Russia looks like a value trap

Last week, I wrote about the impressions I gained of President Putin during my time managing a Russian equity portfolio . At the time, I promised to follow up with some thoughts on the state of the Russian stock market – which has fallen by 14% over the last month.

Unfortunately, things have only got worse since last week.

Yesterday, the Court of Arbitration in The Hague awarded former shareholders of oil giant Yukos $50bn in damages against the Russian state. If Putin refuses to cough up, it could result in court-backed action to seize Russian property abroad.

And that’s on top of tougher economic sanctions related to the situation in Ukraine.

It looks like the walls are closing in on the Russian bear. So, for those who can stomach the regime, is now the time to invest in Russian stocks? Let’s find out.

You can learn from my mistakes

There have been some great opportunities to make big returns in Russia since it revived its stock market in 1995. But it’s been a real rollercoaster ride, and the country often crops up as one of the world’s biggest annual stock market risers or fallers. Investing in Moscow tends to be an extreme experience – there’s rarely any middle ground.

My own time running an East European fund is a great example.

After a solid start, I sailed into the 2008 financial crisis with too much exposure. Six weeks before Lehman Brothers collapsed, Russia had invaded Georgia. I saw the market weakness over that war as a buying opportunity rather than a reason to throw in the towel.

Which was unfortunate.

Russia was hit very badly post-Lehman as the oil price collapsed and the RTS Index of Russian stocks fell by 80% from its high. It’s a bit of an understatement to say that this was a character-forming experience! Especially when I had a lot of my own money in the market.

Thankfully, my fund didn’t fall by quite as much and I managed to hold my nerve. By putting some cash into the market as it began to turn, I gained over 100% the following year.

These sorts of swings weren’t a new thing, of course. One thing I really regret is not launching my fund a couple of years earlier than I did. The market had doubled in 2005, the year before I launched. You didn’t need any particular insights to make money in a market like that – throwing darts at the market pages in Vedomosti, Russia’s FT, would have been enough to pick some big winners!

But where do we stand today?

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Two reasons not to buy Russia

In May 2008, the RTS Index peak was 2,478. Over six years later, and with Wall Street making new all-time highs, the index stands at just under half that level.

The big recovery from the bottom of the crisis had taken Russia up by over 300% by mid-2011. But we have been drifting downwards ever since.

It really looks like a value trap to me. Many commentators had pointed to a market price/earnings ratio  of under five to argue that Russia was “cheap” at the start of this year; but we’re down by a further 16% so far. There are two big problems that stop me making an investment today.

1. The economy is performing very poorly

During the oil price boom of the previous decade, growth averaged around 7% a year. Current forecasts are for barely any GDP growth.

2. Corporate governance remains very poor

There’s been no reform and state-controlled stocks such as Gazprom are definitely not run for the benefit of minority shareholders.

Add to that the political strife which could remain a feature of our front pages for many months and I just don’t think it’s worth bothering. I say that with sadness, because I have a lot of affection for the country. I can only see one thing happening that would encourage me to take the plunge and make a trade.

The one thing that would change my mind

If the market were to really tank, then I would have a go. That would mean at least testing the lows made in March, another 15%-20% further down from here.

At that point, there might be the sense of revulsion about Russian equities which is needed to spark a rebound. When a market is universally hated, the only place to go is up. But I don’t think Russia is there yet.

When it is, you’ll need a strong stomach, because buying will feel like a foolish thing to be doing – people will think you’re mad. But history shows there are big returns to be made when sentiment turns.

I’ll let you know if I decide to try my luck!

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