For Vladimir Putin, this past week’s G20 meeting offered a chance to change the narrative between his nation and the West. His motivation is clear: the Russian economy has been placed in a choke hold by Western sanctions in recent years, and any move to improve trade relations would help an economy that is only now coming out from under a prolonged recession.
The moves to ostracize Russia have been felt by Russian equities. Indeed, Russia was the only attendee at the G20 conference—besides Canada—that has delivered negative market returns in 2017. That has led to a growing valuation gap, and for those with strong stomachs and a long-term view, a possible rapprochement with the U.S. and Europe could be just the catalyst they’ve been looking for.
The economic sanctions in place against Russia have had an impact. But blame for the Russian equities slump can also be pinned on an over-reliance on crude oil exports, which account for two-thirds of total exports, according to Win Thin, global head of emerging market currency strategy with Brown Brothers Harriman.
The recent drop in oil prices to below $50 per barrel is clearly impacting the performance of the Russian market and fund flows for Russian ETFs, says Todd Rosenbluth, director of mutual fund and ETF research at CFRA. For example, a hefty 47 percent weighting in energy has caused the iShares MSCI Russia Capped ETF (ERUS) to fall 13 percent thus far in 2017, lagging the MSCI ACWI Ex USA Index by 27 percentage points, according to Morningstar. With nearly $500 million in assets, this fund carries a 0.64 percent expense ratio.
With a slightly smaller one-third weighting in energy, the VanEck Vectors Russia ETF (RSX) is off by a slightly less painful 10 percent year-to-date. The fund, which has $1.9 billion in assets and a 0.65 percent expense ratio, appears to hold deep value as its average holding trades for just 75 percent of book value and it carries a robust 6.4 percent dividend yield.
Germany’s Star Capital, which ranks 39 countries by a range of valuation measures, found that Russian stocks traded for just 7.1 times trailing earnings, the world’s lowest earnings multiple, and well below the global average of 19.8.
“So many Russian stocks are trading at sharp discounts to their emerging-markets peers” says Rosenbluth.
Economic Green Shoots
Despite the ongoing slump in oil export revenue, the Russian economy has begun to modestly rebound after an economic contraction that lasted seven straight quarters. It grew 1.4 percent in the first quarter, and should expand two percent this year, according to the nation’s Ministry of Economic Development.
Domestic demand is helping to fill the gap created by slumping oil export revenue. New car sales, for example, are now rising at a 15 percent annual pace, after a multi-year contraction. Firmer consumer spending is the likely result of a pullback in inflation, which has fallen from 7.5 percent to a recent 4.1 percent. In response, the Russian Central Bank has begun cutting interest rates.