Russian stock market sell-off: we’ve been here before

Russian stock market sell-off: we’ve been here before
Russia's stock market has crashed and is expected to crash again when the regulator reopens it. But Russia's market has crashed a dozen times already. However, investors worry that "this time is different", but in a bad way. / wiki
By Ben Aris March 1, 2022

The market capitalisation of Russia’s stock market has just been cut in half. We have been here before as Russia has seen over a dozen stock market crashes before. However, the unanswered question remains the iconic: “is this time different?” The depth and breadth of the new sanctions could prove to be a game changer.  

There is a famous adage for Russian equity investors: “You only have to ask yourself one thing. Is this a crisis year? If it is not, then usually the market will return at least 20%; if it is, then the market could lose up to 75% of its value.”

The 20%/75% rule has stopped working so well since the 2008 crisis, but the point about deciding if Russia is in a crisis year or not still holds, as the upsides are less but the downside in a bad year is still precipitous. The sell-off between the dollar-denominated Russia Trading System (RTS) index peak in October this of 1,900 to the recent low of 743 last week is not quite that bad – but almost. The market has lost 60.9% in a week. 

This collapse is doubly painful, as it is not just rich international investment banks that make up about half of the investment into Russian stocks that have taken the blow, but a large number of regular Russian retail investors.  

As bne IntelliNews has reported, after seven years of rate cuts by the Central Bank of Russia (CBR) the returns from Russia’s preferred store of value – long-term bank deposits – fell to next to nothing in the last few years. Russian households looking for a better return have been piling into the stock market, pushing its value up by half in 2019 and again in 2021 as the economy emerged from a four-year recession.  

The corporate and bank sectors have been booming, making record returns, and a surfeit of QE money in the international capital markets fuelled a Russian IPO boom that has seen a dozen Russian companies come to market in the last year, raising tens of billions of dollars.  

But once again the Russian retail investor has been stuffed. The first big wave of retail investors into Russian stocks came after late-president Boris Yeltsin set up the PIFs (mutual investment funds) to attract Russian savings into the young domestic capital market. Some 18 months later the Russian stock market went into free fall, with the RTS index dropping to its all-time low of a mere 38.  

Another upset was the so-called “People’s IPO”, when state-owned banking giant VTB Bank listed in Moscow and London in 2007 with a price of 13.6 kopeks, attracting some $1bn in retail investments. Again, about 18 months later the Global Financial Crisis hit, sending the markets tumbling again. The VTB investment was still underwater 15 years later – and now doubly so as VTB’s shares were particularly hard hit by the SWIFT sanctions announced last week that singled the bank out for special attention. Currently the shares are priced at 2 kopeks and the highest they have been in the last 53 weeks is 5.7 kopeks.  

Russian retail investors have become a major force on the Russian equity market with well over a million actively traded accounts that already account for some 40% of the daily turnover, according to brokerages.

They had a good year in 2021 until the military build-up started at the end of October 2021. The RTS started that year at 1,419 and rose to a peak of 1,900 in October, returning investors 33.9% over the period. But as tensions rose the market sold off again to end the year at 1,605, which was still a return of 9.4%.

Then came the bloodbath last month. The collapse of equity prices at the end of February has taken the index back to its 2018 level – before many of the investors got into the market. Those that got in early will have simply lost all the money they made in the last four years, but the majority will have seen the value of their investments cut in half, with little prospect of a recovery.  

Russia’s stock market’s capitalisation was $314bn in January 2019, having more than doubled in value from the 2014 crisis when it was last halved. The market capitalisation was up at $391bn in January 2020 and rose even more strongly in 2021 to reach $496bn as of January this year, but as of Friday, February 25 – the last day the markets were open before the sanctions were imposed over the weekend – the capitalisation had sunk to $239bn.  

The markets have been closed for two days since then, but when they open again they are expected to tumble again – and a long way. The floor to the selling in the 2008 crisis was 500, but it could well be that the market falls further than that. Russia’s economic relationship to the rest of the world in 2008 remained the same: the economy was still open to the rest of the world and business continued, albeit at a lower level. However, Elina Ribakova, deputy chief economist with the Institute of International Finance (IIF), told bne IntelliNews in a webcast on March 1 that Russia’s economic relationship with the rest of the world has been fundamentally changed by these sanctions.  

