Russia’s cheap stocks look tempting

June 24, 2010

Russia’s stock market has languished this year, as investors took fright over events in Europe. While this lacklustre performance mirrors other emerging markets, Russia’s cheaper valuations mean it is better placed to bounce back.

Russia now looks like a bargain on both a historic and geographic basis. Its market is still 40 percent down on two years ago — much more than the 15 percent decline in the MSCI Emerging Markets Index. Russia is now around 40 percent cheaper than its peers on a price/earnings basis: it is trading at 6.6 times expected 2010 earnings, compared with an 11.5 average for emerging markets, reckons Renaissance Capital. This discount has widened from around 30 percent at the start of the year, not far from the long-term historic average.

Although Russia deserves a discount because of its political risk and the fragility of its oil-based economy, the gap is starting to look excessive. After all, Russia has seen a far bigger GDP turnaround than other countries — after shrinking 7.5 percent last year, it is now growing at around a 5 percent rate. Morgan Stanley predicts Russian corporate earnings will increase 50 percent this year, twice as fast as in China.

So why aren’t investors snapping up Russian bargains? The answer lies outside Russia, home to many buyers of the free float of these stocks. They fear a double-dip global recession and another tumble in the oil price, by far the most important factor for Russia’s stock market. And investors remember that the Russian stock market lost 80 percent of its value in six months in 1998.

But the bullish oil price forecasts out there could prove half-way right. And even if Russia’s market does tank again, there is a comforting factor. Russian oligarchs aren’t as heavily leveraged as they were two years ago, so they would have less need to raise collateral in a hurry by selling shares.

Taken together, these factors mean that Russia’s cheap shares could be positioned for a nice rebound if global risk appetite recovers a bit. Investors who dally could miss a bounce.

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