The Mysterious Russian Stock Market

“The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable,” observed famous investor Warren Buffett. Despite the fact that I manage investment portfolios for high net worth clients and institutions, I am similarly often intrigued by how the markets sometimes react. Since most of my clients are wealthy Russian families, throughout this year I have been bombarded with questions regarding why I don’t include Russian stocks in my portfolios, why I blatantly disregard the amazing value they apparently represent and the predicted imminent rally of the Russian stock market. After considerable soul-searching, I had to admit that I had no rational reason to avoid Russian stocks, yet I stubbornly resisted buying them in 2013 and, as a result, my portfolios since the beginning of the year are up about 7 percent, while the RTS stock index is down about 25 percent. So, I had set out to find some answers.

I have been working with investments for over 20 years, and while attending numerous conferences I can recall many presentations of various Russia-oriented funds whose battle cry of “there had never been a better time to invest in the Russian stock market” had only sporadically coincided with reality. The chief argument of RTS being the cheapest stock market in the world, and thus representing an amazing value, is used in every single presentation. One strategist whose intellectual qualities I hold in high regard in January 2010 announced on CNBC that the Russian stock market will be driven higher by disinflation. For the next couple of years the Russian market experienced huge volatility, having lost about 50 percent of its value during 2011 while Dow Jones was up about 20 percent during the same time period with minimal volatility.

Similarly, well regarded investment professionals have publicly stated that they expected the Russian stock market to take off with the rise in oil and gas prices, or when people finally realize how cheap it is based on relative valuation and what opportunities they are missing out. The timing of those comments has often been as unfortunate. More recently, in February 2013, Reuters wrote about the surprising lack of interest in Russian equities, which made them cheaper than unstable countries such as Pakistan or those in dire economic straits such as Greece. Once again, cheap was apparently not cheap enough; RTS continued to fall about 20 percent in 2013.

So what conclusion can we derive from the above observations? Apparently being a world power with solid economic fundamentals and a decent credit rating is not enough to command a higher valuation than Pakistan or Greece?
What is really going on here? There are many explanations that one can easily find – a high concentration of energy stocks, lack of transparency, corporate governance, etc. Yet somehow all these sound more like rationalizations than reasons. Stock prices have more to do with demand than fundamentals, and while in most markets good fundamentals drive demand, this apparently does not seem the case with Russia.

We should all start looking more in investor psychology than economic data. In the modern world, the paradigm of investing moved from “return on investment” to “return of investment” and, let’s be honest, every time Russia gets in the news, it’s often not good news. The stock market is never wrong, and Russian companies (and its investors) are learning the first fundamental rule of capitalism – every asset is worth as much as someone is willing to pay for it. This principle explains why Facebook is trading at a P/E ratio of 167 and Gazprom is trading at a P/E of 2.3, which is a 75 percent discount to Exxon.

Speaking of Gazprom, I can’t help but smile every time some of my clients remind me that at $10 per share, it’s an amazing bargain, having been over $40 somewhat recently. What I vividly recall is how I was trying to convince a client in 1999 to buy Gazprom at $0.10 per share (yes, 10 cents!) and he was refusing, calling it “a pile of junk.” So when it comes to the Russian equity market, it brings a new meaning to a term “relative value” and investors should bear that in mind.