COMMENT: The Russian equity market – before, during and after the Crimea crisis

By bne IntelliNews April 2, 2014

Peter Szopo of Erste Asset Management -

Looking at the Russian financial dataflow over the past 12 months, three points are obvious: a) The weakness in Russian data started well before the Crimea conflict; b) data deteriorated, as one would expect, as the crisis developed; and c) while all eyes were focused on Crimea, the world moved on – unfortunately not in a direction supportive for Russian equities. Given its recent underperformance and notoriously low valuations, the Russian stock market will stage a strong comeback as soon as tensions start subsiding. In fact, this process has already started after the Crimea referendum. However, as a result both of the longer-term fallout from the Crimea conflict and global developments, the rebound will likely be more muted compared with recoveries following similarly massive corrections in the past.

Russian macro data already started softening in second half of 2012. Industrial production and business investment turned negative in the first quarter of 2013 and in the course of the year GDP forecasts for 2013 and 2014 were significantly reduced. At present, the IMF expects GDP growth of 2% and 2.5% for 2014 and 2015 respectively, but these figures will definitely come down in the Fund's new World Economic Outlook, which is due in the next two weeks. Sell-side analysts already seem to have incorporated the impact of the Crimea crisis, resulting in a downgrade of 2014 consensus growth to 1.2%. The World Bank's recent Russia report, which was released in the last week of March, provides both a low-risk and high-risk growth scenario, with estimated GDP growth of 1.8% even in their optimistic scenario. Assuming that the fallout from the Crimea crisis will be more pronounced, which we think is a realistic assumption, World Bank economists suggest that the Russian economy will contract in 2014. 

Russia: IP, retail trade, investment (y/y)


Russia: GDP forecast history (consensus, IMF)

Source: Bloomberg, GEMetrixx. 1) Three months rolling averages


Source: Bloomberg, IMF.

The impact of the sanctions as such will be minor, assuming no further worsening of the situation, but investment and retail demand will suffer from surging interest rates, the weakening currency and deteriorating sentiment. Capital outflow remains a major problem, with official estimates of net outflows this year in the range $100bn. Even this figure implies a sharp deceleration going forward, because in the first quarter of this year alone the net outflow is expected to be $70bn.

Turnaround in mid-March, but markets still sharply down. From year-end 2013 to March 14, the last trading day before the Crimea referendum, the Russian market lost 17.7% in ruble terms. The turbulence was not restricted to the equity market. The 10-year sovereign yield surged by 24% to 9.7%, while the ruble lost 10% versus the dollar. Interestingly, equity investors were the last to respond to the Ukraine crisis. While the rise in interest rates and the currency already started in the fourth quarter of 2013, stocks crashed only when the separation of Crimea from Ukraine started to unfold. Since then, stocks have rebounded and stocks finished the quarter 14.6% down in dollar terms – the worst performance since the second quarter of 2012.

Russia: Bonds, equities, ruble (Oct 1, 2013 = 100)


Russia: Sector performance and upside

Source: Bloomberg. 1) Note: Micex performance is inverted


Source: Bloomberg, GEMetrixx.  1) Benchmarks for Total: MXEF; OG: MXEU0EN; MM: MXWO0MT; TL: MXEU0TL; FI: MXEU0FI

Overall upside 15% in the near term, higher in telecoms and banks. If Russia stays out of East Ukraine, which we think is the most likely scenario, and the West accepts that Crimea is unlikely to return to the status quo ante, we may see a further recovery. Despite the recent rally, losses have been only partly recovered. Before the turnaround in mid-March, the market had lost 20% relative to the broader EM universe since year-end 2013. Since then it regained 7%, which implies that the MSCI Russia needs to outperform its EM peers by another 16% to return to its (relative) pre-crisis level. Repeating this exercise also for key sectors that are priced globally shows that the return to normalcy implies significant upside for telecoms (27%) and - even higher  – for banks (32%). (Note that for these estimates the relative performance of Russian sectors was benchmarked against their European - for oil & gas, telecoms, and banks - or global sector peers in case of metal and metals & mining).

Not all is well. While regional investors were focused on the events around Ukraine, the broader economic news flow has also not been helpful. Signals from the first US Federal Reserve meeting under the new leadership of Janet Yellen were somewhat confusing, but most observers see the Fed indicating a tightening of US monetary policy. In addition, the Chinese PMI (HSBC's version of it) weakened further and strains in the country's financial system have become even more obvious. As a consequence industrial metals, particularly copper, headed south. On average, industrial metals lost close to 5% in the first quarter (S&P industrial metals index), although the regained some lost ground in recent days. Finally, also crude prices continued drifting lower, with Brent finishing the quarter at $107 a barrel. The technical rebound after the market's overreaction to the West's sanctions has still some room go, but with interest rates still hovering around 9%, a volatile currency and both the international and the national news-flow coming in weak, there is no reason to get carried away. The Russian market will be facing serious headwinds over the next 6-12 months.

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