Russia's ruble denominated MICEX stock index hit an all time high of 1971 on April 21, beating its previous record of 1970.5 set in 2007. The MICEX index has fallen back a little to close at 1957.18 as of April 25, but the dollar denominated RTS index also crossed the psychologically important 900 mark for the first time in nearly two years and was trading at 929.30 at the close on April 25. However, the RTS is still less than half its all time high of 2487.92 set on May 19, 2008 just before Lehman Brothers collapse that sparked the Great Recession.

Should investors get excited about the new MICEX high, and will the RTS ever get back anywhere near its previous record? What is the fair value of both indices these days? Russia’s stock market is clearly linked to the price of oil, but the old relation has been broken and portfolio managers are scratching their heads trying to work out what the new paradigm is.

In the boom years a clear relationship emerged between oil prices and the value of shares. The MICEX and RTS indices used used to be about the same number and as bne IntelliNews has already reported the rule of thumb was the value of index is simply 15.5-times the price of oil.

That ratio has been remarkably robust. Since the inception of both the RTS and MICEX indices have have a long term average ratio of 14.8 and 15.2 respectively to oil prices. Moreover, even over a shorter period post-Lehman the average ratio has stayed roughly the same: the ratios between now and 2010, when the economy settled after the last big global crunch, are 16.8 for the RTS although MICEX has been pushed higher by its recently jump to an average of 20.9 over the last six years. As the chart shows until the devaluation of the ruble at the end of 2014 the ratio was holding consistently.

This relationship took a while to establish itself. The RTS was founded in 1995 with the index set at an arbitrary 100 and the MICEX index in 1997 at the same value. The RTS swung wildly between 4-times oil prices and 20-times oil prices in the early years, while the MICEX index took longer to find an equilibrium trading at the low end of the range for years. However, as the boom got underway in about 2003 both indices converged on the 15.5 mark. The frizz of the boom years is apparent in both the indices and the oil/index ratio in the middle of the noughties when both indices were gaining some 50% a year in value.

The 2008 crisis saw a sharp correction in the value of the indices but not the price to oil ratio, which collapsed back to around the 15.5 mark again and stayed extremely close to this level for the next seven years. Even as oil prices swung wildly to just below $50 per barrel in 2009 only to rapidly recover to around the $100 mark a year later the oil/index ratio remains remarkably steady at about 15.5. 

Then everything changed in December 2014 when oil suddenly collapsed to a low of $27.88 a barrel in January 2016, the lowest since 2003, and Russia entered a “new normal” with the price of a barrel expected to be in the range of $35-$60 a barrel for years to come. The impact on stocks was immediately apparent. Since then the MICEX and RTS have completely diverged with the MICEX soaring and the RTS tanking.

But in terms of the index-to-oil-price the RTS moves have been less extreme. Indeed, despite its low value, the RTS on the basis of its ratio to oil prices now looks overvalued. With the cost of Brent at $44.99 on April 25 the “fair value” of both indices should be 697.34 if the old relationship still help. Currently the RTS oil/index ratio is 21.66 while the MICEX index is a massive 45-times the price of oil, by far the highest it has ever been.

So the market is massively over priced irrespective of which index investors are invested into, right? Well, it is not so simple. The structure of the economy may have been fundamentally changed by the collapse of oil prices. Oil and gas tax revenues made up 50% of the federal budget revenues as recently as 2014, but in the first quarter of this year that fell to 28.5%, its lowest level since president Vladimir Putin took over in 2000 (apart from a few months in the bowl of the 2009 crisis when the oil tax take share fell to a similar level).

The torrents of petrodollars are a thing of the past and the state now is making the bulk of its living from boring taxes like corporate profit tax and especially VAT. That should change the way that investors look at Russian stocks.

The big question can be boiled down to simply: “Has Russia become a normal country?” The companies connected to extraction industries and the state used to be hot, but in a normal country it will be firms that cater to consumers, growing sectors like agriculture and innovators in services or tech that are the ones that will make money – and they will do it independently of oil prices, based solely on the fact that Russia is home to 147mn consumers that want to buy all the gizmos and services that de rigueur in the west.