In 1999 Al Breach, the 20-something year old head of research at Goldman Sachs in Moscow, made a legendary call. He persuaded his bosses to mark the entire Russian equity market up to “Buy.”
Many thought him crazy. Russia’s financial system had just collapsed. The government had defaulted on $40bn of GKOs, the state’s main treasury bill that was largely held by foreign investors (and since replaced with the OFZs). Unemployment, inflation and poverty were soaring, while GDP growth had just gone through a 14-point swing from around 7% growth to a 7.5% contraction. And the government had no more than around $5bn in foreign exchange reserves.
But Breach was right. Any investor brave enough to have followed his advice would have made a mint. Renaissance Capital, the doyen of Russia’s equity markets in the 1990s, has just made the same call, marking the majority of Russian equities up to Buy.
The pattern was less obvious in 1999, but since then it has become pretty clear that the Russian equity market goes through regular supercycles of booms and busts.
The RTS peaked in 1997 at over 500, but that autumn the index hit its all-time low of a mere 38.3 on October 6. A year later the index had more than doubled to 88.7. Another year on the index had doubled again to 194.5. The following year the index had done less well and lost some ground to 175.1 on October 6, 2001. But the year after it had almost doubled again from the 2000 level to 349 on October 7, 2002 – a ten-fold gain on its October 6, 1999 low in only four years.
And so on. You get the picture. The RTS continued to climb fairly steadily in the following years until it finally reached its all time peak of 2,487.92 on May 19, 2008, when the market crashed again and by the end of October that year was down to 551.96.
Clearly with these wild swings the game is all about getting your timing right, and investing just after a particularly nasty crisis actually makes a lot of sense.
“The last four 50%+ oil price declines (1997-1998, 2000-2001, 2007-2008 and 2014-2016) were all great entry points for investors into Russian equities,” the Renaissance Capital research team of Daniel Salter, Charles Robertson, Sofya Donets and Vikram Lopez said in a note to clients on April 24.
“Over a quarter of a century of data since the inception of MSCI Russia (at end-1994) shows us that provided oil prices have fallen by 65%+ from their peak, Russian equities have always shown a positive dollar return over the subsequent six months (and have also outperformed MSCI EM over the same six months). We are thus overweight Russian equities on a six-month view,” the Rencap team conclude.
Russia is a cyclical market, not a steady recovery and growth market. Over the long term all the gains investors make in the good years – in non-crisis years the Russian equity market usually returns about 20% or more – tend to get destroyed in crisis years. And the crisis years can be are very bad indeed. Following the August 1998 meltdown the leading dollar-denominated Russia Trading System (RTS) index lost 85%. In March this year the RTS was down just under 50% YTD. But just as an investor can lose their shirt investing in Russian stocks ahead of a crisis, they can equally make very good returns by investing just after one.
Buy on the oil crash, sell on the oil boom
To paraphrase Baron de Rothschild’s famous, “buy on the sound of cannons, sell on the sound of trumpets” investors should buy on the oil crash and sell on the oil boom. This is the fifth time oil prices have fallen by half, says Rencap.
1. 1997-1998 when the 1997 Asian financial crisis morphed into Russia’s 1998 crisis. Brent oil fell by 59% from $21.7 per barrel to $9.0/bl and the MSCI Russia Index declined by 94% from peak to trough (all figures in dollars).
2. 2001, coinciding with the 2001 US recession which followed the bursting of the tech bubble in 2000. Brent oil fell by 56% from $37.7/bl to $16.6/bl and MSCI Russia declined by 52% from peak to trough.
3. 2008-2009 during the global financial crisis. Brent oil fell by 77% from $146/bl to $34.0/bl and MSCI Russia declined by 80% from peak to trough.
4. 2014-2016, which saw OPEC decide not to cut output despite the rise in shale oil production in the US and amidst a growth slowdown in China. Brent oil fell by 77% from $115/bl to $26.4/l and MSCI Russia declined by 57% from peak to trough.
5. 2020- the current coronavirus crisis. Brent oil fell by 75% from $69.0/bl to $17.3/bl and MSCI Russia declined by 51% from peak to trough.
Each of these collapses saw Russian equities lose half their value in dollar terms from peak to trough.
“Each of the four oil price collapses over 1997-2016 has represented a great buying opportunity for Russian equities, which rose by 50-239% over the following six months from the equity market bottom (34-114% from the oil price bottom),” says Rencap.
In the rebound from 2014-2016, the sector winners were financials, telecoms, energy and materials; the relative losers were consumer staples and utilities.
This portfolio is largely a list of investor’s darlings from the last few years and as the major stocks on the market are likely to attract the first round of investment as many have simply become “too cheap to ignore.”
Sberbank has become Russia’s “tourist stock”, the name investors buy before they buy anything else, as in addition to being a very large bank that enjoys many competitive advantages thanks to its state-owned status, it is also a play on both the consumer story and the overall economic recovery.
Rosneft and Norilsk Nickel are the largest oil and metal companies respectively, whereas Novatek is Russia’s biggest independent producer of gas and LNG. Novatek’s share were on a run last year and doubled in value together with those of Lukoil, Russia’s largest privately owned oil company.