Global Investing

Oil falls. So does the Russian stock market

Russian equities have had their worst week since early-December, with losses of over 6 percent. But don’t look too far for the reason — world crude futures have fallen to three-month lows around $114 a barrel on worries that U.S. and world economic growth may not be picking up after all.  They too have fallen 6 percent so far this week. Check out the following graphics showing how Russian stocks and its currency move in lock-step with oil prices:

If anything, the falls on Russian assets are outpacing the weakness on global crude oil markets in recent months, possibly because the jitters that caused last December’s massive falls have not been entirely overcome. Anti-government demonstrators are no longer hitting the streets but  with President-elect Vladimir Putin to be sworn in next week, fears are the  Kremlin may prefer squeezing more cash from energy companies to implementing the reforms the economy desperately needs.  Latest plans flagged on Thursday  to raise oil and gas extraction taxes would seem to confirm these worries and are hitting energy sector shares — half the Moscow index.

All this has widened Russian stock valuations to almost record levels against the broader emerging equity set.  But that is unlikely to entice buyers if the oil price stays where it is — after all half of Russia’s revenues come from oil and it needs an oil price of around $120 a barrel  to balance its budget. Chris Weafer, chief strategist at Troika Dialog puts it succinctly:

Russia does not have a strong enough domestic story to compensate for the commodities export risk

Where will the FDI flow?

For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)

Ukraine’s $58 billion problem

Ukrainian officials were at pains to reassure investors last week that no debt default was in the offing. But people familiar with the numbers will find it hard to believe them.

The government must find over $5.3 billion this year to repay maturing external debt, including $3 billion to the IMF and $2 billion to Russian state bank VTB. Bad enough but there is worse:  Ukrainian companies and banks too have hefty debt maturities this year. Total external financing needs– corporate and sovereign – amount to $58 billion, analysts at Capital Economics calculate. That’s a third of Ukraine’s GDP and makes a default of some kind very likely. The following graphic is from Capital Economics.

In normal circumstances Ukraine — and Ukrainian companies — could have gone to market and borrowed the money. Quite a few developing countries such as Lithuania recently tapped markets, others including Jamaica plan to do so. Ukraine’s problem is its refusal to toe the IMF line.  Agreeing to the IMF’s main demand to lift crippling gas subsidies would unlock a $15 billion loan programme, giving  access to the loan cash as well as to global bond markets. But removing subsidies would be political suicide ahead of elections in October.  And with the sovereign frozen out of bond markets, Ukrainian companies too will find it hard to raise cash.

Three snapshots for Thursday

Initial claims for state unemployment benefits slipped 2,000 to a seasonally adjusted 386,000, the Labor Department said. The prior week’s figure was revised up to 388,000 from the previously reported 380,000.

The four-week moving average for new claims, considered a better measure of labor market trends, rose 5,500 to 374,750.

Brazil’s central bank raised its key interest rate for a fourth straight time on Wednesday as it seeks to rein in persistent inflation, and indicated more rate increases could be on the way soon. This follows a 50bps rate cut from India earlier in the week.

BRICS: future aid superpowers?

Britain’s aid programme for India hit the headlines this year, when New Delhi, much to the fury of the Daily Mail, described Britain’s £200 million annual aid to it as peanuts. Whether it makes sense to send money to a fast-growing emerging power that spends billions of dollars on arms is up for debate but few know that India has been boosting its own aid programme for other poor nations.  A report released today by NGO Global Health Strategies Initiatives (GHSi) finds that India’s foreign assistance grew 10.8 percent annually between 2005 and 2010.

The actual sums flowing from India are,  to use its own phrase, peanuts. The country provided $680 million in 2010. Compare that to the $3.2 billion annual contribution even from crisis-hit Italy. The difference is that Indian donations have risen from $443 million in 2005, while Italy’s have fallen 10 percent in this period, GHSi found. Indian aid has grown in fact at a rate 10 times that of the United States. Add to that Indian pharma companies’ contribution – the source of 60- 80 percent of the vaccines procured by United Nations agencies.

Other members of the BRICS group of developing countries are also stepping up overseas assistance, with a special focus on healthcare, the report said. BRICS leaders meet this week to ink a deal on setting up a BRICS development bank.

Russia’s new Eurobond: what’s the fair price?

