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. Last Updated: 07/27/2016

Market Matures on Strategic Buying

The equity markets are booming, with trading volumes hitting all-time highs and the benchmark index at levels not seen since the 1998 economic crisis. But it is not the quantity of the action that is catching the attention of economists so much as the quality.

In 1997, the year the RTS index hit its historic high of 571, stock valuations were being driven mainly by short-term speculators from abroad, who vanished in a cloud of smoke when the economy collapsed. Now, however, native investors are doing the driving and the result is that the market is functioning less like a casino and more like a tool to influence corporate behavior -- one of its primary functions.

"What has really happened in the last several years is that the economy stabilized, people got more wealthy and they are now looking around for ways to invest their money," said Peter Boon, chief strategist at Brunswick UBS. "The equity market has finally matured enough to give people that opportunity."

The country's stock market capitalization has soared to a record $143.5 billion, the Federal Securities Commission said Tuesday.

The benchmark bourse, the dollar-denominated RTS, has gained some 23 percent since the beginning of the year, compared to 34 percent for the whole of 2002. Leading the blue chips are Moscow utility Mosenergo and No. 4 crude producer Surgutneftegaz, which are up more than a staggering 90 percent and 50 percent, respectively.

In both cases, the main buyers have been domestic and strategic.

"The process of building strategic stakes in Russian companies has been going on for a couple of years, but now it has finally became obvious because it is on a much larger scale," Boone said.

For Eric Kraus, chief strategist at investment bank Sovlink, the developments make for good entertainment. "We had almost forgotten the wild volatility, the mad speculation, the waves of liquidity," he wrote in a recent research note.

Indeed, for brokers, business has never been better, with the top 10 performing blue chips up 31 percent on average since the start of the year. Although Mosenergo and Surgut stand apart, Yukos, Gazprom and Sberbank are all up more than 20 percent and the remaining five -- Norilsk Nickel, UES, Tatneft, Sibneft and LUKoil -- are all up more than 10 percent.

Analysts are expecting little movement in the next few weeks, save perhaps a minor technical correction as Moscow empties for the May holidays, which run through May 11, but nearly all see higher gains by year's end.

Brunswick UBS is forecasting the RTS will hit 475 by the end of the year, while Troika Dialog is targeting 481, suggesting growth of another 15 percent.

At 520, United Financial Group has the most bullish forecast and sees at least five reasons for it -- solid economic growth of between 5 percent and 6 percent, robust oil prices, radical tax cuts, strong balance of payments and further liquidity "spillover" effects.

However, despite the market being more "rational" than it was a few years ago, analysts say it still remains essentially an oil story and an insiders' game.

"If you are an insider you will be able to see what is going on in Surgut and trade it, but if you are a foreigner and you are looking to buy something in Russia, you will end up choosing a well-run company that will treat shareholders well," Boone said.

In the near future there will essentially be three types of companies, Boone said: The first will be well managed and will build value, such as YukosSibneft, TNK-BP, Vimpelcom, MTS or Norilsk Nickel. The second includes companies that will be taken over during the course of restructuring, such as energos, and the third will consist of companies like Surgut, which will remain cheap because they are badly managed and cannot be taken over.

But in the meantime, foreign investors will continue to be in the minority, said Phil Poole, head of emerging markets research at ING in London.


MT