Emerging market laggard tipped to catch up

Political uncertainty has kept a lid on Russian stocks of late, but that could soon change. We look at why Russia's insulation from the US could make it a good refuge for your money.

Russia's benchmark RTS index took a breather last year, trailing other major emerging markets with a 19% gain. Political uncertainty towards the end of the year kept a lid on stocks. Now, though, with president Vladimir Putin backing his close ally, Dmitry Medvedev, to succeed him as president in March and receiving Medvedev's endorsement as his first choice for prime minister, this issue has been resolved.

Putin has caused jitters over property rights during the past few years by hounding oil giant Yukos into bankruptcy and increasing state control over the energy sector. However, he is credited with stabilising the economy after the chaos of the Yeltsin years. Investors have now received a signal that "the regime that delivered Russia from economic chaos" and presided over "sustained growth and booming foreign investment isn't going anywhere", says S. Adam Cardais on Transitions Online.

The economy is certainly in sound shape, with growth humming along at around 7%, a current-account surplus of around 6%, a budget surplus and scant foreign debt. Much of Russia's spectacular growth has been driven by high oil prices (commodities comprise 80% of Russia's exports) in recent years, but it's no longer just an oil story: "we're starting to see real contributions from light industry and the consumer sector", says Tim Seymour of Seygem Asset Management.

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Consumption is gathering momentum it rose by 12% last year as Russia's middle-class expands. The latter has increased sevenfold since 2000 and now comprises over 21% of the population, says Robin Geffen of Neptune Investment Management; it is expected to double over the next decade. Given pay rises in excess of 20% over the past three years, it's no wonder Wimm-Bill-Dann, one of Russia's leading food producers, grew sales by 43% in the first nine months of 2007.

Meanwhile, growth should be underpinned by rising government investment; the Kremlin has said it intends to beef up Russia's infrastructure by doubling spending on the electricity, railways and raw materials sectors, says Handelsblatt.

Given the strong domestic macroeconomic outlook "and its relative insulation from US and European growth uncertainties", Russia is among the countries least likely to deliver downgrades to earnings forecasts, says a recent UBS report. The Russian economy is "well-insulated from outside domestic shocks and its financial institutions have no exposure to subprime problems", so there seems no reason why the market should be trading at a discount in most sectors to its emerging peers, adds Yainnis G. Mostrous of Growth Engines on Financialsense.com; according to Geffen, the market's p/e is under ten. Given all this, no wonder many analysts reckon the market is due a big bounce; Charles Tennes of KIT Fortis Investments sees scope for a 25% rise in the RTS index this year.

Russia thus appears to be a relatively safe haven and an appealing long-term investment proposition, although it seems unlikely that any emerging market can remain unscathed if risk aversion rises amid US and global growth jitters.

Those tempted to nibble at Russia, according to Mark Dampier of Hargreaves Lansdown, should consider Geffen's Neptune Russia and Greater Russia fund and the Jupiter Emerging European Opportunities fund, which has around half its assets in Russia and the rest in up-and-coming eastern European markets.