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The Russian equity market usually enjoys a rally between September and the end of the year that often returns about 20% to investors, known as the “Santa rally.” But this year as investors anticipate the end of the global coronavirus (COVID-19) pandemic the traditional rally will get a boost, and is expected to run a lot longer than normal as the epidemic starts to fade away in the first half of next year.
Equity markets have already jumped in November following the announcement by US pharmaceutical giant Pfizer that it has a working vaccine with over 90% efficacy. Coupled with Joe Biden’s win in the US presidential election and investors rushed into the markets all at once to adjust their portfolios to the new realities.
“We have just seen the biggest rotation in the history of the Russian market,” says Smolyaninov. “Investors realised that after the US elections they need to change tack and they were closing out the popular short positions and reinvesting into things that have been ignored like oil and gas… it's a complete flip trade.”
The size of the rotation is a result of the severity of the crisis. Since the markets crashed at the end of February investors have almost universally taken up defensive positions in, what Sberbank CIB dubbed, the stay-at-home stocks – things like media, tech, pharmaceuticals – and shorted the back-to-work stocks – transport, banks and oil & gas.
That trade reversed after Pfizer as investors went back to a more normal “balanced portfolio”, buying up the traditional blue chips. In Russia some 70% of the market capitalisation is made up by companies in the extractive industries, which have all been badly wounded in this year's crisis.
Leading traditional blue chip stocks on markets across the global gained as much as 20% in a week as everyone made the same decision to rebalance their portfolio at the same time. However, the frenetic buying and selling was not very visible in the indices, as there was almost as much selling of stay-at-home stocks as buying of back-to-work stocks, leaving the index more or less unchanged. The RTS index rose from around 1,100 to around 1,250 over the first two weeks of November as a result, a nice, but not remarkable, increase.
After being almost flat following the sell-off in March, there is now a very clear recovery kick at the end of the RTS index chart.
Game of two halves
There are now four viable vaccine contenders, including Russia’s Sputnik V that will start to be distributed in December. The main task of inoculating the general population is expected to start in about April and by the second half of next year the pandemic should fade away.
Investors were shorting stocks that were likely to be adversely affected by the pandemic, while they had taken long positions in the leading IT firms such as Yandex and Mail.ru as well and the best retail companies like X5 Retail Group and Magnit.
Commodities in particular were hard hit and the oil & gas sector is still some 30% down year to date. However, consumer stocks and metallurgy went back into the black in July, lifted by the booming e-commerce trade and strong sales amongst Russia’s leading supermarkets that have come through the pandemic largely unscathed. Indeed as bne IntelliNews has reported, e-commerce is booming and the leading players in the retail sector have actually seen sales grow.
Russian assets saw strong $320mn inflows from combined equity and bond fund flows in the second week of November compared with $255mn in the previous week, the largest two-week inflows since January. For much of the preceding months the Russian markets have seen outflows or at best anaemic inflows of the order of a few tens of millions of dollars at best.
BCS GM said the inflows were so strong it was worried that the market might even be overheating a bit. The inflows in the first week of November were the biggest this year – including the boom months in January and February before any of this year’s crises were even visible.
“The Russia-dedicated funds reported large intakes received by both traditional funds ($50mn) and ETFs ($77mn). However, there were two funds, one in every category that made the final number as impressive as strong as second best since July 2018 – the VanEck Vectors Russia ETF (RSX) reported a whopping $97mn of weekly inflow among the ETF category, while the Pictet – Russian Equities fund showed a $52mn weekly intake,” BCS GM said in a note.
The massive rotation was visible in the US markets where the NASDAQ, which is home to corona-preferred stocks like tech, was falling, but at the same time the Dow Jones, which holds the more traditional industrial and financial stocks, was rising in the middle of November.
“The global stock allocation ship was skewed too much in one direction and that ship was starting to take on water. Now people are closing the popular short/long positions as the ship returns to its more usual course,” says Smolyaninov.
Actually this process has been going on since the summer, even before the mass rotation began in November. Following the big sell-off in March investors slowly started buying back into their favourite stocks focusing mainly on the stay-at-home names, with Russia’s internet giant Yandex being the clear favourite as it simply became “too cheap to ignore.”
