Ben Aris in Moscow -

So far Nathan Rothschild's adage "buy on the sound of cannons, sell on the sound of trumpets" is holding true: investors who bought Russian stocks shortly before Moscow annexed Crimea, when the RTS Index hit a low of 1062, would by now have seen a return of 32%. After President Vladimir Putin asked on June 24 for Russia's upper house of parliament to repeal a law that granted him the right to use military force in Ukraine, the RTS closed at a five-month high of 1421.

Enthusiasm for Russian stocks in some quarters is gathering momentum, as bne wrote in a piece two weeks ago. Since then, several more prominent investors have increased their Russian equity allocations and marked the country up to "overweight."

"Russia is cheap. I am buying," said investment guru Mark Mobius, executive chairman of Templeton Emerging Markets Group, in early June, in a reversal of the cut from 61% to 46% he he has overseen of holdings in Russian assets.

JP Morgan Chase also released a note on June 19 saying that it was marking Russia up to "overweight," also partly because Russian equities are so cheap, but more importantly because the dividend yields on Russian stocks are above the emerging market average for the first time ever. The revenue-hungry government is now forcing its largest companies to pay dividends – a trend that has crossed into privately owned companies.

"We are [emerging market] bulls. We are raising Russia to [overweight] from [underweight] in our CEEMEA allocation - as the Ukraine crisis subsides, we want to move back into this consensus [underweight] market which should benefit from the value trade as well as faster global growth," David Aserkoff, an analyst with JP Morgan, wrote in a note released in June.

These punts are based on assessments that the political risks associated with the Ukraine crisis are falling. Peter Elam Hakansson, CEO and founder of Russia's leading dedicated investment fund East Capital explains: "The de-escalation of the crisis in Ukraine, including a relatively smooth presidential election at the end of the month — combined with large energy deals — supported the market and currency. Many domestic-oriented stocks — which corrected a lot in the beginning of the year — rebounded sharply on the improved sentiment, currency appreciation and company-specific news."

The growing interest in Russian equity was given a boost as the Russian economy also performed unexpectedly well in May. Industrial production in particular was much better than analysts were expecting – the fourth month in a row that industrial output has performed better than consensus forecasts. Industrial output growth rose to 2.8% on year in May from 2.4% in April. Unusually for Russia, the acceleration was driven by a pickup in manufacturing rather than more oil and gas exports, which is very good news because this is Russia's most sustainable form of growth.

"Even though we and the market had anticipated a relatively strong figure, accounting for some favourable base effect of a poor May 2013, the actual result still exceeded those expectations, suggesting a stronger trend in industry," Alfa Bank's chief economist Natalia Orlova said in a note. "At the same time, we are not completely surprised by the acceleration, as industry is apparently benefitting from the budget boost we mentioned previously. Budget spending surprisingly continued to accelerate to 25% year-on-year in May and reached 10% year-on-year in the first five months of this year, which is significantly above the 5% annual plan."

The jury remains out on whether this will result in a pickup in economic growth. Renaissance Capital and the New Economic School in Moscow released their latest Russian economic trends report on June 20, arguing the economy is growing faster than previously thought. "The upside revision of the RenCap-NES leading GDP indicator signals to us that recovery in Russia might be around the corner. We keep our 1.6% Russian GDP growth call for 2014," the highly respected monthly report said.

And there could be more good news for Russian equities just around the corner. Having hooked the ruble bond market up to the international financial system at the start of last year, the government is pushing hard to include Russian equities in Euroclear's payment and settlement system for the start of 2015, which would give traders in London direct access to stocks listed on the Moscow Exchange. However, according to investment bankers Russian equities could be included as soon as July. Adding bonds to Euroclear was an enormous success and attracted four-times more investment than the government was expected. The hope that is including equities into the system will also give the stocks a bump.

Stocks still a risky bet

But not everybody agrees. Morgan Stanley reduced its Russian holdings by 30% in May, cutting its portfolio to $27.13m from $35.8m by decreasing its holding of all stocks except AFK Sistema, Russia's leading services conglomerate.