Russia’s upcoming dollar bond, the first in two years, should fly off the shelves. It’s good timing — elections are past, the world economy seems to be recovering and crucially for Russia, oil prices are over $125 a barrel.  And the rise in core yields has massively tightened emerging markets’ yield premium to  U.S. Treasuries, offering an attractive window to raise cash.  Russia’s spread premium over Treasuries hit the narrowest levels in 7 months recently and despite some widening this week it is still some 75 basis points below end-2011 levels.

Initial indications from the ongoing roadshow are for a two-tranche bond with 10- and 20-year maturities, possibly raising a total of $3.5 billion.

But market bullishness notwithstanding, investors say Moscow should resist temptation to price the bond too high, a mistake it made during its last foray into global capital markets in April 2010. Fund managers have unpleasant memories of that deal, recalling that Russia unexpectedly tightened the yield offered by 25-28 bps, making the bond an expensive one for investors who had already placed bids. The bond price fell sharply once trading kicked off and yields across the Russian curve rose around 25-30 basis points. Jeremy Brewin, a fund manager at Aviva said:

What chances true democracy in oil-rich Iran?

Truly, oil can be a curse. Having it may enrich a country (more likely its rulers) but it does not seem condusive to democracy. And the more oil a country produces, the less likely it is to make the transition to democracy, according to research from investment bank Renaisssance Capital.

So as Iran goes to the polls today, what are the chances it will become a democracy? (Iran itself could argue, reasonably enough, that it is the most democratic country in the region — everyone over the age of 18, including women, are allowed to vote, though the choice of candidates is restricted)

Surprisingly, the Renaissance report’s author Charles Robertson concludes, Iran does have a chance to achieve democracy, though probably not this year. He says no oil exporting country that produces more than 150,000 barrels per day of oil per million of population has ever achieved a transition to democracy (note Norway was already a democracy before it found oil). But others which produce less oil have done so, notably Algeria, Gabon, Congo Indonesia, Nigeria and Ecuador (Some of these democracies are clearly flawed). Robertson writes:

Emerging beats developed in 2012

Robust growth from the emerging market basket in January was always going to be tough to beat, but research from February’s gains show just how strong these markets are performing against developed ones, and not just from the traditional BRICs either, research from S&P Indices shows.

Egypt has been a prime example. Following a bout of political unrest and subsequent removal of Hosni Mubarak after nearly 30 years in power, Egypt’s market returns have rocketed, climbing 15.3 percent in February on top of January’s 44.3 percent take-off.

Thailand, Chile, Turkey and Colombia are also on the to-watch list as these emerging lights have all flashed double-digit returns in the first two months of this year, while all twenty emerging markets included in the S&P data were up, gaining an average of 6.62 percent, making gains in the year-to-date a mouth-watering 18.95 percent.

The haves and have-nots of the (energy) world

Nothing like an oil price spike to bring out the differences between the haves and have-nots of this world. The ones who have oil and those who don’t.

With oil at $124 a barrel,  the stock markets of big oil importers India and South Korea posted their first weekly loss of 2012 on Friday.  But in Russia, where energy stocks make up 60 percent of the index, shares had their best day since November, rising more than 4 percent. The rouble’s exchange rate with the dollar jumped 1.5 percent but the lira in neighbouring Turkey (an oil importer) fell.

Emerging currencies and shares have performed exceptionally well this year. Some of last year’s laggards such as the Indian rupee have risen almost 10 percent and stocks have jumped 16-18 percent. But unless crude prices moderate soon, the 2012 rally in the  stocks, bonds and currencies of oil-poor countries may have had its day. Societe Generale writes:

Discovering the pleasure of dividends in Russia

American financier J.D. Rockefeller said watching dividends rolling in was the only thing that gave him pleasure. But it is a pleasure which until now has largely bypassed shareholders in most big Russian companies. That might be about to change.

Russian firms,  especially the big commodity producers, are generally seen as poor dividend payers. So dividend yields, the ratio of dividends to the share price,  have been unattractive.

On a trailing 5-year period, the average dividend yield in Russia was 1.8 percent compared to 2.5 percent for emerging markets, notes Soren Beck-Petersen, investment director for emerging markets at HSBC Global Asset Management. That absence of positive cash flow from companies is one reason why Russia has always traded so cheap relative to other emerging markets, he says.