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. Last Updated: 07/27/2016

Oil, Power, Connections Spell 4th-Quarter Growth

Since reaching its historical high on Aug. 7, the Russian market has been as insipid as old patio furniture. As of that date, the market had skyrocketed 204 percent; now it posts a year-to-date return of 160 percent. Seasoned investment veterans seem to be nervously glancing at one another, waiting to see who will make a move first.

As new investors deliberate on an investment in Russian stocks, they are certain to wonder if the market has grown too fast. At any rate, they are sure to ask: "Where is the market headed during this fourth quarter?"

Without a doubt, the biggest event during the next three months will be the official inclusion of Russia into the IFC Investable Composite Index on Nov. 3. What this means is that many institutional emerging market investors will no longer be able to ignore the Russian stock market.

According to officials from the International Finance Corporation, or IFC, the World Bank's private investment arm, about $8 billion in portfolio investment tracks this index, and independent of Russia's weight in the index (a decent guess would be 4 to 5 percent), new money will, if not flood the market, give it a well-deserved baptism. This will be accompanied by membership in the Morgan Stanley investable index of emerging markets, another benchmark for investors.

On a sector-by-sector basis, most of the action will be with oil stocks. Investors will continue to put their money into companies with assets in the ground, and a series of big-name sales such as Tyumen Oil, Eastern Oil and Rosneft will clarify the disposition of forces in the industry and shed light on possible mergers in the future. LUKoil will do whatever necessary to take over Norsi-Oil, a top refinery and distribution company in Nizhny Novgorod, and smart investors will snatch up LUKoil stock before the euphoria of its debut on the New York Stock Exchange in the first quarter of 1998.

Gazprom, as always, will chart its own course and continue to defy market expectations. Even if the market is moribund during the fourth quarter, Gazprom is likely to maintain its upward momentum. Nonresident investors with cast-iron stomachs will keep on buying domestic shares of this phenomenal company in Russia -- although doing so is illegal -- which could possibly drive up the price close to $2 per share come January. There's no reason why Gazprom cannot, by the end of 1997, be a $40 billion company.

Telecom stocks, usually an innocuous lot, are about to cross a threshold. Because of the umbrella structure of Russia's telecommunications industry, mergers and takeovers are ruled out, and regional telecoms are prevented from resorting to equity finance because doing so would dilute a controlling stake in each regional company with Svyazinvest. Now that Svyazinvest has acquired a strategic partner, strategic investment in the industry can begin. Regional companies will get the green light on issuing additional stock, and Svyazinvest will purchase as much as it needs to maintain controlling ownership. Officials from Mustcom, the offshore company that purchased 25 percent of Svyazinvest, have already given approval to this financial scheme, and Nizhnovsvyazinform is likely to be the first company to issue stock.

In the power industry, look for Unified Energy Systems to resolve its perennial conflict with Irkutskenergo, the energy-rich power supplier with countless Chinese knocking on its door. One possible denouement is a 20-20 split between the two companies (i.e. the 40 percent stake in Irkutskenergo, which now belongs to the Irkutsk region, would be divided between the two parties), which would sprinkle sugar on top of UES' upcoming issue of convertible bonds, the other major "power" event during the fourth quarter. The bonds, which are backed by 5 percent of UES stock, are set to be issued in November, so UES officials, bolstered by First Deputy Prime Minister Boris Nemtsov, are in a hurry to resolve the "Irkutsk question." If Nemtsov and UES get their way, UES bonds will go on sale backed up by assets in Irkutsk, which would ultimately have the same effect as did the transfer of control in Rostelecom to Svyazinvest (although to a lesser degree).

Generally, one can be sure that the bull run of Russia's stock market is not over. However, the halcyon days of buying on fundamentals are gone. While there is still room left for asset play, the most liquid stocks are already fairly priced and are therefore becoming more earnings sensitive. Investors are slowly adjusting to the need to study the bottom line and to look for signs that Russia's economy is on the rebound. In this sense, the stock market will react to good news on the new tax code, which cuts corporate taxes, and next year's federal budget, the last two factors that will influence markets in the fourth quarter.

Gary Peach is the editor of the weekly newsletter Capital Markets Russia.