More generally, according to a Bloomberg Markets Global Investor Poll in April, 56% of respondents said the Russian market is "the worst in terms of investments" out of the world's eight biggest economies and recommend selling Russian assets due to the Ukraine crisis. Likewise, only 8% of institutional investors with $30 trillion worth of assets under management consider Russia a promising market, making it the least attractive major market in the world, according to another survey by Great Britain's Create Research Center.

Moreover much of the money flowing into Russia at the moment is so-called hot money. Inflow into Russia's Exchange Traded Funds (ETFs) was strongest in May, according to EPFR Global, which tracks portfolio investments. But money invested into these highly volatile instruments can leave as quickly as it arrives, which tends to concentrate investments into a few liquid blue-chip names.

Finally, some commentators say that the belief political risks are falling is wrong. Tim Ash, head of research at Standard Bank, said in a note: "This rally seems to be driven by the assumption that the sanctions threat has eased, post the Normandy meeting [in May] between Presidents [Vladimir] Putin and [Petro] Poroshenko, and the assumption that peace talks will ensue and succeed in calming the crisis in Ukraine, and the impact of Crimea can be isolated. It also comes against a backdrop of flush global liquidity being pumped back into EM, after the ECB’s recent move to further loosen policy in the Eurozone. Some short covering has also driven the rally in Russian assets. However, is there any real, fundamental justification for taking a more constructive view on Russia? We would argue absolutely not – Russia is a weaker and more unpredictable investment story as a result of events over the past few months."

Economic outlook still cloudy with a chance of showers

The economic outlook for the rest of the year remains decidedly uncertain. RenCap-NES kept its leading GDP indicator final estimate for growth for this year at 1.6%, which is a lot better than the zero growth many other economists have been predicting.

Much depends on what happens to capital flight. Russia has been haemorrhaging money since the onset of the 2008 crisis, losing an average of about $60bn a year, according to Alfa Bank.

But this trend might also be about to reverse and the month-on-month capital flight slowed to $4.6bn in April. Central Bank Deputy Chairman Dmitry Skobelkin said at the start of June the amount of money withdrawn from the Russian economy illegally fell to $26bn in 2013 from $39bn in 2012 and that capital flight may even turn positive in July for the first time in six years.

VTB Capital also asked in a report released on June 17: "Is the worst of capital flight already behind us?" and concluded that it was falling. But the two factors that would determine if the capital flow numbers are negative for this year were how many dollars the population buys to protect itself against devaluation of the ruble and how big the shortfall in portfolio inflows to Russia. Redollarisation of Russians' savings peaked in March when the population bought nearly $5bn worth of hard currency, but has since fallen back to the more typical $1.8bn they bought in April.

More unpredictable are the foreign inflows to Russia. Here the outlook is less good. Foreign direct investment flows into Russia will fall to half of last year's bumper result of $80bn, as the conflict with Ukraine prompts companies to delay expansion, the Vienna Institute for International Economic Studies said. And about a quarter of last year's result was due to the sale of TNK-BP to Rosneft.

Capital flight has been a huge drag on the economy, but it is also indicative of the confidence Russian businessmen have in their own economy. The flip side of their current pessimism is the extremely disappointing direct investment figures, which are well below the levels needed to produce any sort of sustainable growth.

A prerequisite for Russia's economic recovery would be a reversal in capital flows and, ironically, the US threat of imposing financial sanctions on Russia has helped the CBR's cause: businessmen in Moscow report that since May large amounts of Russian cash have been returning home from abroad for only the second time in 20 years (the other time was during the boom of 2004-2007), because the oligarchs currently believe their money is safer in a Russian bank than parked in some hot offshore haven.

So is the recent rally in Russian equities the start of a sustained recovery? It is still too early to say; as the French mathematician Blaise Pascal said: "“Il n'est pas certain que tout soit incertain."