From: "James Beadle" <jamesdbeadle@yahoo.co.uk>
Subject: Fair Value and the Russian Equity Market
Date: Mon, 18 Jul 2005
As a proponent of the efficient market theory, which argues that equity markets are always fairly valued, I consistently find myself confounded by the rollercoaster that is the RTS index.
The index has recently been re-valued to resemble something closer to a well diversified basket; yet it continues to bounce around like a ship in a storm. It is true, of course, that post-soviet Russia has often been just such a ship, thrashing around helplessly without any direction, but there are also countless occasions where the market has veered away from the calmer waters it might have easily reached.
The last two months have been just such an occasion: the RTS has gained 18% since mid May. Rather than the kind of tumultuous backdrop one might expect to such a price movement, Russia's macro picture has been relatively quiet.
Under normal circumstance, a stock market should steadily increment value at the rate of return dictated by its risk premium, correcting swiftly to any sudden developments. Could it be that Russia risk is so unsettled? Not exactly.
The last month has seen slight improvement to the country's risk dynamics, underscored by the government's campaign to lure foreign investors back and smother the implications of the Yukos affair. Success, though, has been limited. The slaughter of Yukos diverged so far from the norms of investable market practise that it will take years to restore the improved risk profile the government had worked so hard to earn.
Why, then, is Russia suddenly back among the world's best performing equity markets? High oil prices help, but not because they allow the oils to drive the market as one might expect: The newly balanced RTS gives less weight to oil companies, and increased taxation is depriving them of the benefits of higher prices (notably without protecting them from the risks of a price crash).
In time, the implications of this taxation might register with the investment community, but for now the assumption is that, directly or otherwise, higher oil revenues lead to broader economic strength across the country. This synopsis is supported by efforts to increase public sector salaries, and may well have the momentum to self-fulfil, yet one can't help but worry that the benefits of high oil prices no longer drive the economy.
The Stabilisation Fund is efficiently sterilising the enormous capital gains that Russia might otherwise have put to inflationary use, and oil companies have surely lost some incentive to invest, exactly at the time when easy opportunities for oil export growth have passed. If Russia's primary economic driver has been cut out of the equation and broader investment sources have been scared off by the government's political use of judicial procedure, why is Russia outperforming?
The answer, as so often, comes from beyond the dynamics of the Russian market: Global funds are once again turning their attention to emerging markets. Russia's empirical and circumstantial dynamics are assuring a disproportionate share of emerging market capital inflow.
So, where do we go from here? The index surge has been driven by capital flows rather than fundamentals, and fair value has surely been reached, surpassed if you value the implications of Yukos.
Yukos itself put on 10% Thursday, as Nevzlin addressed a congressional commission in the US, but more broadly the pro-Yukos camp has accepted defeat. That leaves the government less hindered in its campaign to lure investment, and assures a more benign investor approach.
Given the scope of Russia's potential, most players would be happy to see the Yukos saga disappear from view. If the government plays it right, reigns in its wayward voices and interests, and begins to address the structural and managerial failings of its oil and gas champions, the market might warrant sustaining its recent ride.
If the market has definitively forgotten Yukos, summer spenders could easily push it higher in expectation of short-term profit. But summertime is silly season in Russia: volumes plummet, dachas and beach houses lure, and August is the preferred time for Russian crises.
Volatility is often exaggerated under the lower volumes that we are already beginning to see, and the RTS has a tendency to abuse technical levels with impunity, so both positive and negative shocks are conceivable. Either way, assuming no new fundamental upside developments, the post-summer market will likely revisit today's levels; 750 in mid July looks like a good time to take profits and a well earned break.