A Rally Met With Disbelief

A big rally is currently underway in Russian stocks now that it seems certain that the Crimea is going to be absorbed into the Russian Federation. Many observers believe the rally won't hold, which is actually a bullish sign. Keep in mind that the Russian stock market is the cheapest in the world. While it is cheap for a great many more or less good reasons, a trailing P/E ratio of about 5 certainly gives investors a big 'margin of error'.

As an example regarding the current state of disbelief, here is a recent Bloomberg missive:

“The rebound in Russian stocks will prove short-lived as President Vladimir Putinfaces stiffer sanctions as he moves toward annexing Crimea, according to PineBridge Investments LLC and Firebird Management LLC.

The European Union and the U.S. announced sanctions targeting Russian officials, and President Barack Obamawarned the nation will face more penalties if it doesn’t pull back from Crimea. Putin is scheduled to address lawmakers today after more than 96 percent of voters in Crimea backed joining Russia in a referendum on March 16.

The Bloomberg Russia-US Equity Index climbed the most in two weeks yesterday and the Micex Index jumped from the lowest level since 2010 as the violence that some investors worried would break out during the referendum didn’t materialize. The Micex fell into a bear market last week, having plunged 15 percent this year, amid concern that Putin’s military incursion into Ukraine would deepen Russia’s economic slowdown. The Micex Index rose 0.3 percent as of 11:03 a.m. in Moscow today.

“There are clear indications that Putin is going to approve the annexation of Crimea and, as soon as he does that, the market will decline,” Ian Hague, founding partner of New York-based Firebird, which manages $1.3 billion of assets including Russian stocks, said by phone from Geneva yesterday. “The annexation will lead to much more damaging sanctions by the U.S. and EU. Russia is not getting away with it.”

First of all, Russia is most definitely going to 'get away with it'. The threat of sanctions is nothing to fear. It has been discounted many times over in Russian stock prices. Moreover, we can confidently predict that the EU will be very careful not to impose sanctions that actually do a lot of economic damage, because it would be the equivalent of shooting itself into the foot. Russia's leadership is bound to retaliate if it is threatened with truly damaging sanctions, and the EU will then suffer just as much as Russia, if not more.

It should be added that a policy of imposing economic sanctions is nonsensical anyway. As a rule, they hit only innocent people that had nothing to do with what their political leaders have perpetrated. Once again, it needs to be pointed out that there is actually no such thing as a collective 'Russia'. Russia is not a person, it is simply a geographic area. Certain individuals in that geographic area have made a decision Western governments don't like, but which they themselves have clearly provoked. Punishing all citizens of Russia is going to accomplish nothing except fomenting hatred and convincing Russian citizens that the West is out to demonize and harm them and cannot be trusted. This in turn could have quite negative long term implications for peace in Europe. 

Anyway, we believe the rally in Russian stocks is not a fluke, and sanctions are extremely unlikely to derail it. It is certainly possible that the recent lows will be retested in the weeks ahead, but we believe pullbacks will represent a buying opportunity.

Russian Stocks and the Ruble

A daily chart of the MICEX index: a very strong rally has begun at Friday's intraday low. Since then, the index has already added more than 150 points, or roughly 13%. Pullbacks should probably be bought, especially as the ruble is now also quite cheap – click to enlarge.

Next a daily chart of the RTS index, which mirrors the strong advance in the MICEX over the past few days. The RTS faces resistance between the 1250 and 1275 level, and it is to be expected that the rally will stall out there. It could be argued that the current rebound is part of a fourth wave and that one more wave down is yet to come, perhaps retesting or even slightly undercutting Friday's lows, but obviously, this does not have to happen.

The RTS daily – it remains to be seen whether this will turn into a 'V' recovery or if the low needs to be retested. In any case, Russian stocks remain extremely cheap – click to enlarge.

Meanwhile, the Ruble has also strengthened in recent days, and it is to be expected that the downtrend will at the very least be corrected significantly:

The ruble, daily – probably a bigger correction will now commence, whereby this will of course partly depend on the near term news flow regarding the Ukraine - click to enlarge.

Conclusion:

The Ukraine crisis has probably created an excellent opportunity to invest in Russian stocks at an especially large discount. These stocks were already dirt cheap before the crisis-induced decline. There is a residual risk that stems from the possibility of negative news flow should Russia decide to take action with respect to other parts of the Eastern Ukraine. However, as we have mentioned previously, we actually do not believe that Mr. Putin has any designs on other Ukrainian regions at this stage now that the port of Sevastopol has been secured (it would make little sense). Should no further untoward developments on that score emerge, Russian stocks are unlikely to get much cheaper. Obviously, we don't think that the threat of sanctions is a good reason to avoid this market.

Addendum: Russia ETF

For US based investors, there exists a NYSE listed ETF of Russian stocks, symbol RSX. It mirrors the RTS index quite well, and is also approaching short term resistance:

RSX, daily – the NYSE listed Russia ETF – click to enlarge.

Charts by: Investing.com, StockCharts, BigCharts