US President Joe Biden and Russian President Vladimir Putin meet today in a palace on the shores of Lake Geneva to try to find some common ground and stabilise fraught relations between US and Russia.
However, even before they arrive, the mere suggestion the two leaders might meet and try to get on with each other has been driving a big rally on Russia’s stock market as geopolitical tensions that have dogged the equity market have melted like snow in the summer sunshine.
An oil price shock and the global coronavirus (COVID-19) pandemic that knocked the global economy sideways in 2020 are also on the retreat, adding a tailwind to the rise in valuations. Conditions for investors are becoming more benign by the day.
After being range-bound between 900 and 1,300 for about five years, Russia’s dollar-denominated Russia Trading System (RTS) index has rallied over 20% this year and is close to breaking through the 1,700 mark – a level it has not seen since March 2012.
The RTS index is already up 22% to 1,687 as of June 15, making it one of the best performing markets in the world. Within that, banking stocks have been the stars, returning 51% YTD, and have been rallying since the end of last year. More recently, the oil & gas sector and metal & mining stocks have joined the party and have also started to rally strongly on the back of a sustained rally in oil, gas and major metal prices: the oil & gas sector is up 23% and metals & mining are up 22% respectively over the same period.
The bounce-back this year is not entirely unexpected, as bne IntelliNews reported in a cover story in December “Brighter Days Ahead.” What is unexpected is the strength of the recovery and the effect on the stock market; the Russian equity market has surged to its highest level in eight years and analysts believe that it could continue to rally for another year.
The most obvious change is the rapid falling away of geopolitical tensions, which have been on a proverbial rollercoaster ride this year.
Tensions soared as Russia built up its troops on Ukraine’s border in April, but that episode has culminated in a one-on-one summit in Geneva between US President Joe Biden and Russian President Vladimir Putin to make a start at resolving their many issues.
“The market loves it, as the risk premiums are down,” says Slava Smolyaninov, head of strategy at BSC GM, in an exclusive interview with bne IntelliNews. “Only two months ago we went from a potential open military clash on Ukraine border as Russia massed its troops in a move that was watched by the whole world. From that we are now [watching] a potential attempt [by] the US and Russia to understand each other and deal with some of the issues that have been building up between them for years.”
Smolyaninov says that the risk of war is a “big deal” for emerging markets (EM) investors but that he is now particularly encouraged, as it was the US side that asked for the Geneva summit meeting and there seems to be a sincere interest in dealing with the extremely poor relations from both sides.
More generally, there seems to be a stock market rally associated with the change of US presidents. Smolyaninov says he looked back at the run-up to the first meeting between Putin and US president Donald Trump, where the Russian market rallied strongly outperforming the other EM markets by 10%. However, the hubris didn't last, as Trump began to crash about like a bull in a china shop and the RTS fell back into the range-bound trading it had occupied since the last oil shock and Crimea-induced sanctions regime was imposed in 2014.
That began to change in 2019 as the Russian economy finally began to emerge from a deep post-2014 crisis recession and at last broke out its range. The prospect of a Biden win also pushed prices higher, but as the chart shows clearly, the annus horribilis of 2020 knocked the index all the way back to fresh six-year lows.
But like Trump, the inauguration of Biden seems to have caused a fresh “new president” rally as investors are once again hoping a fresh start is possible – and this time round it appears their hopes a bit more justified.
The difference between the first year of the Trump presidency and now is that Russia’s economy was still stuck in a deep recession in 2016 and so after the initial optimism faded the market reverted to its range. It wasn't until 2019 when the economy finally began to emerge from recession that the market started to rally.
With Biden the “new president” rally has been much stronger, as it has the resumption of the economic growth that was already apparent in 2019 and has in addition the tailwind of the post-crisis bounce-back that always follows a big crisis. A year of pent-up demand is being released as the pandemic progresses to an end. That has sparked a commodities boom that is being fuelled by the rising demand, which has been globally synchronised by the pandemic: everyone is coming to the same recovery at the same time.
The second force driving the market up is the re-inflation of the global economy after a double whammy in the 2020: the slump in the oil price in March after the OPEC+ production deal collapsed when Russia walked out of the talks, and the coronavirus (COVID-19) pandemic that hit about a month later.
“Since the beginning of May into mid-June there has been a re-inflation that has driven the ruble and the market up,” says Smolyaninov.
As this year got underway the virus has yet not been defeated by the new vaccines, but economies around the world – Russia’s included – have bounced back a lot more strongly than analysts were expecting – and they were already expecting a post-pandemic recovery.
“The [Production Manufacturing Index] around Europe and the rest of the globe is already pretty high, beating already high expectations,” says Smolyaninov. “That combined with very strong material prices that are even stronger than before works perfectly for a commodity oriented market like Russia’s”
Russia’s economy returned to growth in March, putting in a 0.5% expansion, and the momentum has been gathering since them.
Banks have led the charge all year and have easily outperformed the rest of the market. Investors treat banks as a proxy for a general economic recovery and they tend to do well when the economy is doing well, but this year they have done especially so.
Currently Russia’s banks are reporting their best profits in five years and with the economic growth their profits are being supercharged, as they have started to release capital provisioned for bad debt as the levels of non-performing loans (NLPs) they have been carrying on their books for years are resolved.
“All the banks have been rallying,” says Smolyaninov. “This is a high beta business: banks suffer when the economy is doing badly and there are financial difficulties. But in the last two or three months banks have been doing superbly. No one was expecting the reserves that VTB released. It was a huge jump in profits. And it all went through its P&L where investors can see it.”
Banking stocks have been through some very wild swings in recent years. TCS Holdings, which owns Tinkoff bank, Russia’s only purely online bank, IPO’ed at $17.50 in 2013 only to see its share price crash to below $1 the next year after Russia annexed the Crimea. When Russia’s economy started to recover in 2017-2018 the stock got back to $16 and then topped $20 in the 2019 rally and managed to hang on its valuation for most of 2020. Currently it is trading at an astounding $79.5 as of June 14 with a price-to-earnings ratio (p/e) of over 22x.
Metals, oil and gas have been a bit slower to rally but all the prices of the main commodities are now at multi-year highs and things like copper prices are currency at all-time highs.
“Who would have thought at the start of the year that oil would be over $70 per barrel, steel at ten-year highs and things like copper at all-time highs?” asks Smolyaninov.
Will it last? Russia’s stock market has been moribund for half a decade. The local debt market has attracted a lot of attention, but stocks fell off the radar in 2014 and have been largely ignored since then. What changed is the imposition of sanctions, which history has shown usually take decades to remove and longer.
Analysts and investors are now scrambling to catch up with the rapid gains to date. In the short term the rally is anticipated to continue simply because Russian stocks pay the best dividend yields in the world and have done so for several years now.
“In this market with this ruble rate to the dollar then Russian companies are making a lot of profits that will be paid out as dividends by next summer,” says Smolyaninov. “Given we are living in a zero interest policy rate world and you can earn 6-7% from just the dividends then the Russian market is looking very appealing.”
Bankers had a fair price outlook for the RTS for this year of around 1,700, but that target looks like it will be reached already in the next week. GDP growth targets have also been upgraded on the back of the rosy economic news several times already. The RTS target is already also overdue for an upgrade.
Looking further down the road and the outlook is less clear. Despite all the good news, inflation and stagnate real incomes remain sticky problems that won’t be solved easily or quickly. Moreover, the structural problems remain: the fixed investment needed to fuel long-term systemic growth is under par, without which Russia’s economy cannot reach its full potential. While there are plenty of good corporate stories, without broad-based deep structural reforms and a significant increase in investment the stock appreciation story will remain capped.