So damaging was the collapse in the Russian markets and economy in 2008 and 2009 that some people questioned Russia’s status in the influential BRIC grouping.
But a spectacular market recovery last year and promising signs for its economy suggest that Russia should not be frozen out just yet.
DOWN, BUT NOT OUT
The financial crisis hit Russia particularly hard. The Russian economy’s reliance on the export of energy and other commodities means it rode the wave of rising prices to mid-2008, but spectacularly wiped-out when commodity prices cracked.
In 2008, Russian shares lost 72%1 and at the climax of the crisis in September and October, when stocks around the world were tumbling in the wake of Lehman Brothers’ collapse, circuit breakers on Russian markets put trading to a halt for several days.
What followed in 2009 was a deep recession that wiped 9%2 of the value of Russia’s GDP.
The economy has now stabilised and Russia’s shares are among the best performing in the world since the nadir of the crisis having returned 206%1 from January 2009 to 22 March 2010.
Could Russia silence the bears in 2010?
OVERWHELMING OIL?
There is no escaping Russia’s reliance on energy exports. For all the efforts the government makes to rebalance the economy, an investment in Russia will be dominated by the ebb and flow of oil and gas.
In 2009, Russia became the world’s number one producer of oil and gas. Its giant energy producer, Gazprom, represents more than a quarter of the Russian equity market.
History suggests the tight correlation between oil prices and the Russian market – particularly at times of stress. Although the market turned at the top and bottom before oil, the magnitude and timing of the slide is comparable.
It is therefore safe to assume that a broad investment in the Russian market requires a bullish stance on energy prices and, by implication, world growth.
THE BEAR IS NOT TRAPPED
Goldman Sachs coined the BRIC acronym in arguing that the four countries would dominate the global economy by 2050. This argument remains intact, in spite of Russia’s economic setback in 2008.
By 2050, Goldman Sachs predicts that Russia will become the largest economy in Europe and the fifth-largest in the world, behind its fellow BRICs and the US.
But this prediction is not based on wildly optimistic rates of growth over the next few decades. In fact, the highest annual growth rate used in Goldman’s projections is 4.5%. That is considerably lower than the annual rate of expansion achieved since the financial crisis of 1998. To take its place among the world’s economic elite, Russia does not need to shoot the lights out, just avoid blowing up.
CURRENT MARKET CONDITIONS
That’s all very well, but 2050 is a long time to wait for an investment to come to fruition and Russia is still licking its wounds from a bruising couple of years.
What are the shorter-term prospects for the country?
The Russian authorities are wrestling with a growing dilemma. Oil has risen 80%* in value since December 2008, carrying with it the value of the rouble.
But high interest rates (currently 8.5%*), a hangover from a long-term battle against double-digit inflation, feed a growing rouble carry trade. While a strong currency is good for importers and consumers craving foreign goods, it damages the country’s wish to diversify the economy through strengthening export manufacturing.
IF IT AIN’T GOT THAT BLING
If Russia’s economy is to stand any chance of breaking its reliance on energy exports and enjoying a more robust economic recovery, its consumers need to rediscover their (sometimes extravagant) spending habits. In the decade since the Russian financial crisis, consumer spending had increased steadily especially in luxury goods and an appreciating rouble helped boost consumer’s spending power.
At the peak of the consumer spending boom in 2008, Russia’s taste for luxury mean that Porsche sold more cars in Russia than they did in the US.
But that growth collapsed in 2009 as consumers’ growing confidence was shattered by the crisis and the rouble shed 36%1 against the dollar. Relatively few Russians own shares so, in the general population, changing trends in spending are largely connected to insecurity about jobs and wages rather than the markets.
In a survey, a third of Russians said they planned to trade down in one or more categories of goods though some people suggest certain status-symbol luxury items such as fur coats are immune in a downturn.
RUSSIAN BANKING
• Russia has one of the most profitable and underpenetrated banking sectors in the world – Sberbank is Russia’s largest bank with a 51% market share of deposits3.
• Banks are typically more conservatively run than in other countries.
• Sberbank is well capitalised (at 17.2%) and its high deposit base means a high net interest margin on lending of +7%3.
• Among other things, its strong deposit and loan business are a play on the Russian consumer.
CONCLUSION
Russia might have lost some of its shine in the past two years, but fully justifies its position among the BRICs.
In spite of the damage to the economy suffered last year, it is still on course to become Europe’s largest economy. To be bullish on Russia in the short term requires a bullish view on oil, gas and, by implication, world growth (what emerging market does not?).
The paradox is that Russia’s Achilles heel is also its trump card and, among the BRICs, its vast oil and gas industries have the power to lift the entire economy and carry its consumers and other industrial and service sectors with it.
Russia faces some tough challenges in the short term, but should reward careful, well-prepared investors over the long term.
Even though the Russian market doubled in value last year, Russian equities are still relatively well priced. Goldman Sachs analysis indicates Russian equities, priced on a 12-month forward PE basis, are cheaper than the US, Europe, Japan and all its BRIC counterparts.
This is a guest post from Tom Stevenson, Investment Director at Fidelity International. It is the second in a series of articles in a BRIC by BRIC mini-series, produced exclusively for BrilliantWithMoney and Informed Choice. You can read the first article, about China, here.
Past performance is not a guide to what might happen in the future. Please note the value of investments can go down as well as up so you may get less than you invested. Investments in small and emerging markets can be more volatile than other developed markets and changes in currency exchange rates may affect the value of an investment. The ideas and conclusions in Tom Stevenson’s article are his own and do not necessarily reflect the views of Fidelity’s portfolio managers. They are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.
Sources:
1. Datastream
2. Goldman Sachs
3. Fidelity
