Russian stocks are ‘screamingly cheap’

Investors underestimated the risks of an escalation in Ukraine, said David Thebault of Global Equities, a Paris-based asset manager. This week, they got “a wake-up call” as Russia’s grip on Ukraine’s Crimean peninsula tightened ominously.

Many Western markets slid by around 1% on Monday alone, while gold jumped to a four-month high as rattled investors sought out the traditional safe haven.

Russia bore the brunt of the sell-off amid talk of Western sanctions hitting the economy. Russian stocks fell by 12% on Monday and the rouble slid to yet another record low against the dollar and the euro.

Market heavyweight Gazprom, the gas giant that supplies Europe through Ukraine, slumped by 17%. The Russian central bank raised interest rates by 1.5%, the biggest hike since the debt crisis of 1998, to stem the slide in the rouble.

The impact on Russia

The Russian market slide is overdone, according to several commentators. The imposition of sanctions by the West is hardly a done deal. America may be keen, but Putin is confident that European elites “are more concerned about making money than standing up to him”, said Ben Judah on Politico.com.

“Everything Russia’s elites hold dear is now locked up in European properties and bank accounts.” Europe has repeatedly balked at passing anything similar to America’s Magnitsky Act, which bars a few Russian officials from entering America.

Sanctions that target the economy rather than oligarchs look even less likely. “Europe needs Russia,” says Allister Heath in City AM. A full 36% of Germany’s gas, 23% of France’s and 27% of Italy’s is Russian. “Putin could inflict immense damage.”

The West also needs Russia to prop up near-bankrupt Ukraine. More than half of Ukraine’s gas consumption is imported from Russia.

Also, Russia has amassed almost $500bn of foreign-exchange reserves, says Capital Economics – “a substantial buffer” to ride out a period of capital outflows. Unlike in Ukraine, a balance of payments crisis “is not a threat” right now.

Structural weaknesses

However, as Capital Economics notes, while this crisis won’t send the Russian economy off a cliff, the underlying position is pretty grim anyway. The big picture is that the economy is stagnating on an annual basis.

A consumption boom is petering out, and to raise the economy’s speed limit now, investment in production capacity will have to rise. Russia invests just 21% of its GDP, well below the emerging-market average of 30%.

A shrinking work force and poor productivity, a legacy of communism, are further problems. Endemic corruption and weak property rights – companies cannot be confident that their assets won’t be seized by the state – are the main obstacles to boosting investment.

Meanwhile, the current account is slipping into deficit, a sign of falling competitiveness. Overall public debt is low at 15% of GDP – but due to rising public spending over the past few years, the energy-dependent economy now needs an oil price of $110 a barrel just to balance the budget.

Time to buy

MICEX index price chartBut there comes a point when all the bad news is in the price, and that point has surely been reached in Russia. Given its longstanding problems, Russia is usually very cheap, says James Mackintosh in the Financial Times, but now it is “screamingly cheap”.

The MSCI Russia index is on a price-to-book-value ratio of 0.7, virtually the same as after the Lehman Brothers crisis. The cyclically-adjusted price-earnings (Cape) ratio is below seven, cheaper than any of the world’s stock markets except Greece.

If Russia one day gets its act together, investors buying now should be handsomely rewarded. You can buy in via JPMorgan Russia Securities trust (LSE: JRS) or the iShares MSCI Russia Capped ETF (NYSE: ERUS).

Merryn

Claim 12 issues of MoneyWeek (plus much more) for just £12!

Let MoneyWeek show you how to profit, whatever the outcome of the upcoming general election.

Start your no-obligation trial today and get up to speed on:

  • The latest shifts in the economy…
  • The ongoing Brexit negotiations…
  • The new tax rules…
  • Trump’s protectionist policies…

Plus lots more.

We’ll show you what it all means for your money.

Plus, the moment you begin your trial, we’ll rush you over THREE free investment reports:

‘How to escape the most hated tax in Britain’: Inheritance tax hits many unsuspecting families. Our report tells how to pass on up to £2m of your money to your family without the taxman getting a look in.

‘How to profit from a Trump presidency’: The election of Donald Trump was a watershed moment for the US economy. This report details the sectors our analysts think will boom from Trump’s premiership, and gives specific investments you can buy to profit.

‘Best shares to watch in 2017’: Includes the transcript from our roundtable panel of investment professionals – and 12 tips they’re currently tipping. The report also analyses key assets, including property, oil and the countries whose stock markets currently offer the most value.