3 Reasons to Invest in the Russian Stock Market Right Now

Who’d have thought the Russian stock market would be the place to put some of your cash, especially now that Moscow just annexed part of another sovereign country and the threat of wider conflict between Russia and Ukraine may be looming?

Because of the volatility of the situation, Russian investors have begun to flee their own stocks; to date, a falling ruble and other economic problems there have led to a 20 percent reduction in the Russian stock market.

Which is precisely why now might be the time to get in, say U.S. investors.

“[The] sell-off has taken the market to technically extreme oversold levels,” Jacob Nell of Morgan Stanley wrote in an investor’s note March 4, when the crisis was just beginning.

“Valuation multiples have only been cheaper at the depths of the 2008 crisis (when earnings fell by 60%). And oil markets are stable in contrast to sell-offs in Russia historically. Despite the obvious hit to growth expectations implied by the crisis, any sign that tensions are beginning to de-escalate would constitute a buying opportunity.”

Granted, cheap valuations don’t mean that returns will be quick, but you get the idea.

With the Crimea vote for independence and annexation into the Russian federal now past, U.S. market conditions are improving. Wall Street is rising steadily once again after comments by Russian President Vladimir Putin signaled that tensions over Ukraine would likely abate.

“What had been going on in the Ukraine has been weighing on the minds of investors for a while, so it is a relief that we are apparently moving beyond this,” said Joseph Tanious, global market strategist at J.P. Morgan Asset Management in New York.

“While from an economic standpoint the Ukraine doesn’t have a major impact on the global economy, there were worries about more tension between Russia and western powers, and how far this kind of standoff could go.”

Something to think about moving forward as regards your investment portfolio. Virtually all major global events affect markets.

Yet two days ago the White House issued a warning amid U.S. sanctions which froze assets of both Russian and Ukrainian nationals. Today, Russia responded with sanctions of its own against top U.S. officials, barring them from entering the country.

John McCain brushed off the sanctions with a joke, ”I guess this means my spring break in Siberia is off, my Gazprom stock is lost, and my secret bank account in Moscow is frozen.”

However, speculation over Russian ruble and stock markets in Europe and Russia continue. Over the past few days, investors have been eying the ruble and Russian markets which rallied despite the increased tensions and warning issued by White House Spokesman Jay Carney:

REPORTER: The Russian stock market has been soaring the past couple of days. Is this a sign that the sanctions are ineffective if they’re not really paying a cost? And the reality is it’s up about eight-, nine-percent the last couple of days, their main stock exchange.

JAY CARNEY: I think it’s down for the year, and I think the ruble has lost its value, and I think that he long-term effect of actions taken by the Russian government in clear violation of the United Nations charter, in clear violation of its treaty commitments, that are destabilizing and illegal will have an impact on their economy. All by themselves. They will also incur costs because of the sanctions that we and the EU have imposed, and there will be more actions taken under the authorities that exist with the two executive orders that the president has signed. So I wouldn’t — I wouldn’t, if I were you, invest in Russian equities right now… unless you’re going short.

While the White House tends to avoid commenting on shifts in financial markets, Carney said U.S. and European sanctions, compounded by Russia’s aggressive takeover of Crimea, will hurt Russia’s economy.

However, with risk comes opportunity. And “the riskier the stocks the better” says financial columnist and former management consultant Brett Arends.

Arends provides three reasons why he is going to invest in Russia despite the fact that it is a corrupt dictatorship embroiled in international crisis with its leader risking isolation and embargo.

1. The Moscow stock market is just on the cusp of a rare and exclusive club.

The 60% club, reserved for asset classes which have fallen more than 60% from their all-time peak. The Moscow market plunged on Monday in the wake of President Vladimir Putin’s invasion of the Crimea and the potential for a war over the Ukraine. Stocks had already fallen a long way in the preceding few years. This week saw panic.

The Russian market is down 59%, in US dollar terms, from the all-time high seen in the spring of 2008, according to market data firm MSCI.

Even better? Russian small cap stocks nearly entered the 80% club. On Monday, they were down 78% from their peak in December 2007.

These really are rare clubs. Past members of the 60% club include Las Vegas real estate (2011), gold bullion (2000), the Nasdaq Composite index (2002), and the Nikkei 225 (2001).

Cue the Bennett Rule, named for my old friend Peter Bennett, a veteran and highly successful money manager at Walker Crips in London: Always take a wager on a durable asset class (i.e., not, say, Pets.com) when it joins the 60% Club. Over the following five years you will almost always make a handsome profit.

It’s rough and ready, but there is sense to it. When an asset has fallen that far, it’s usually oversold. The market has given up and lost interest. Naturally it doesn’t always work, and things can go down quite a way further before bottoming out. A few very rare assets join the 80% club. One or two join the 90%. But if you hang on, it really doesn’t matter.

2. Everyone else is too afraid to.

Look around. Are you seeing lots of money managers and analysts buying and recommending Russian stocks? Of course not. That’s the point. They’re too afraid.

You didn’t see these people being bullish of, say, gold at $250 an ounce, or Las Vegas real estate in 2011, or Greek stocks in 2012.

The comedian John Cleese once said the typical Englishman’s highest ambition was to go through life without ever being embarrassed. Money managers and Wall Street analysts are in the same boat. Embarrassment is professional death.

And, all other things being equal, when so many people are constrained from being bullish it would tend to make an asset underpriced.

3. They are cheap.

The Russian market trades on just five times forecast earnings, according to estimates. Small company stocks, which have fallen further, seem even cheaper. Of the top holdings in the Market Vectors small cap Russian fund, several are just three times forecast earnings.

The world market trades on 15 times forecast earnings, and United States stocks 17 times, according to estimates.

Yes, there are plenty of risks. But that is a major reason the stocks are already so cheap.

When we buy a share we are just buying a share of a company’s future cash flow. That’s it. And, by definition, the less we pay for each dollar of future cashflow, the better the deal. I don’t think I’ve ever seen a solvent company’s stock trade on three times forecast earnings before.

Remember this is still speculation and you should probably consult your portfolio manager before taking the leap into the Russian market.