Recovering Russia lures investors, even after bumper year of returns

FILE PHOTO: A street performer dressed as a bear is seen at a Christmas and New Year market, with the Kremlin's Spasskaya Tower seen in the background, at the Red Square in Moscow, Russia, December 5, 2016. REUTERS/Maxim Shemetov/File Photo

It’s been a tough couple of years for Vladimir Miroshnikov, head of business development at Rolf, one of Russia’s biggest car dealerships. But like many foreign investors, he’s banking on an economic turnaround in 2017.

Russian car sales, once growing around 50 percent a year, dropped off a cliff in 2015 after the rouble’s 2014 collapse and fell a further 10 percent in 2016.

Miroshnikov remains cautious, saying the next few months will be tough and seeing the possibility of “a recovery only in the second half of 2017”. However, he told Reuters he expects sales will at least stop falling over the year as a whole.

Foreign investors are more enthusiastic in hoping for a revival in economic growth and consumer demand after two years of recession. Even after roughly 50 percent gains on Russian stocks and rouble bonds in 2016, analysts and fund managers interviewed for this article remain almost unanimously bullish on the country.

Russia figures among the top 2017 trades for Deutsche Bank, Goldman Sachs, UBS, JPMorgan, Rabobank and Bank of America Merrill Lynch among others, with Goldman predicting it “to move from a recovery to a growth phase”.

On the face of it, the stars do seem aligned for Russia.

Data showed manufacturing expanding in December at its fastest pace since March 2011, a signal that the economy is starting to grow again.

Prices for oil, its lifeblood, will average $57 a barrel, according to analysts’ forecasts in Reuters polls, $10 higher than in 2016. And if the central bank brings inflation down to its 4 percent target, ordinary Russians should have more money to spend.

Two other factors have added impetus to the trade.

First, Republican Donald Trump won U.S. elections on Nov. 8 with a promise to improve ties with Russia, holding out the possibility of easing sanctions imposed after Moscow’s 2014 annexation of Crimea from Ukraine.

And on Dec. 7, Glencore and Qatar teamed up to pay $11 billion for a stake in state oil firm Rosneft, confirming Russia’s allure for international investors.

Some are confident that the sanctions, tightened over Russia’s role in a separatist rebellion in eastern Ukraine, will go after the new U.S. administration takes over.

“I like Russia for some very simple reasons: The most obvious reason is Trump, because sanctions will be lifted,” Luca Paolini, chief strategist at Pictet Asset Management, said.

“But it is a little more complicated than that. It is one of the few emerging markets where we feel it is cyclical…where we think there is some decent potential in almost every scenario.”

Hopes related to sanctions got a setback this week as Washington imposed fresh curbs on Russian intelligence agencies over the hacking of political groups during the U.S. election campaign.

But many reckon Trump will roll back the measures once he takes office in January. President Vladimir Putin said on Friday that Moscow would not expel anyone in retaliation, adding that he would wait for the actions of Trump before deciding on any further steps in relations with the United States.

Take the politics out, and Russia looks attractive relative to many big emerging market (EM) economies. Unlike countries such as Mexico or Turkey, it has a balance of payments surplus, making it less vulnerable to the rise in global borrowing costs.

Russia is favoured by bond investors too because falling inflation may bring 150-200 basis points in official interest rate cuts next year. That will keep inflation-adjusted bond yields at among the highest in the world.

“There is a lot more acceptance now that Russia is in a good place,” said Yerlan Syzdykov, head of emerging debt at Pioneer Investments.

Syzdykov holds more Russian bonds than their weight in emerging market indexes, but Pioneer is also bullish on Moscow-listed stocks, he said, adding that the fund was looking to “put more money into cyclical recovery stories”.

Corporate results have been encouraging. Earnings-per-share, a key profitability indicator, recently surpassed their 10-year average for the first time since 2012.

In recent months analysts have revised up their estimates of Russian companies’ earnings at a faster pace than the rise in oil prices, Thomson Reuters Datastream shows.

But some are sceptical. VTB Capital analyst Maria Kolbina, for instance, says Russians’ real incomes will need to grow by 5-7 percent annually for a couple of years for consumer demand to recover significantly.

Russia also scores poorly on all measures of corruption and transparency; its fortunes remain tied to oil exports and a recent report by the anti-monopoly service found state ownership of the economy had doubled since 2005 to 70 percent.

But Pictet’s Paolini says asset prices reflect these concerns. Russia has historically traded at a discount to other emerging markets and even after the 2016 gains, shares’ ratio to forward earnings is half the emerging markets average.

“Russia’s PE is still very low, I would be worried if you had a strong performance and very expensive valuations. But that is not the case, Russia’s PE is 6, Brazil is 14,” Paolini said.

Many also see positive structural changes afoot.

“When people say nothing is changing, they think of corruption and, true, there doesn’t seem to be much change on that front. But the move to inflation targeting and a floating currency is a huge structural change,” said David Hauner, head of EEMEA cross-asset strategy and economics at Bank of America Merrill Lynch (BAML).

Hauner advised clients last year to load up on rouble bonds, a bet which paid off handsomely. He predicts at least 10 percent returns next year, against zero from emerging debt overall.

BAML is also overweight Russian equities and Hauner said hefty dividend payouts and falling inflation were not yet reflected in share prices.

“The PE gap relative to EM has not improved at all, even though Russia has fundamentally improved,” he said. “The only negative thing to say about Russia is that everyone likes it, so if something goes wrong it could be quite painful.”

[Source:- Reuters]