Russia Will Recover
- By Steven Dashevsky
- Sep. 18 2008 00:00
The country's benchmark RTS Index has fallen 54 percent year-to-date and 36 percent in September alone, making it one of the worst performers globally. The global macro issues -- the liquidity crunch and the falling commodity prices -- as well as the increased concern about Russia's political risks were the fundamental reasons for the sell-off, while the indiscriminate liquidation selling by funds and leveraged investors added fuel to the fire.
As a result of this sell-off, Russian equities have now moved into a distressed territory. More than that, the standard analytical terms of "cheap" or "undervalued" can hardly be used to describe the market that now consists of a collection of valuation anomalies rarely seen in any country in modern markets history. Most of Russia's largest natural resource stocks are worth less than three times their forecasted 2008 cash flow. Steel and coal stocks discount long-term prices from 60 percent to 80 percent below their current levels, while oil stocks are discounted to the level of $50 or $60 per barrel. The RTS has been trading at about four times price-to-earnings ratios, the lowest multiple seen in this decade.
In general, there is little point in trying to explain current stock prices by any economic scenario when the dramatic falls have been generated mostly by a wave of liquidation selling and margin calls amid shrinking liquidity. The stock prices exist without any connection to the values of the businesses that they are supposed to represent.
Thus far, the damage is limited to losses sustained by domestic and foreign equity investors, but the crisis now threatens to spread to the real economy and the country's financial system as a whole. Already, several Russian banks were rumored to be in trouble after being unable to repay debts collateralized by the rapidly plunging shares, while car sales have plunged in August, most likely a reflection of declining availability of credit. Banks and real estate developers, who are heavily dependent on external funding and lax lending standards, could be among the first real victims.
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Nonetheless, it is crucial for investors to see concrete evidence that the safety cushion the country has created during the sunny days of constantly climbing oil prices will be sufficient to defend the banking system and the currency. They also need to be assured that domestic consumption will continue to expand even if oil prices drop to $70 per barrel and that the government is ready to swiftly and effectively react to the crisis with appropriate policy measures.
Prime Minister Vladimir Putin said Tuesday that Russia will be able to relatively easily survive the current crisis, while Finance Minister Alexei Kudrin said the Russian budget will remain in surplus in 2009 even if oil averages $70 per barrel next year. I tend to agree with these conclusions. Russia's reserves seem more than adequate compared to the some $23 billion that foreign investors have so far withdrawn since the conflict with Georgia broke out in early August. Moreover, with virtually no debt, the Russian state has substantial borrowing capacity. I believe that the Russian budget will remain in positive territory as long as the price exceeds $70 per barrel.
The government's response to date has been adequate and professional. The Central Bank has provided the three major banks -- Sberbank, VTB and Gazprombank -- with $44 billion in emergency funding to be used to improve the liquidity throughout the banking system. At the same time, the government has thus far steered away from the direct intervention in the stock market -- and correctly so because it would amount to bailing out portfolio investors using Russian government funds, and this has proven to be very ineffective in the past in many other markets.
It is probably too early to declare an end to the crisis. We can expect more failures among the financial institutions and possibly among real estate developers when external financing dries up. It will also take some time for the liquidity in the banking system and the stock market to stabilize.
Still, it is important to remember that all major emerging market crises in history were predominantly top-down in nature, usually involving defaults on sovereign debt, massive currency devaluations and political upheaval, or a combination of the above. In Russia's case, its reserves should be more than sufficient to weather the crisis, and it is not going bankrupt as it did in 1998. The country's largest companies continue to generate massive cash flows even at reduced commodity prices, and its economy remains strong. Yes, the economy is slowing because of declining investments amid a serious credit crunch, but the absolute growth rates of both gross domestic product and corporate earnings remain healthy. The falling commodity prices and rising focus on costs by major Russian companies are likely to reduce inflation to a more manageable number. And while decoupling from the fortunes of the U.S. economy or broader global economic models is impossible in these jittery markets, the resilience of the Russian economy and corporate earnings will ultimately be recognized by investors.
The bottom line is that over time, markets with strong fundamentals and low valuations always recover after corrections. Russia has strong fundamentals and low valuations, and therefore it is going to recover sooner or later. The hysterical forced-selling in September could be the harbinger that the market's true bottom is approaching.
Steven Dashevsky is managing director and head of equities at UniCredit Aton in Moscow.