Troika Dialog -
"I think I am afraid of being happy because whenever I get too happy, something bad always happens." Charlie Brown
August is vacation month in Russia. In theory, not much should happen. In practice, it has historically seen a disproportionate share of events and accidents with lasting impacts. For this reason, Russians approach August with a mixture of a lightened holiday mood and stoicism. For equity investors, it also brings low volumes, as is expected in mid-summer, except when volatility rises due to "unexpected" events. The RTS Index has moved more than 10% seven of the last 14 Augusts. So, hit the beach - but keep the Blackberry on.
Knowledge is power
To quote former US defense secretary Donald Rumsfeld, we already have several "known knowns" and "known unknowns" this August. We need to worry about the "unknown unknowns". The game-changing "known knowns" are a) Russia's formal WTO accession on August 22 and b) the expected application by NCD (National Securities Depository) to the market regulator for the license to operate the Central Depositary. The "known unknowns" are external and linked with the continuing, and escalating, crisis in the Eurozone. There is certainly clear potential for a worsening of the situation that would then drive investors from risk assets or lead to structural changes in the global marketplace. Among the "unknown unknowns" are other events that regularly occur in or affect Russia.
WTO entry is certainly a game changer, despite the widespread skepticism that it will not have much of an effect. No doubt the impact will occur slowly rather than dramatically but, just as has been the case in the 153 current members (including the 15 transition economies that have joined since the WTO was set up in 1995), the competitive pressures of a more open economy will force changes in efficiency and competitiveness. The Central Depositary is also a game changer. The license is expected to be approved in the autumn and it has to start operating by January 2013 according to the law. This is a major part of the ongoing financial sector reform. This programme will in time lead to a more efficient capital market with consequences for how companies obtain funds and how people save. The other "known known" is the Finance Ministry's promised review of budget conditions under the scenario of oil at $60 per barrel.
There is no clear pattern among stocks or sectors. In quiet August months, the best-performing stocks are defensive themes. In years when the market moves more than 10% (plus or minus), the high-beta names (extractive industry exporters) and banks usually move most. Given that one cannot position for the "unknown unknowns", the prudent strategy is to stay near the relatively safe defensive sectors and low-beta stocks: construction, gold producers, media and IT, real estate, retailers and transport.
August: events and consequences since 1998
Diary update. As is tradition this time of year, we remind of the August events since 1998 that have significantly impacted the country or economy, or that have, in light of subsequent events, turned out to be major turning points for both.
1998. Russia defaulted on its domestic debt, leading to a complete collapse in the equity market with the RTS Index eventually reaching a low of 38.5 on October 5. Foreign investors exited Russia in 1998 and, apart from trading funds, did not return until 2004. But $10,000 invested into the RTS Index at the low in that period was worth over $660,000 at the peak in May 2008 and just under $350,000 today. No other major market can match this return over a similar period.
1999. Vladimir Putin was appointed Russia's Prime Minister in August 1999. The legacy of that event has completely dominated Russia and the investment market since.
2000. August 2000 was marked with a series of accidents that included the sinking of the Kursk submarine and a major fire in one of the country's landmark structures, Moscow's Ostankino TV tower.
2001. This was a relatively quiet August, the only memorable event being the bizarre visit of North Korea's "Dear Leader", Kim Jong Il. He only traveled by train, so his month-long visit caused huge disruption to the rail network. His train was filmed arriving at a Moscow station with very visible bullet holes on the side. This was put down to angry commuters in Russia's regions expressing their frustration at the delays caused. No wasting time with letters of complaint here.
2002. August was a month when major forest and bog fires raged in the Moscow region. Just as was the case in 2010, the smoke and heat caused economic disruption. Impossible to draw any numerical comparisons as, in 2002, the economy was quite different from todays.
2003. The only notable event in a quiet August was the formation of TNK-BP, in which BP and its local partners held 50% each. That event is widely credited as leading to the government's review of the country's so-called strategic industries and setting out new rules for foreign investment in these industries. Of course, in recent years, the partnership has been bedeviled with disputes, as it is again today. This time, the dispute is more serious and very likely will lead to an end to the partnership in the coming months.
