MacroScope

from Global Investing:

Sanctions bite Russia but some investors are fishing

By Andrew Winterbottom

Russian stocks are up today, for the fifth day in a row and at the highest level in two weeks. What's going on? As we wrote  here earlier in the week, foreign investors have been fleeing this market.  However it could be that some of them are starting to put aside concerns about the potential for further sanctions on Moscow and are scouring Russia's stock markets for contrarian buying opportunities.

Russian stocks, chronically undervalued, are trading now at a discount of more than 60 percent to broader emerging markets, and to China which by all accounts is the standout beneficiary of the Russian woes. Just how cheap Russian shares are can be gauged from the fact they trade at a discount event to turbulent Pakistan. Here is a link that compares Russian equity valuations with other emerging and developed markets:  http://link.reuters.com/guv77v

While tensions between Russia and the West look to be only increasing, the risks of investing in Russia at present are obvious. But with greater risk comes greater potential reward, says Jonathan Bell, head of emerging market equities at Nomura Asset Management:

Even for the level of risk the market is extremely cheap... We've had price movements due to technical behaviour and short-term considerations that don't necessarily reflect the underlying fundamentals.

Bell likes the IT and domestic brand name sectors - those not in danger of feeling the hit of further sanctions but that have fallen alongside companies that have been hit with Western sanctions, such as Sberbank and Gazprom.

Euro zone recovery snuffed out

A BMW logo is seen the wheel of a car in Mexico City

A glut of euro zone GDP data is landing confirming a markedly poor second quarter for the currency area.

The mighty German economy has shrunk by 0.2 percent on the quarter, undercutting the Bundesbank’s forecast of stagnation. Foreign trade and investment were notable weak spots and the signs are they may not improve soon.

France has fared little better, flatlining again in the second quarter. That has forced the French government to confront reality, saying it would miss its deficit target again this year and cutting its 2014 forecast for 1 percent growth in half. There was no mention of the 2015 goal when France’s public deficit is due to come into line with the EU’s 3 percent of GDP cap, but Finance Minister Michel Sapin said Paris would cut its deficit “at an appropriate pace”.

All eyes on Putin

Russia's President Vladimir Putin talks to reporters during a meeting in Brasilia

Russian President Vladimir Putin will meet his top security officials prior to visiting annexed Crimea on Thursday with members of his government.

One way or another, with Ukrainian government forces encircling the main pro-Russian rebel stronghold of Donetsk, matters are coming to a head. Putin must decide whether to up his support for the separatists in east Ukraine or back off.

Tens of thousands of Russian troops remain camped near the Ukraine border and a Russian convoy of trucks carrying tonnes of humanitarian aid is heading for  eastern Ukraine. Kiev says it would not allow the vehicles to cross into its territory and it and Western governments warned Moscow against any attempt to turn the operation into a military intervention by stealth in a region facing a humanitarian crisis after four months of warfare.

Moment of truth in Ukraine

A Ukrainian serviceman guards a checkpoint near Donetsk

Financial markets perked up on Monday after Russia called off military exercises near the Ukraine border but was the confidence well founded?

NATO’s chief told Reuters there was a “high probability” Russia could launch an invasion of Ukraine where the government said it was in the “final stages” of recapturing Donetsk, the main city held by pro-Russian rebels, a battle that could be a decisive turning point in the biggest confrontation between Russia and the West since the Cold War.

Vladimir Putin must now decide whether to leave the rebels to their fate or step up his support. Thousands of Russian troops are still massed near the border and a Russian convoy of 280 trucks carrying humanitarian aid for Ukraine set off on Tuesday amid Western warnings against using help as a pretext for an invasion.

End game in east Ukraine?

A Ukrainian serviceman sits on a military armoured vehicle near Donetsk

Ukrainian government forces say they are preparing for the final stage of recapturing the city of Donetsk from pro-Russian separatist rebels after shelling its outskirts and making significant gains over the weekend.

The city faces increasing shortages of food, water and electricity. Vladimir Putin must now decide whether to leave the rebels to their fate or step up his support.  Kiev said on Saturday it had headed off an attempt by Russia to send troops into Ukraine under the guise of peacekeepers accompanying a humanitarian convoy sanctioned by the Red Cross. Moscow dismissed the allegation as a “fairy tale”.

On a weekend telephone call, U.S. President Barack Obama and German Chancellor Angela Merkel agreed that any Russian intervention in Ukraine, even under purported ‘humanitarian’ auspices, without the express authorization of Kiev was unacceptable and would provoke “additional consequences.”

