Imagine a country with a strong national balance sheet. Perhaps its national debt is running at only 12% of GDP, and it runs a more or less balanced budget.
Then imagine this same country had positive real interest rates. So if you kept your cash there you’d actually make a return on it after inflation.
Then really let your thoughts go wild. What if this place was also home to a middle class that was getting richer, not poorer, as wages and disposable income rose? Where the population was also highly educated (think almost 100% literacy? And where the unemployment rate was at its lowest in modern history.
My guess is that you would want to be invested in it. And that when you found out that the market was also one of the cheapest in the world you’d be desperate to invest in it.
But what if I went on to tell you that the country I had in mind was Russia?
There are lots of good reasons to avoid Russia
Not so keen any more are you?
You aren’t alone. I wrote last week here that while my inbox is always jammed with all manner of rubbish, I very rarely get sent reports on Russia. Most investors lost interest in it long ago.
That sort of makes sense. As the analysts at Hermes – who have just sent me a report on Russia – note, whenever Russia is in the news, it is in a bad way. Think the “nefarious American spy” and his ill-fitting blond wig. Or the jailing of “three young women for disturbing the bones of ancient saints with really bad music.”
There are also really good reasons not to invest in Russia, beyond these obvious stupidities. There is the fact that it is effectively a one-party state. There’s also the matter of the 50%-plus correlation between the oil price and the MSCI Russia stock market index priced in dollars. That correlation has stood for around the last decade at least, so if oil prices collapse, odds are that the Russian market won’t be the best performer in your portfolio either.
But all that said, when we look at markets we have to look at the price, and ask if the bad news is priced in or not. And in the case of Russia, it surely is.
One good reason to buy – Russia is incredibly cheap
You see Russia isn’t just cheap – it’s really cheap. The market as a whole trades on a cyclically-adjusted price/earnings (CAPE) ratio of around eight times. The current price/earnings ratio is a mere five times (way below its historical mean). That puts it on a discount to its emerging market peers of well over 30%.
Compare that with mother of all one-party states, China. It trades on a p/e of nearly ten times. And the most oil dependent market I can think of, Saudi Arabia, is on 12 times.
Obviously there is a huge range of valuations across the Russian market. The likes of oil and gas groups Gazprom and Lukoil are trading on very, very low valuations. Companies more connected to the growing middle class and consumer spending are more expensive (stocks such as broadcaster CTC Media or rail operator Globaltrans for example).
But overall, if you look at comparative numbers, it is pretty hard to argue that the downside risk isn’t in the price in Russia. And look at the country’s plus points, and you will soon see that it is easy to argue that the upside risk is not. The basic argument is outlined above.
But there’s more. The market has seen some pretty impressive technical improvements recently, says Hermes. Russia has entered the World Trade Organisation. It has joined clearing house Euroclear for government bonds. It has adopted international accounting standards. There is a wave of privatisations on the way. And state companies are finally being forced to pay dividends.
Add it all up and it is surely something of a contrarian investor’s dream. Jim Rogers certainly appears to think so. On a recent episode of Stansberry Radio, he said that his top pick right now is Russia.
The reason is simple: “Everyone hates Russia for many good reasons… including me for a long time. That’s usually a place that you should look, when people hate a market. And so I am looking.”
Where should you look? According to research house Gavkal the answer is in the “stealth sectors of the Russian economy”: consumer goods, machinery and equipment and business services. I’ll be relying on someone else to pick those stocks for me by holding a fund.
One option is the JP Morgan Russian Securities investment trust (LSE: JRS). I am also interested in a reader suggestion that we look at a Swedish-listed investment trust from East Capital, the East Capital Explorer (Stockholm: ECEX) that has significant Russian holdings.
Holding Russia isn’t a particularly comfortable thing to do and you are unlikely to find yourself investing in – as they say at Hermes – a “relaxed way”, or making it a huge part of your portfolio. However, given how few cheap markets there are left in the world it doesn’t make much sense to ignore it either.
PS In my original piece I mentioned that Russia’s demographics weren’t as bad as those of many Western countries. Some readers have queried that. So here is a piece that shows off Russia’s new baby boom. Note that the birthrate rose by 5.6% last year.
• This article is taken from the free investment email Money Morning.
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