Russian market sell-off - we've been here before

By bne IntelliNews October 1, 2008

Ben Aris in Berlin -

September's sell-off in the Russian equity market has been labelled the worst in 10 years, but just how bad was it?

There have been several allusions to Russia's 1998 financial meltdown in recent weeks, which saw the value of Russian stocks reduced to pennies on the pound and remain there for five years. But since then, the investment bank Uralsib identifies 11 sell-offs over the last decade, where it took at most three months for the index to win back all the ground lost. In all these episodes the right hand arm of the selling "V" is bigger and taller than the left arm: what this means in the real world is that despite short-term triggers, investors retained their faith in the long-term "Russian growth" story and eventually bought back shares.

That faith is now being questioned. Comparing these sell-offs with the big one in 1998, then - as now - the external drivers of growth were all important; the depth and severity of the current collapse of the US economy will have an unpredictable impact on the Russian growth story. Looking at the collapse in 1998 and the 11 subsequent corrections, this sell-off has features of both.

The Big One: 1998

The collapse of Russia's stock market between 1997 and 1998 was one of the worst crashes since the 1920s. Investors into Russia had been popping the corks for most of 1997 as the RTS index soared to a peak of 571.6 on October 6, 1997. However, just like today, it was the impact of an external financial crisis that proved Russia's undoing: Asian countries had over extended themselves borrowing too much foreign currency and suffered a domino-like chain of collapses.

While most people remember the government's default on its international debt and devaluation of the ruble on August 17, 1998 as the low point of the crash, selling on the equity market actually started about a year earlier and it took another two months for the RTS to reach its nadir: the index was still at 109.4 on the day of devaluation and continued falling to a low of a mere 38.5 on October 5, 1998. If this sell-off is of the same ilk as the collapse in 1998, then it will take five years for the RTS index to recover: from the high of 571.6 on October 6, 1997, the RTS didn't break through the 570 barrier again until October 1, 2003.

Dragon Capital in Kyiv recently made a historical study of previous equity market sell-offs and found on average that developed markets dropped by 27% in a crisis, while emerging markets fell on average 51%, and these crises lasted 313 days and 393 days respectively. In 1997, the RTS went much further, giving up 95% of its value over 250 work days and took a total of 1,505 work days to get back to where it was before the sell-off.

So how does the current crash compare with that at the end of the 1990s? The chart below plots both sell-offs, measuring the percentage fall from the high point of 571.6 in 1997 to the nadir (indexed at zero) and back up again to the RTS index's starting point of 570 (the yellow line). The horizontal axis is the number of working days. The chart also looks at the same numbers from three perspectives: over the full five years it took the RTS to recover; over 70 days either side of the nadir; and finally zooms in on what was happing during the worst of the selling (by capping the vertical axis at 100% change in share prices).

The first thing that jumps out at you is that while it was possible to lose a lot of money in the 1998 crisis on the way down, it was also possible to make a great deal more on the way back up. An investor that bought $1 of Russian stocks in October 1997 would have seen its value fall to 5 cents a year later. However, if the same investor was brave enough to buy another dollar of equities on October 5, 1998, the value of the shares would have passed $500 only two weeks later - the market was clearly massively oversold and quickly corrected. Even if the same investor waited two weeks after the nadir to buy, he would still have made a 10% return after 21 days, a 50% return after 101 days, and 100% return after 158 days. Still, prices were extremely volatile for more than a year and few were willing to risk investing anything.

This autumn's sell-off (the red line) has much in common with a typical emerging market crisis, but is also clearly not as extreme as many. The market lost 57% of its value over a period of 86 work days between May and September, going from an all-time high of 2488 set on May 19 to 1058 on September 17 - a third of the time that the 1997-8 selling took. If Russia keeps to the typical emerging market form outlined by Dragon, it will take another eight and half months for the market to recover.

However, analysts point out that the last 200-point fall in the second week of September was mostly forced selling, which is clear from the graph. If this is taken into account, then the market actually dropped 40%, which is milder than an "average" crisis.

At end of the collapse in 1998, the market was clearly oversold but took about two weeks to correct to the bottom value in the mid-50s. The correction this time was much more rapid, with the index taking only a few hours to rise 22% after trading resumed on September 19 to around 1300 where it stablised.

Sell-offs in the last decade

Comparing September's sell-off with those since the 1998 financial meltdown and it's clear this crash was by far the worst in a decade.

The second chart below compares all 11 sell-offs with the most recent one (the red line). The 86 days of selling that ended in September's panic went on three times longer than the average peak-to-nadir duration of 28.6 workdays for the others and it was much steeper.

But while these sell-offs took a month and half on average, the subsequent recovery went on for much longer: the average recovery period was 73 work days (about three and half months), with the longest lasting almost a year in 2006 and the shortest 40 work days in the winter of 2005, brought to an abrupt halt by the arrest of Yukos shareholder Mikhail Khodorkovsky. In the recovery period, the prices had risen 10% from the nadir within an average of 14 workdays and at most it took 26 work days to reach this point.

If this crash is similar to the less dramatic sell-offs of the last decade, then by scaling up the average recovery period to match the length of the sell-off, it would take nearly 11 months for prices to recover the ground lost - a bit longer than Dragon's estimates for a typical emerging market sell-off. However, if you count out the forced selling in the week of September 16, the estimate for the recovery period is about the same - eight and half months.

Several leading analysts have speculated that the RTS has a good chance of reaching 1500 in the short term, which would be a 13% rise from 1300. If the RTS comes close to the 1500-mark by the end of October, then this sell-off would be behaving similarly to previous such ones over the last decade. If the RTS fails to reach this point or actually sinks further from the current 1250 mark it was at the end of September, it would suggest that investors think there has been a fundamental change in the Russia story.

Of course, the big difference with this sell-off and the previous ones is that over the last decade investors have largely been reacting to events in Russia, whereas this crash is being driven by what is happening in the US. If the authorities in Washington can finally get a handle on the situation, investors could stick with the idea that the Russian growth story remains largely intact. If they fail, then it will take much longer before it is clear how a global slowdown will impact on Russia and its equity market.

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