When Mario met Jean-Claude

European Central Bank President Draghi and Eurogroup President -Juncker talk during a news conference in Nicosia, Cyprus

A day before the European Central Bank’s monthly policy meeting, ECB President Mario Draghi will travel to Luxembourg for talks with incoming European Commission president Jean-Claude Juncker. Oh to be a fly on the wall.

Some in the ECB are concerned that ultra-low sovereign borrowing costs and Draghi’s “whatever it takes” promise has relieved pressure on euro zone governments to carry on with structural economic reforms.
Juncker has signalled he is comfortable with a Franco-Italian drive to focus on growth and job creation rather than cutting debt.

ECB policymakers would probably be happy with that if it came in tandem with reforms to make euro zone economies more competitive. But it is worried about slippage.

The Scottish question

First Minister of Scotland Alex Salmond smiles as he watches a diving event at the 2014 Commonwealth Games in Edinburgh

Scottish nationalist leader Alex Salmond and former British finance minister Alistair Darling, who is fronting the campaign to remain part of the United Kingdom, go head-to-head in the first and possibly only live television debate of the campaign. It is a bigger moment for Salmond, Scotland’s First Minister, who must garner a shift in the polls which consistently put his “Yes” campaign significantly behind with the referendum only six weeks away.

At the last British general election, Liberal Democrat leader Nick Clegg was widely perceived to have won the leaders’ debates yet it didn’t translate into votes. There are, however, a large number of “don’t knows” to play for in Scotland and Salmond is by common consent the more charismatic figure and slick orator.
During the two-hour debate, Darling is likely to highlight the uncertainty over whether an independent Scotland could retain the pound and automatically be part of the EU and how the nationalists would fund their public spending pledges.

The “No” campaign can also point to the greater devolved powers all the major parties are promising Edinburgh should the Scots vote no. Overnight, Britain’s three main national political parties all said they would seek further powers for Scotland in the event of a “No” vote, in the areas of fiscal responsibility and social security.

A reminder that all is not well in the euro zone

Bank of Portugal Governor Costa arrives to read a statement in Lisbon

A reminder that while the euro zone crisis may be in abeyance, it still has the ability to bite.

Portugal will blow 4.4 billion euros of the 6.4 billion euros left from Lisbon’s recently exited international bailout programme shoring up troubled lender Banco Espirito Santo which will be split into “bad” and “good” banks. Junior bondholders and shareholders will be heavily hit.

BES’s tale of woe is so specific that there is no obvious reason to think it will be replicated. But it is a reminder that bank stress tests later this year could throw up other nasties and more immediately the saga leaves Lisbon short of rescue funds should anything else blow up. The bond market is likely to react adversely. The 4.4 billion euros will come in the form of a state loan to a bank resolution fund which the government insists will be paid back.

Q3 rebound but at cost of price cutting?

A woman walks past a shop in Madrid

Manufacturing PMI surveys across the euro zone and for Britain are due. The emerging pattern is of an improving third quarter after a generally poor second three months of the year.

The UK economy continues to romp ahead – growing by 0.8 percent in the second quarter – but on the continent there are signs of a new slowdown. The Bundesbank now forecasts no Q2 growth at all in Germany and though the euro zone flash PMI, released a week ago, showed the currency area rebounding in July, that largely came at the cost of companies cutting prices further, thereby pushing inflation lower still.

France continues to languish but Spain is one brightening spot, posting 0.6 percent quarterly growth in Q2, not stellar but healthy and adding to 0.4 percent growth in Q1.

EU cuts off Russian banks, puts ball in Moscow’s court

Russia's President Vladimir Putin talks to reporters during a meeting in Brasilia

True to its word, the EU agreed sweeping sanctions on Russia yesterday, targeting trade in equipment for the defence and oil sectors and, most crucially, barring Russia’s state-run banks from accessing European capital markets. The measures will be imposed this week and will last for a year initially with three monthly reviews allowing them to be toughened if necessary.

There was no rowing back from the blueprint produced last week – having already agreed to exempt the gas sector – and the United States quickly followed suit, targeting Russian banks VTB, Bank of Moscow, and Russian Agriculture Bank, as well as United Shipbuilding Corp.

That is important. Both sides are striving to shut down alternative sources of capital for Russia’s financial sector although there has already been some reaching out to Asia. Gazprombank held a two-day roadshow with fixed-income investors in Seoul last week.