Yandex’s shares went back into the black in terms of loss/gain YTD on June 18 and have returned a whopping 49% to investors YTD as of November 25. Leading supermarket chain Magnit followed the same path and has returned 20% over the same period, including a recovery from being down 48.7% from its January 1 level on March 12. In the depths of the panic selling in March Yandex has also come back from a -30% loss. Following these spectacular recoveries the argument is that in 2021 the rest of the market will make similar comebacks.
So is this time to mortgage your house and get into the market? It's still a bit early, argues Smolyaninov. Despite the good vaccine news the world is currently in the throes of a second wave and countries are reporting record-high infection rates – in many case the infection rates are twice as high as during the peak of the first wave. It's going to get worse over Christmas before it gets better.
“Global equity markets continue to be driven by conflicting narratives, one of which focuses on vaccines and the economy reopening, while the other focuses on the rising number of COVID-19 cases,” Mitch Jennings, senior analyst at Sova Capital, said in a note to clients on November 20. “The latter is becoming hard to ignore, with Russia’s new confirmed infections hitting a record high today.”
As a result, Sova Capital took Sberbank ordinary and pref shares off its Buy list – both the lead back-to-work stocks – but at the same time took profits in children store Detsky Mir, agricultural producer RusAgro and supermarket chain Magnit – the leading stay-at-home names.
It looks like by the end of November the market was pausing for breath before attempting to scale the next ridge.
Start of a new super-cycle
Much of the recent buying and selling has simply been a reaction to the imminent end to a particularly nasty crisis. But underlying the recent gains are bigger forces that should continue to push the market up even after these short-term effects wear off.
“Our key conclusion for investors is to buy anything and everything EM and FM – and while that may sound like the sort of thing we always say, in fact, it’s not,” said Charlie Robertson, chief economist at Renaissance Capital, who argues that a Biden presidency will reverse the flow of FDI into America and could begin sending out $1bn a day, much of it headed to emerging markets. (see related “Brighter days” article.)
Before the world went off the rails in March Russia’s equity market was enjoying its strongest rally in five years. Since the last oil shock in 2014 the RTS had been stuck in a trading band of 900-1,300 but in February it topped 1,600 and was on course to continue climbing.
Driving the gains is the ongoing economic development and effective reforms the Russian government has been making, ironically finally goaded into action by that same crisis in 2014.
Secondly, the Russian equity market is very seasonal with a Santa rally usually pushing stocks up at this time of year, as bne IntelliNews detailed in “Russian rallies.” There are several periods to look at that usually produce good results: a spring rally between January and April (average return in the last decade 7.2%); a Santa rally between September and December (3.2%); and a winter rally between September and April (6.0%). What clearly works least well is a buy-and-hold strategy or investing over the summer.
Thirdly, after almost every big crisis there is a relief rally where the market can return over 100% in a single year.
The relief rallies in the 90s and noughties are very clear, with the market returning 197% in 1999 the year after Russia’s financial sector collapsed and it defaulted on its debt. There was a similarly large 129% in 2009 after the sub prime global financial crisis the year before.
In the last decade the picture has been less clear as the Russian economy began to stagnate in 2011 before growth actually fell below zero in 2013. However, there was another relief rally in 2016 when the oil price collapse crisis of 2014 finally wore off. The rally in 2019 when the market returned 44% was not so much a relief rally as the market starting to respond to the Kremlin’s spending on the 12 national projects that are supposed to “transform” the national economy. It is this last driver that is expected to return and drive the markets from this point onwards.
Smolyaninov goes further than predicting just a relief rally in 2021. BCS EM's position is there is now at least a 33% upside to the fundamental value of the market. That is different from just predicting the best stocks will do well. He is talking about an across-the-board re-rating of the Russian market.
Russian stocks have always been priced more cheaply than their EM peers, as in addition to the regular discount EM stocks receive there is a special “Russia risk” discount on the price of stocks.
“It is very rare when we see such a big fundamental upside, but the big question is how and when it will materialise,” says Smolyaninov.
There is a lot at play in this call, but one of the most obvious changes is the government’s commitment to forcing all the state-owned enterprises (SOEs) to pay out 50% of their profit as dividends. The Ministry of Finance ordered the pay-outs several years ago but it was only this year that all the SOEs – including the very biggest such as Sberbank and Rosneft – were expected to finally fully comply.
The government has made a basic choice to tap the wealth produced by the biggest SOEs not by taxing them but by forcing them to pay generous dividends. That is good news for investors, as almost all of Russia’s top companies have been partly privatised in the meantime, so shareholders will share in the bounty of these dividend payments.
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