“Russia has been closed off from the rest of the world. It’s going to be a pariah state with a similar sanctions regime as was imposed on somewhere like Iran. This is a fundamental change in the way the economy works,” Ribakova said.  

The 1998 sell-off

Russia’s market has sold off many times before and the biggest of all was in 1998, when the economy all but collapsed completely.  

The collapse of Russia's stock market between 1997 and 1998 was one of the worst crashes in the world since the US stock market crisis in the 1920s. Investors into Russia had been popping the corks for most of 1997 as the RTS index soared to a peak of 571.6 on October 6, 1997 until the unfolding currency crisis that year finally worked its way through to hit Russia in the summer of 1998. Asian countries had over-extended themselves, borrowing too much foreign currency and suffered a domino chain of collapses.

The peak of the collapse came on August 17, 1998, when the government defaulted on its state treasury bills, then called GKOs. But the selling on the stock market actually started in the autumn of 1997 and went on for two more months after the default before the RTS sank to its lowest point. The index was still at 109.4 on the day of default and devaluation, but dropped to its nadir of 38.5 on October 5, 1998.  

The RTS then took five years to regain its pre-crisis peak: from the high of 571.6 on October 6, 1997, the RTS didn't break through the 570 barrier again until October 1, 2003. And investors that bought in 1999 made huge returns. Some must be wondering if they cannot make the same huge returns this time if they buy as soon as the markets open again in the coming weeks.  

A study by Dragon Capital in Kyiv in 2008 estimated that on average a developed market crisis sees a fall of 27%, while emerging markets fall on average by 51%, and these crises lasted 313 days and 393 days respectively. In 1997, the RTS went much further, giving up 95% of its value over 250 work days and took a total of 1,505 work days to get back to where it was before the sell-off.

Stock market crashes in emerging markets destroy most of the investors' value, but the recovery presents the opportunity to make even more money on the way back up again – if you correctly call the nadir.

An investor that bought $1 of Russian stocks in October 1997 would have seen its value fall to 5 cents a year later. However, if the same investor was brave enough to buy a dollar of equities on October 5, 1998, the value of the shares would have passed $500 only two weeks later – the market was clearly massively oversold and quickly corrected. Even if the same investor waited two weeks after the nadir to buy, he would still have made a 10% return after 21 days, a 50% return after 101 days, and 100% return after 158 days. Still, prices were extremely volatile for more than a year and few were willing to risk investing anything.

Timing is everything but in the midst of a full blown meltdown, calling the market’s bottom is almost impossible. At the end of the collapse in 1998, the market was clearly oversold but took about two weeks to correct to the bottom value in the mid-50s. In the subsequent sell-off in 2008 the correction was much more rapid, with the index taking only a few hours to rise 22% after suspended trading resumed on September 19, 2008 to around 1,300, where it stabilised.

Game changer?  

There have been over a dozen significant sell-offs since the big one in 1998 and typically these take a month and half to go from apex to nadir and the subsequent recovery to pre-crisis levels has taken much longer.  

The average recovery period was 73 work days (about three and half months), with the longest lasting almost a year in 2006 and the shortest 40 work days in the winter of 2005.  

But the recovery assumes that all else is equal. While there is no clear correlation between a booming economy and stock prices rising, a deep recession will clearly hold back asset price growth. After the sell-off that followed the sanctions imposed in 2014 after Russia annexed Crimea and the associated oil price shock and devaluation of the same year, the RTS became stuck in a trading band of between 900-1,300 for almost five years until the blue chips started growing in 2018 as the economy began to emerge from the recession and investors began to buy shares again as they became “too cheap to ignore.”  

It is the looming economic recession now that will probably depress share prices after the dust settles from the current shock. The sanctions on the Central Bank of Russia’s gross international reserves (GIR) and the SWIFT sanctions on February 27 could prove to be a game changer, as they put the Kremlin under a lot more pressure. While the remaining reserves of circa $300bn remain sufficient to ensure stability in the short term, they may not be enough to keep the boat afloat in the long term. Capital Economics predicted a 5% contraction following the outbreak of hostilities, but Ribakova expects the contraction to be more like 20% this year or more. In that case it could take years for the market valuations to recover – if they ever do.