Roland Nash, head of research at Renaissance Capital -

Russia's stock market looks like it is staging an end of year rally, perversely ignoring a year stacked with bad news.

Perversely Russia's stock market looks like it is staging an end of year rally, stubbornly ignoring a year stacked with bad news to yet again take the "best performing market in the world" title

For the 9th time in 12 years, the Russian equity market in 2006 is among the top five best performing markets globally. Up 40%, the MSCI-Renaissance index clearly outperforms MSCI Emerging Markets (up 10%) and the next biggest winner, MSCI China (up 35%). What makes this performance particularly impressive is that it is against a backdrop of a period of weakening hydrocarbon and commodity prices. Gains in previous years could always be attributed to rising oil prices or shrinking spreads. That equities have gained 30% since the pull back in May, despite the ending of the bull market for oil, is an important milestone for Russian equities - the market seems to have confidence that Russian companies can generate longer-term value without having to rely entirely on rising demand for commodities.

In fact, out-performance of equities not only belies the oil price. Newsflow out of Russia in recent months hardly seems conducive to rising markets. The decision on Shtokman and the sudden proliferation of 'systematic violation' charges against Shell, Exxon and BP over various sections of Russian environmental and subsoil law suggests that the future of hydrocarbon ownership is domestic, and quite possibly up for pre-election negotiation. The accumulation of financial firepower by Gazprom and Rosneft indicates that knives are being sharpened.

Outside of hydrocarbons, Russia received its annual award as terminally corrupt (ranking alongside Rwanda) from the questionably reliable Transparency International. Indicating the impressive scale of the graft, the Prosecutor General's office recently accused the bureaucracy of squeezing the private sector out of no less than $240 bn (30% of GDP) annually. Russia apparently faces a winter when the gas supplies will run short, and the power sector fail (again). And this is not even to mention the proliferation of shootings, the 'ultranationalist marches' or the downward spiral in US-Russia relations on everything from Iran to Georgia.

Perhaps most surprising about equity performance has been the ability of the market to absorb the wave of IPOs. Year to date, 18 Russian companies have raised $21 billion in primary or secondary issuance. Since mid-September, 10 companies have come to the market, raising $7 billion. Before the end of the year, there could be another 5 companies raising money. And it is not as if all of these companies are unmissable investment opportunities coming at deep discounts to their peers. Yet instead of absorbing potential demand, the increased supply of paper seems to have simply served to advertise to a wider audience the potential of Russian corporates.

If the market is able to look beyond this range of negative media, absorb $21 billion of new issuance and still gain $300 billion in value, in an environment of weaker commodity prices, it seems a pretty healthy assumption that the market will continue to rally into the end of the year, and probably end up above our year-end target for the RTS of 1750. Reasons include...

o Liquidity. The domestic money supply has increased by 40% over the last 12 months, keeping pace with the equity market. Moreover, an increasing proportion is gradually finding its way into the equity market. Russia's financial revolution marches on. Domestic mutual funds, insurance funds and pension funds continue to rapidly accumulate funds. On-line brokers and money managers of various descriptions are among the most advertised products on Moscow billboards. Moreover, oligarchs and government friendly companies are utilizing fresh liquidity to accumulate shares.

o IPOs. Most of the more recent IPOs have been substantially over-subscribed, some as many as 20 times. The marketing blitz associated with this number of IPOs has resulted in new money looking at Russia, particularly from the more conservative sources. Pension fund money is flowing meaningfully into Russian equity for the first time since YUKOS collapsed. In the few deals when international demand has looked shaky, friendly domestic money has come to the rescue, indicating deep pockets - particularly among those oligarchs who have raised cash through their own IPOs. New valuation benchmarks have been set in some sectors, including steel and real estate. Rather than forcing a sell-off in similar sectors, issuance seems to have attracted money into substitutes.

o Oil price. Fears over the failure of future earnings to meet next year targets seem to have dissipated since OPEC has drawn a line under the oil price. Whether this line proves secure remains the biggest question determining performance next year. Relying on OPEC to limit supply aligns incentives rather less dependably than with the developing world pushing demand. With the rouble appreciating, next year could still see aggregate earnings being squeezed. Nonetheless, the recent rally has shown that only a stable oil price is needed for the market to perform.

o Metals prices. The backdrop to metals has proven a lot more solid than that for oil. Unlike oil, where spot is below both consensus levels for next year and forward prices, spot metal prices remain above both for many of Russia's most important exports. Nickel at $31,000 is the most obvious, well above our $18,000 assumption for 07, and considerably above the $26,000 12-month forward. Copper is similarly well supported at $7380 current, $5170 assumed and $7200 forward. Gold is slightly below both, but only just.

o End of year factor. Since Russian equities began trading in 1995, there has only two years when equities have dropped between November 1 and December 31st - in 1997 following the Asian crisis, and in 2004 when the government was pummelling YUKOS. Even including these two years, the average return in the final two months of the year has been 12%. Whether it's natural optimism about the following year, or end of year window dressing, Russian equities generally tend to have a positive final couple of months.

News flow has hardly been positive for Russia over the last few months. Yet, as has so frequently proved the case since 2000, private money seems to be telling a different story from public information. FDI, according to some sources, will rise to $25 billion in 2006, 30% higher than a year earlier and at last a respectable level on a per capita basis relative to emerging market comparables. M&A activity is similarly up, reaching $25 bn in H1 2006. And the stock market has gained $300 billion in value so far this year.

Overlooked electoral uncertainty and new sources of oil production are issues that may change the outlook for Russian equity in 2007. But in the short-term, it seems that we can enjoy the traditional end of year rally, despite the negative noise.