Kingsmill Bond of Troika Dialog -

There is no new Cold War. As strains from the Georgian war spread, investors should avoid the tired calls for a renewed Cold War as the last gasp of the warriors against the Soviet Union. There is neither the ideological difference, nor the equality of power, nor the desire on either side to spark another. The conflict of words we are witnessing is rather an aspect of the waning global power of the US and the rising local power of Russia.

More tensions are likely. The conflict will strengthen hawks in both the US and Central and Eastern Europe, as well as in Russia. In the US, Senator John McCain has used the Georgian conflict as a central issue in his presidential campaign. In Eastern Europe, Ukraine has turned up the tension by its comments on the Black Sea fleet and US missile bases. And in Russia, those fearing encirclement by Nato have only had their fears enhanced.

Investors are unlikely to buy. Unknown political risk and constant negative headlines are not likely to induce investors to buy the market, especially at a time when commodity prices are falling and legal risks seem high. We estimate that foreign investors own around half the free float, and at the last time data was available, they were nearly 2% overweight the market. Although the market is cheap at 7.5 times forward earnings, it was cheaper than this in the period before 2003 when we also faced considerable scepticism on the Russian investment story.

Market is vulnerable to foreign capital flight. Although Russia's macroeconomic framework remains extremely robust, it is foreigners who are the country's key sources for long-term debt and equity capital as long-term domestic sources of money are still relatively underdeveloped. Foreign selling not only undermines the equity market, but can slow growth if companies are unable to access international debt markets.

No rally till 2009. Although the market is cheap and the domestic story remains resilient, it will need a pretty significant catalyst (such as a rising oil price or a major package of oil tax reforms) to counter global risk aversion and investor shock after the events of the last month, even if Russia pulls out of Georgia. We would be surprised to see a catalyst to take the market up before year-end.

A good opportunity to find bargains. The two key risks for emerging markets have always been macroeconomic disaster and politicians leading the country away from a market economy, and a good rule has been to avoid markets affected by these until after a major shock. However, we believe that neither risk applies in Russia, and expect the rising cost of money to create attractive bargains, especially among the domestic plays.

Ukraine is the most vulnerable area. Unlike Russia, the Ukrainian macroeconomic framework is dependent upon foreign capital, as the country runs a large current account deficit. The latest geopolitical fragility could damage the country's currency and market still further.

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