2004. August 2004 will be remembered as a month of several major terrorist acts in Russia. The list included a car bomb outside a Moscow metro station, two aircraft crashes caused by terrorism and, on September 1, the Beslan school attack. The events, especially the school attack, led to a change of stance by the Kremlin in Chechnya, and eventually to the inauguration of the Kadyrov regime in April 2007 and major investment flows to the region to restore some relative calm.
2005. The first recorded case of bird (avian) flu in Russia was recognized in August. As elsewhere, it caused considerable travel disruption for a few weeks. Then it was forgotten.
2006. Absolutely nothing of significance happened in Russia, or concerning Russia, in August 2006.
2007. The only distraction in August 2007 was the planting of a Russian flag on the Arctic seafloor by a Russian mini-sub. The event kick-started the debate about ownership of a large portion of the Arctic and the rights to mineral exploration/production. That debate is still on going, but Russia is expected to submit its claim to greater sovereignty to the UN later this year or early next year. The flag planting also marked a more proactive phase in Russia's approach to the Arctic, which has since included a sovereignty deal with Norway and a JV between Rosneft and ExxonMobil to explore some blocks in the Arctic region.
2008. The Russia-Georgia war broke out as the world was hurtling toward recession and oil prices were in sharp decline. Therefore, it is impossible to know what the war's individual effect on investor sentiment was and how much of the market weakness it caused. But, the longer-term effect of the war has been more positive. The international criticism and capital outflow (again, mainly caused by the global economy and the sliding oil price) highlighted the difficulty facing the government with its efforts to attract major new foreign investment. That was at least a contributory factor to the new foreign policy strategy in Russia.
2009. One of RusHydro's power stations suffered a catastrophic explosion in which 75 people died and a big portion of the regional power supply was lost. Beyond the short-term effects of the accident, the episode provoked a big debate in Russia over the state of the country's infrastructure and an acceptance that the "basics" need to be fixed before any progress toward creating a diversified economy can be achieved.
2010. The major event was the drought that destroyed a large part of Russia's annual grain harvest and led to an almost year-long ban on exports. There were also widespread forest fires and a flare up of the peat-bog fires around Moscow. Those events directly contributed to a loss of around 1.0 pp of GDP growth last year and higher inflation. The longer-term legacy was caused by almost the surprise realization of just how dependent Russia had become on imported food (and medicines), and how little investment has been made in the agriculture and food sectors since the end of the Soviet Union. Those events in August - as much as anything else - pushed the agriculture, food and pharmaceutical industries to the top of the priority development list and will dominate investment to a (likely) much greater extent than technology this decade.
2011. The summer of 2011 saw a mixture of tragedy and silliness. The major tragedy was not in August but in July when the river boat "Bulgaria" sank on the Volga River with 122 confirmed deaths. August started with reports of UFO sightings over Moscow and other parts of Russia (film footage on YouTube). Prime Minister Vladimir Putin found several archaeological artifacts during a dive in the Black Sea, while, on Russia's Pacific Coast, bathers were more wary of several reported shark attacks. Globally, the major event of the month was the downgrade of the US credit rating to below AAA, which has had a significant impact on all world equity markets since. The major business event in Russia was the signing of a long-term cooperation deal between ExxonMobil and Rosneft to jointly explore several Arctic blocks and to develop other projects.
Other notable August events in Russia's history
1530. Tsar Ivan the Terrible, aka Ivan Grozny (lit, Fearsome) was born. He was the only Russian ruler to abdicate. He did so in 1564, blaming the aristocracy and the church of corruption and treason. But the court could not rule without him and, fearing a revolt by the citizens, begged him to return. He did so within a few months on the condition that he be granted absolute power. He then presided over a period of terror never previously seen in Russia, according to historians.
1914. Russia entered the World War I.
1939. Russia and Germany signed the Molotov-Ribbentrop Pact, which preceded World War II.
1945. Russia declared war on Japan. This declaration is still in place due to the dispute over the Kuril Islands. It is believed that it remains an issue that has prevented much larger Japanese investment in Russia's Far East, the development of which has been identified by Putin as one of his key objectives for this presidency.
1961. Start of the construction of the Berlin Wall.
1968. Soviet troops arrive in Prague.
1991. Coup against Soviet leader Mikhail Gorbachev (failed after three days).
1996. First Chechen war ends.
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