Russian Stocks are Quietly Outperforming

Russia has a lot of problems. They have severe concentration of wealth due to corruption and oligopolistic aspects to their economy. Growth is slow and population levels are stagnant. And yet their stock market is on fire lately.  

Since I last wrote about Russia in March and discussed the potential opportunity there, the Russian market is up substantially, outpacing most developed markets (S&P 500, MSCI EAFE, Japan) and the other three major BRIC emerging markets (Brazil, India, China):   

Russia also had the top score out of 30 countries in my April international report. We’ll see how it does for the rest of this year and next, but so far it’s a nice start. 

Good investment returns come not merely from what is doing well, but specifically from what is doing better than it’s expected to do.

A historical example of this would be the Nifty Fifty stocks of the 1960s USA. Everyone thought that a group of 50 super-blue-chip companies at the time like Disney, Coca Cola, Xerox, and IBM were invincible, and that they would only go up and that you could pay any price for them.

It turned out that the vast majority of those companies indeed did do very well fundamentally. However, most of their stocks went on to have negative real returns over the next 10-20 year period in what was the second worst bear market in U.S. history, second only to the Great Depression. Why? Because they were dramatically overpriced, often at P/E ratios of 30, 40, or 50, which was far above what their growth rates should have been paid for.

Russia’s stock market is doing well now not necessarily because it’s doing great economically. It’s doing “okay” after a period where it was priced for Armageddon. With Brent crude in the $60’s per barrel, Russian producers make money compared to 2015-2017, but not as much as they would prefer.

Even after this run up, Russia has a P/E ratio of under 6, a CAPE ratio of under 10, a high dividend, below book value, and a market capitalization to GDP that is considerably below its peak from the prior decade. According to the Big Mac Index, its currency is the cheapest in the world in terms of purchasing power parity, which gives them a huge advantage on wheat exports and other aspects of international trade for as long as it stays this undervalued relative to the dollar and euro.

A Financial Fortress

Ever since the country was crippled in the aftermath of the 1997 Asian Financial Crisis, Russia has been strengthening its financial position. It has further hardened its resiliency after emerging from the 2015 oil price crash, which put the country into a recession.

The country has been a gold bug lately as it has tried to de-dollarize its reserves:

When considering all official reserves (not just gold), Russia has one of the highest ratio of reserves relative to GDP and especially to its broad money supply:

Russia also has a relatively high real yield on its bonds:

And according to the Bank for International Settlements, they have very low debt:

Basically, if you are concerned about low/zero/negative interest rate policy around the globe, along with money printing or currency devaluation, exposure to a commodity-driven country with tight monetary policy and high real yields, like Russia, is an option to consider. Their currency is cheap, their stocks are cheap, their bonds are cheap, and they have gold, oil, gas, nickel, etc. 

Russia’s central bank governor, Elvira Nabiullina, is one of the best in the world. Since being appointed to the position in 2013, she has focused strictly on the long term in a world where almost everyone is focused on the short term.

Last week from Bloomberg:

Tight budget and monetary policies have increased Russia’s resilience to external risks in recent years, but with President Vladimir Putin’s popularity sagging, the Kremlin is eager for ways to boost living standards. Russia’s Finance Ministry suggested last month that the nation should start spending some of the tens of billions of dollars saved up in a rainy day fund to spur growth. Nabiullina has publicly opposed the idea.

“The main risk to our development now is from ourselves,” Nabiullina said at the International Financial Congress banking forum in St. Petersburg on Thursday. “If we try to use cheap money to mask our structural problems, we’ll just be wasting more time. We’ll lose the macro stability we’ve spent so much time building.”

Russia could find itself vulnerable again if oil has another big drop in prices, or if the United States decides to increase sanctions on it. Nabiullina knows this and is working to keep Russian reserves high so that they can weather external pressure if need be, whenever or wherever it might arise.

I don’t know how Russian equities will perform throughout the rest of this year and into next. It depends on oil prices, politics, global economic conditions, and changes in valuation.

However, Russia is cheap. It should be cheap due to its low growth, high corruption, and sector concentration in commodities, but it’s likely still undervalued. I have a positive long-term view of Russian equity performance over the next five years, assuming no major tail risks occur (war, major sanctions, a long-term oil price decline, etc). Due to those tail risks, I don’t have a large position, but I continue to be long RSX (large caps, very energy/commodities/finance focused) and RSXJ (small caps, more diversified) within my diversified portfolio.