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. Last Updated: 07/27/2016

Analysts Warn RTS in Overdrive

The market went into overdrive Thursday as the Russian Trading System climbed up another 2.5 percent to hit a new record high of 588.4 by close of trading.

The market surge drew the attention of Prime Minister Mikhail Kasyanov, who boasted at a Cabinet meeting that the country's stock market capitalization has "the highest growth rate in the world."

But even as Kasyanov fueled the fire with his comments, analysts warned the market could soon overheat.

"A bubble is more than likely" in the future, said Roland Nash, chief strategist at Renaissance Capital. "In a country with a weak public sector, a very strong link to the oil price and poor public transparency, it's almost inevitable that you would have overshoots in both directions."

"We're now in territory that stretches fundamental valuations," he warned.

The RTS index almost reached Renaissance's end-of-the-year target of 590 Thursday. But Nash said that target is based on "some aggressive assumptions" -- including continuing high commodity prices and political stability.

Analysts pointed to increasing capital flight sparked by this summer's legal attack on Yukos as a sign that not all was peachy. The Central Bank's reserves dropped $2.9 billion from July 4 to Sept. 5, reversing a steady climb over the first half of the year.

Although reserves regained some lost ground last week, inching back $500 million to reach $62.6 billion by last Friday, analysts said that recovery had been too short-lived to talk about a reversal of flight.

Nash said that unlike the 1997 bull run, which was powered by foreign money, the latest rise was driven by Russians until very recently.

"If the Russians start taking money of the country, it removes a great deal of support" from the stock exchange, he said.

Another aspect of the bull run that is raising concern is growing investor interest in risky second-tier stocks that are less transparent and generally have worse management.

"Investors have become addicted to high returns in Russia, and to get those high returns they now have to take more risks," Nash said.

"Some of these [second tiers] have not been visited since '97, and their management understands that investors are just temporary friends," warned James Fenkner, head of research at Troika Dialog.

He noted that Russia's stock market capitalization to GDP ratio is now in the range of 30 percent to 50 percent, compared to around 15 percent to 20 percent in other Eastern European economies.

"I don't understand how it could get larger" under current conditions, he said.

But judging by the recent rally, the skeptics are far outnumbered by optimists. Brunswick UBS, for instance, believes the RTS index is undervalued.

Al Breach, Brunswick's chief economist, said that even if oil falls to $19.5 per barrel, Brunswick projects RTS growing by 20 percent over the next year -- and around 50 percent if oil stays strong. "Two things make a bubble: a lot of credit expansion [debt], and overvalued assets. Russia has neither," he said.