SUMMER IS TRADITIONALLY a quiet period for Moscow traders. They say goodbye to the smoggy capital and head for their dachas, leaving behind their positions in cash to avoid any nasty August surprises, such as the one in 1998 that wiped 55% off the RTS, the Moscow equity index.
This year, though, intrepid traders who decided to sweat it out in the capital rather than cool off in their rural retreats have been well rewarded. The RTS, having fallen to 630 in May, started to rise in June. In August, it smashed through an all-time high of 730 and headed for 800, leaving analysts scrambling to revalue their year-end targets. It is now at 814, having risen 30% in just over two months.
Roland Nash, chief strategist at Renaissance Capital, says: “This is the largest sustained revaluation since the end of 2003.”
Compare this with last year, when the Russian stockmarket was basically flat, in stark contrast to outperforming markets in such countries as Ukraine and Hungary. What has changed?
The generalized global appeal of emerging markets is an important reason. Glen Finegan, senior analyst at First State Investments, which manages about $4.5 billion in emerging market equity, says: “I’ve never seen risk appetite at these levels. There’s a global search for yield, and risky assets like emerging markets have attracted a lot of capital.”
Liquidity has been particularly high among western European investors. “The high liquidity in western Europe has led to renewed carry-trade plays, and the recovery of the euro against the dollar has led to a euro-inspired bounce in European markets, including Russia,” says Liesbeth Rubinstein, head of EMEA business at Schroder’s.
Liquidity from Asia has also been a reason for eastern European markets. Takashi Ishida, head of retail products at Société Générale Asset Management in Tokyo, says robust stockmarket performance on the Nikkei has increased Japanese investors’ risk appetite and made them look farther abroad for yield, particularly to eastern Europe.
These global conditions mean almost all eastern European stock markets have had a great year, as they did in 2004. What has changed is that Russia is now included in the rally.
“This is the rally that was supposed to happen last year,” says Chuck Tennes, fund manager at local investor Alfa Capital. “It’s a completely logical rally, considering global and domestic economic conditions. The aberration is what happened between April and December 2004, when the natural rally was interrupted by an unusual event.”
Mikhail who? That event was the trial of Mikhail Khodorkovsky and the protracted demise of Yukos, which led many foreign fund managers to move to underweight positions in Russia. Some market observers also suggest the western media was overcritical of Russia last year, particularly when president Vladimir Putin clashed with the US and EU over the Ukrainian election in November.
As the Yukos affair ended, and particularly after Khodorkovsky was convicted on May 16, investors managed to put him out of their mind and refocus attention on Russia’s economic fundamentals – particularly that it is a natural resource economy, and oil prices were at an all-time high. That wasn’t just affecting oil stocks such as LUKoil, which has been one of the strongest performers in the RTS.
“Russian corporations, including telecoms, retail and financial companies, have been generating record earnings and cashflow growth,” says Rubinstein. “It’s partly thanks to the wealth-creation effect from strong oil prices, which means continued improvement in real wages, higher consumption and an excellent retail sector performance.” The amount of petrodollars flowing into the country also created strong domestic liquidity, which analysts believe is one of the main drivers of this summer’s rally. “Larger GEM [global emerging market] funds are still licking their wounds after their mauling last year. [Instead] hedge funds and domestic money have been responsible for the revaluation,” says Nash at Renaissance Capital.
These local investors and hedge funds believe that the international market has got it wrong. Pavel Kolouche, emerging Europe fund manager at hedge fund RAB Capital, says: “Over the past 18 to 20 months, we’ve only had negative news coming out of Russia. As a result, Russian stocks trade at a 20–30% discount to their emerging market peers. The market had become far too negative on Russia.”
Kremlin charm offensive To combat this, Putin has gone on a charm offensive with foreign investors. It seems to have worked. “There’s been some improvement in the policies of the Russian government. They seem to be creating a more friendly environment for investors,” says Nerea Heraz-Mendaza, manager of the AXA WF Emerging Europe equities fund.
As the summer has progressed, other positive news has come out of Russia – the long-delayed liberalization of Gazprom shares seemed to get back on course; Fitch Ratings upgraded the country from BBB– to BBB in early August; and the privatization of telecoms company Svyazinvest appears to be back on track.
Perhaps one of the main indicators of the improvement of market sentiment has been the success of recent IPOs, such as the flotation of independent gas producer Novatek. That deal raised $879 million in a London listing lead managed by CSFB, UBS and Morgan Stanley.
“We did a private placement of Novatek in December, just after the Yuganksneftegaz auction, and we had difficulty raising $35 million. Six months later, and the IPO was 13 times oversubscribed,” says Gerrit Heyns, head of sales at Troika Dialog.
Some fund managers, such as Finegan, stayed clear of the Novatek deal. He remains dubious about property rights in Russia, and says he prefers to play the Russia story through Turkish companies listed outside Russia that have large exposure to the Russian economy, such as Efes Breweries.
But he would appear to be in the minority. “No investment in Russia is completely devoid of concerns about ownership and property rights,” says Tom Ahearne, head of equity capital markets syndicate at CSFB. “Most emerging markets have risks of this kind. But this risk was not overly prevalent in investors’ minds for the Novatek deal.”
Nor for the $600 million IPO of supermarket group Pyaterochka or the $400 million IPO for steel company Evraz Holding in May, nor for the $1.6 billion IPO for Sistema holding group in February.
Gergely Voros, head of Russia and CEE equity origination at Morgan Stanley, says deals such as Novatek and Pyaterochka didn’t just attract dedicated emerging-market funds, but also global and pan-European funds, captivated by the high growth rates of Russian companies compared with global peers.
Election downer? What could bring down the markets from the Russia buzz? Investors are hoping the next year will be quiet on the domestic political front, because of Russia’s presidency of the G8 in 2006. “Everyone is expecting Russia will be on its best behaviour,” says Andrei Uspensky, chief executive of PIO-Global.
However, beyond that there is the prospect of the 2008 elections, and what is likely to be a “massive shift in power” according to Renaissance’s Nash. He thinks the pre-election struggles between different power groups “will go a long way towards undermining most of today’s positive sentiment”.
Investors say they hope that Putin is in a strong enough position to pick a successor who will continue his programme. But as his own presidency has shown, successors rarely act as their predecessors expected. Unsurprisingly, several investors say they would be happy if Putin were to change the constitution and run for a third term as president.
Charles Ryan, chief executive of local brokerage UFG, is a dissenting voice in the investment community. “Putin shouldn’t change the constitution, and he won’t. They have to stick to the constitution, full stop. The presidency is the only institution in this country that has any legitimacy whatsoever. And anything that undermined that legitimacy would be damaging in the long term.”
