The recent flurry of US sanctions leveled against Russia has aggravated frictions between the two nations and cast a long shadow of doubt on the Russian equity market.
Russian President Vladmir Putin more or less forced US President Biden’s hand when he deployed an EU-estimated 150,000 troops to the Ukrainian border. However, pressure had already been mounting for the US to get tougher on Russia following the country’s unprecedented SolarWinds hacking operation and its largely unsuccessful attempts to interfere in the 2020 US presidential election.
The “new normal” for US-Russia relations
Based on these troubling incidents, it seems we have entered a “new normal” in US-Russia relations and should expect risk premiums in Russia’s equity market to remain elevated (Figure 1). During previous moments of tension between the two countries, there were realistic hopes for relations to improve and provide a tailwind for Russian equity returns. This time around, the bilateral strains appear likely to persist and perhaps even worsen under the Biden administration.
From day one, the Biden team’s hawkish messaging on Russia has been clear: 1) Russia poses a serious great-power threat to US geopolitical interests globally; and 2) US foreign policy will emphasize democratic values and human rights as a means of pushing back against authoritarian regimes worldwide, particularly Russia and China. So far, Putin’s only credible response to western sanctions has been “saber-rattling” with Russia’s military might. The combination of a harder US line on Russia and the latter’s defiant stance could be an unpleasant cocktail for Russian equity returns going forward.
Russia’s mixed bag
At first glance, Russia, a robust exporter of natural resources, looks to be a prime beneficiary of the ongoing “reflation trade” in the markets as the global economy continues to recover. Moreover, Russia has built substantial financial buffers to boost its creditworthiness. For example, its international reserves (including the sovereign wealth fund) amount to roughly US$600 billion, while its external debt is only 32% of national GDP. And the Russian economy is on the rebound, aided by monetary and fiscal stimulus amid COVID-19.
All that said, as we consider today’s equity opportunity set in emerging markets, we see attractive natural-resources companies in China, South Africa, Brazil, and elsewhere, but without the worrisome overhangs of Russia/Ukraine border activity and US-imposed sanctions. Admittedly, Russia’s equity market also offers exciting investment opportunities in so-called “new-economy” stocks, but only at what we perceive to be rich valuations of late. The risks associated with these stocks may not justify the potential rewards at present.
Bottom line: The deep rift in bilateral US-Russia relations is unlikely to narrow anytime soon and, in fact, may widen further in the period ahead.
Given this uneasy geopolitical backdrop, we suspect the next window of opportunity for investors to “go long” Russia may not come until after a conflict of greater proportions has taken place — one that results in cheaper equity multiples. In the meantime, select individual Russian equity positions may be worth looking at on a case-by-case basis.