“Russia tends to be either one of the best-performing or worst-performing markets in the world,” says Kevin Dougherty of Pharos Financial Group. Last year Russia’s RTS index tanked by 75%. This year it has risen 57% since early January, making it the best market in dollar terms after Peru.
Foreign investors have put money into the market for nine weeks in a row. This is partly due to the return of global risk appetite and also to rising oil prices, which are the key driver of Russian equities: energy firms comprise half the index. The few strategists who were persuaded to put a year-end target on the RTS thought it could reach 1,000 by December, says Businessneweurope.eu. It’s already there.
But Russia’s macroeconomic backdrop is hardly encouraging. Industrial production slid by 14.3% year-on-year in April. Unemployment has jumped to 10.2%, the highest level this decade, and is weighing on consumption. Retail sales fell by an annual 5.3% in April, the third monthly fall after nine consecutive years of robust growth. Russian consumers, “once known for their exuberant spending, have become increasingly frugal”, says Lidia Kelly in The Wall Street Journal.
Consumption is set to slide by 10% in 2009, reckons Citigroup. Government data out this week showed that the economy had shrunk by an annual 9.5% in the year to the end of March – the sort of decline on the cards for 2009 as a whole, says Neil Shearing of Capital Economics. Russia is in “deep recession”.
The economy has been hit by slumping demand for exports, exacerbated by a collapse in trade finance and the fall in oil prices, while the credit crisis also played a major role. Banks dependent on wholesale funding were squeezed by foreign banks withdrawing liquidity from the system, and rattled investors withdrew capital from Russia, exacerbating the crunch.
This in turn was made worse by botched attempts to devalue the ruble earlier this year. “Firms and households were cut adrift from credit markets,” says Shearing. Credit remains tight, and the rocketing stockmarket “will likely be reminded” quite soon that “there remains considerable dislocation” between the financial sector and the real economy, says Roland Nash of Renaissance Capital. The banking sector is now facing a jump in non-performing loans, which some analysts reckon could rise to 15%-20% of the total.
Another vital issue for the equity market is that Russia is “a levered play on the world”, as Ken Fisher of Fisher Investments puts it. Optimism over the global economy has mounted and the excitement over supposed early signs of recovery has driven up oil prices. But the oil rally is “based on hope”, says Vladimir Tikhomirov of Uralsib in The Moscow Times. There is “far too much supply” and demand remains weak. The price is therefore “too high”.
The broader point is that the global economic crisis is “far from nearing the end”, as Russian president Dmitry Medvedev said this week, and the jump in risk appetite that has boosted all markets looks too early. So it’s likely that at some stage the financial markets “will again recorrelate with the underlying reality of a very weak global economy”, says Eric Kraus of Nikitskyfund.com.
A deteriorating global backdrop would mean a reversal in the RTS index, which, being no longer “extravagantly cheap” now depends on the global rally to keep its momentum going. Given all this, there are likely to be better entry points in the months ahead.