Is it time to buy stocks again? Equity markets sold off massively around the world at the end of February due to the burgeoning coronavirus (COVID-19) pandemic, but as the spread of the virus has reached peak in Asia and more and more European countries are seeing their curves flatten, a few investors are “buying the dip” and purchasing equities.

A record $100bn of capital outflows has left emerging markets in the last three months, but as the Institute of International Finance (IIF) reports, the outflows are clearly starting to slow and should then reverse. Equity outflows have been much larger than debt outflows. 

 

The Russian market has been particularly hard hit and the number of infections is still rising, but stock prices have now stabilised. Moscow Mayor Sergey Sobyanin said this week that Russia was “still in the foothills” but the peak is expected to arrive in the next week or two.

The expectation is that after the pandemic is over – which could happen within a month – there will be a rebound. While the shape of the rebound is still not clear, most qualified commentators are ruling out both an extreme L-shape and V-shape, with the majority preferring some sort of “fat U” recovery. Equity prices are expected to go up again, starting in the developed markets, but Russia is well placed amongst the emerging markets to see a strong rally thanks to its massive monetary and fiscal reserves.

A few investors have already started to buy again, and after losing 40% YTD at its worst in the week of March, the dollar-denominated Russia Trading System (RTS) has clawed back some of its losses and was down by a less catastrophic 31.4% YTD as of April 17.

The oil and gas sector remains in the front line as the fate of Russia’s biggest hydrocarbon producers is intimately tied to the efforts to create a new OPEC++ production cut deal that will reduce output of oil by 9.7mn bpd that was agreed on April 14. The sector’s stocks are down by 39% YTD and have not moved much since the selling began in the last week of March.

OPEC expects a historic record fall in oil demand this year of 6.8mn barrels per day (bpd), the organisation said in a report on April 16. Global oil demand in 2020 is projected to be 92.82mn bpd. The new OPEC++ deal can cut Russia's oil and gas condensate output by 1.3mn bpd compared with 2019, to 10.14mn bpd, whereas under the old OPEC+ deal it only had to cut 300,000 bpd.

Utilities, formerly an investor favourite in the first two months of this year, also remain depressed, having lost 22% YTD as of April 17. The problem with the sector is that previously, investors had expected sector-friendly adjustments to tariffs, but with a recession looming those tariff changes are less likely now. And financials have lost 34% over the same period. Banks are a proxy for rising incomes and economic growth, but again, neither of those things are likely to happen now for a few years.

Analysts at the investment banks are still upbeat , simply because even if the medium-term outlook remains grey, they still expect more “dead cat bounce” in the short term. They point to the good news on OPEC++ and the flattening infection curves as indicators that the market may turn soon.

“Markets may also take heart in headlines that Saudi Arabia and Russia have signalled intent to further reduce output, citing an inadequate price reaction to the latest OPEC+ deal,” said Mark Bradford, a strategist with BCS Global Markets. “The recent downturns offered players an opportunity to embrace headlines that implied COVID-19 may be at least approaching peak, as more hard hit countries prepared to slowly re-open their economies.”

Oil prices will weigh on valuations

But confusion reigns. While stocks are unquestionably cheap, if you compare the current valuations to the oil price then the RTS looks more overvalued than at any time in the last five years.

Traditionally there has been a fairly tight relation between oil prices and the cost of oil: a simple rule of thumb of Russian stock watching is the value of the RTS is usually roughly twenty times the price of oil. If the price of oil is $100 then the RTS should be 2,000. In the past this rule has worked pretty well.

Over the first four months of this year the price of oil has crashed. The value of the RTS index has also plummeted, but a lot less fast and a lot less far than oil. Using the rule of thumb and the RTS is currently about 600 points overvalued.

The average price of oil over the first 15 days of April was only $21.2, down from $63.7 for the month of January. Applying the x20 rule, April’s price of oil implies the RTS should be a mere 641, against its actual value of 1,129.5 on April 15. In other words, the current RTS value is twice what it should be if compared with the price of oil.

The RTS at 600 is extremely low, if compared to other factors that determine a stocks value, like earnings per share. Even in the depths of the 2014 oil shock, when oil prices also sank to around $30, the lowest the RTS fell to was just above 800 and then for only a few days before it rebounded to around 900.

Clearly valuing stocks is very difficult at the moment. It appears that investors are not valuing share prices on basis of current oil prices, but what they expect oil prices to recover to later in the year when the coronavirus burns out and life goes back to a semblance of normality.

Various forecasts for oil prices have been offered and guessing oil prices remains a mug’s game, as oil remains the most volatile of all the commodities. Gaming out the various possibilities with a table of possible prices and implied RTS values means the market at current valuations expects oil to return to about $50: the RTS at 1,129 on April 15 implies an oil price of $56.4, whereas the actual price of oil on that day was $28.

Even this looks a bit rich. Several commentators have predicted that oil will recover to $40 and the budget assumption is also still $42, which implies the RTS index will reach only 800, which some 250 point less than it is now. Other industry figures have said that oil will recover to $55 by the end of the year, which implies the RTS will rise to 1,100, which is where it is now.

During the last oil shock in 2014 it took about two years for the RTS to breach 1,200 and fully five years for it to get to 1,600. Russia’s economy is in much better shape than it was in 2014, so in theory the recovery will go a bit faster this time. But the world still needs to work through how all the rescue and stimulus plans are going to work and there is still plenty of time for something to go badly wrong.