for Russia. I’ve tried on other threads but apparently to no avail. It’s highly misleading. As you point out, Russia’s oil and gas giants are what make it look cheap. But the oil and gas sector globally is cheap too on CAPE – not quite as cheap, but in single digits and with far better governance and better dividends (no stealing). Secondly, Russia’s energy giants’ production and profits have peaked and are in decline. To be bullish, you have to believe payout ratios will increase to compensate, and i wouldn’t count on it. Now we understand why Russia fund managers cite Gapzrom’s 2x p/e to market their funds, but then invest the inflows in 18x p/e Magnit. That said, i do believe there are some opportunities in Russia now outside these 2 stocks. But a secular bull market is impossible without systemic change that looks increasingly unlikely.

  • joe sod

    What about the other big state contolled oil company in Brasil petrobras, any opinions on that one. It is also very cheap I dont really know much about it but maybe it would be more trustworthy than gazprom.

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