Emerging markets have had one hell of a start to the new year, and I don’t mean that in a good way!
The wave of jittery investors selling up has been the story of the year so far. And the US Fed’s stimulus withdrawal programme – known as ‘tapering‘ – is the main culprit. Now, in my opinion, the whole tapering thing is a con. In fact, I strongly suspect that it will soon be reversed.
But in many ways, the Fed has to do the damage before it can go about fixing it!
But for the moment, we’ll stick to the remarkable effect the USA’s so-called tapering is having on the developing world.
Let’s look at Russia, a market that was already trading on a low valuation and which has now been dragged into the emerging markets debacle. In the face of nervous investors ‘risking off’, last week the Russian central bank vowed “unlimited” intervention to defend its currency, the rouble.
Seeing as the Russian market is an area I’d like to delve into in more detail this year, I’d like to spend some time on the subject today. I think that Russia has been unfairly dragged in to the latest Fed-induced maelstrom. But I also think that now may present a great opportunity to get in at the right price.
What went wrong?
Emerging markets have attracted considerable attention over recent years. A lot of newly-printed money from the West has gone straight to work in the East. The only problem is that when the speculators’ ‘hot money’ wants out, it causes a local currency sell-off.
This is exactly the sort of thing that happens in emerging markets. They are always volatile. If there’s been a period of stability and decent performance, it’s as if the markets are looking for an excuse to pull back.
The thing is, however, Russia oughtn’t be tarred with the same brush. At least, not this time.
Russia is no Turkey
Last week, Turkey’s central bank was forced to raise its overnight lending rate from 7.75% to a massive 12.5%. Money was flooding out of the country and the value of the Turkish lira was collapsing. The central bank hiked rates to defend the exchange rate.
As with many emerging markets, Turkey is reliant on foreign capital to keep its economy ticking over. The fact that the central bank took such bold action shows exactly how dependent it is. I mean, just imagine the heartache that this rate rise is going to cause the local economy.
In fact, if you were about during the 1992 sterling crisis – also known as ‘Black Wednesday’, when the British government pulled the pound from the European Exchange Rate Mechanism – you won’t have to imagine the carnage at all.
But I certainly can’t say that Russia has been a great magnet for foreign investment over recent years. In fact, talk to most investors and they’ll assure you that Russia is no place to do business. Don’t forget that many Western investors got burned during the crisis of 1998 when Russia defaulted on its debts, and they didn’t come back.
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So why the big panic then?
For better or for worse, much of Russia’s investment comes from within the country. Essentially, it comes courtesy of the country’s fantastic oil and resource wealth. Crude oil and natural gas exports account for about 50% of Russia’s government revenue too.
There’s absolutely no doubt that this country is heavily dependent on the oil game. That’s why many investors put such a low valuation on the country’s stocks.
But for heaven’s sake – now Russia is getting marked down, because the country is supposedly dependent on hot, new money coming from the Fed. Make your mind up!
Brent crude has remained remarkably steady at around $105 – $110 over recent times. Those prices ensure Russia’s cash-flow. In fact, if anything, the recent smash on the rouble means even more cash comes through the door. That’s because oil exports are priced in dollars. Taxes and duties, paid by the international oil companies, are too. And now, suddenly, these dollars are worth more.
As Matias Silvani of JP Morgan says, “I’m sure the government is happy seeing the currency weaken a bit”. He admits that Russia is facing a “weaker economy, exposure to commodities” and is “trying to gain competitiveness”. But then again, “…a weaker currency, managed, helps on all three fronts”.
The lower rouble gives a fillip to all international exports, not just oil. Of course, the corollary is that import prices go up. And for sure, that means the Russian people will feel poorer. In Russia, probably more than anywhere else, it’s always the man on the street that seems to suffer!
The real point is, today’s world is a very different place to that in 1998. Back then, Brent was trading at $36 and Russia was deeply in hock to foreign entities. Its government was weak and its outlook bleak.
Russia’s silver linings
Nobody quite knows the reasons for the Fed’s tapering smash. Some in the alternative media suggest that it was the right time to put some of the foreign markets “in their place.”
With China and Russia looking relatively strong, that might make sense. And as I’ve alluded to before, at the Fed damage to the markets always offers the opportunity to fix them later!
Unfortunately, we have to put up with this sort of meddling and volatility. But the way I see it, the volatility can be used to our advantage – to gain attractive entry points for our trades.
I see Russia as a great investment. That’s mainly because it’s cheap, and I expect high long-term energy prices. What’s more, Russia is likely to increase its presence in the energy markets.
You may have read about the exciting things going on in the Arctic right now – such the opening up of the Northern Sea Route, otherwise known as the Suez of the North. This could be very exciting for Russia in so many ways.
As part of my efforts to focus on Russia this year, we’ll look at its arctic ambitions very soon.
In the meantime, see here for my favoured way into the Russian market.