“We have upgraded our 2020 RTS Index target to 1,500 after an impressive rally on the bond market,” equity analysts Andrey Kuznetsov and Cole Akeson of Sberbank CIB said in a note on June 8.
The analysts say that Russia’s securities market has started to recover surprisingly quickly, which has caught the attention of international portfolio investors.
“The turnaround in monetary policy has compressed ruble yields to record lows, and we have changed our ruble risk-free rate assumption to 5.5%. We believe that rates will stay low for the foreseeable future. In this environment, the market's price-to-earnings ratio (p/e) should now move toward a range of 9-10 versus the previous norm of 5-6,” says Sberbank.
While the market sold off heavily at the end of February after rallying to seven-year highs before the double whammy of the oil price shock and coronacrisis stop-shock hit, it has rallied again in May, gaining 10% as the two crises recede.
The dollar-denominated Russia Trading System (RTS) index rose to a multi-year high of 1,651 on January 20, gaining more than 30% in just two months before the growing unease over oil prices and the spread of the coronavirus (COVID-19) in China caused a sudden emerging markets (EM) wide sell-off in the last days of February.
In March and May the RTS was trading with some 30% losses since January, with the oil and gas sector being worst affected. In particular, the utilities sector, which had outperformed in the first two months of this year, saw their share prices collapse.
Current YTD performance of RTS by sector (automatically updates to current week)
But in the last month stock prices have begun to recover as the May economic statistics come in and paint a picture that is not quite as disastrous as many feared. As bne IntelliNews reported, the ruble in particular has lost a lot less value than investors feared and has recently rallied to break below RUB70 to the dollar from a RUB80 to the dollar low as the first signs of the Russian rebound appear.
Investors have also been buoyed by the decision of OPEC and Russia to extend the OPEC+ production cut deal that will reduce production of oil by 9.7mn barrels per day (bpd), signed on April 13, for another two months through to July. After Russia and Saudi Arabia collectively cut some 10mn bpd off their output, the Kremlin is saying that the oil market may be balanced as soon as this summer. Oil prices have rallied and broken above $40 again in the last week to what the Kremlin says is its “comfort zone.”
“Rising speculation that a ‘U’-shaped economic recovery is increasingly feasible – even a ‘V’ recovery – has re-entered the dialogue,” Vyacheslav Smolyaninov, chief strategist and deputy head of research at BSC Global Markets, said in a note on June 8. “Also, the arguably improving demand outlook (e.g., China’s crude imports hit an all-time high in May) together with the agreement of OPEC+ to extend the current record level cut in output to end-July is playing to the bulls. With exuberance biting at the bit, pending economic prints this week – backward looking as they are – are unlikely to derail the forward-looking upside impetus.”
Other ingredients going into the pot include the new National Plan for Economic Recovery (NPER) presented by Prime Minister Mikhail Mishustin on June 5 that significantly ramps up the economic stimulus package from the initial super-cautious 1.9% of GDP to around 10% of GDP now.
“Investors have grown accustomed to monetary and fiscal easing as a natural response to crises in developed economies. Now, for the first time ever, Russian policymakers have delivered a similar response,” Sberbank said. “During previous crises, their natural response was more tightening. The combination of local and global stimuli has helped the Russian market to rebound very quickly.”
Stocks have already been rallying in the last few weeks and the metal & mines sector in particular already went back into the black last year, returning a modest 1% YTD, with the utilities sector not far behind, down on 3% YTD.
Moreover, the Russian discount to its global emerging peers has been sinking, according to Sberbank. “Russia's discount to GEMs has shrunk to 30%, the lowest since 2008,” says Sberbank. “We believe this reflects Russia's improved ability to deploy monetary and fiscal stimuli, whereas many other EMs appear unable to stimulate their economies without risking currency depreciation given their high debt burdens and unbalanced budgets.”
Russia famously has considerable fiscal firepower to fight the coronacrisis in the form of RUB9 trillion ($132bn) in the National Welfare Fund (NWF) to cover any budget deficit. But if oil prices stay at $40 then Russia Inc. more or less breaks even and any deficit will be minimal.
In addition, the Russian Ministry of Finance ruble-denominated OFZ treasury bills are seen as something of a safe haven for foreign investors thanks to that fiscal firepower and the inflows into the market in the last month have entire offset the negative effects on the ruble from the fall in oil prices into the 30s.
“The bond market rally suggests a lower risk-free rate,” says Sberbank. “The CBR rate cuts and expectations of further easing have sent the bond market soaring. OFZ yields have compressed by almost 100 bps YTD to record lows. We have thus changed our risk-free rate assumption to 5.5%.”
Typically following a crisis foreign investors return to the bond markets first, which are considered less volatile and have the advantage of paying out cash on their coupons regularly. However, as the recovery continues the yields on bonds fall as the price of bonds rallies and eventually there is a trade into equities which offer better returns. But that process can take years; this time round it seems something of the same sort is happening in only a few months.
Sberbank argues that the lower discount rate on the OFZ justifies higher price-to-earnings ratio (p/e) on stocks and so an improved RTS end-of-year target.
“At the new discount rate, the normal level for Russia's p/e has shifted from 5-6 to 9-10. At current oil prices, this translates into an RTS fair value of 1,500 for 2020 and 1,700 for 2021,” Sberbank argues.
In terms of which sectors will outperform, Sberbank highlights utilities and telecoms as its favourite stocks, while following the heavy selling in the oil and gas names, those too present some attractive opportunities. Consumer stocks and banks are the least predictable and return less, says Sberbank.