There’s been upbeat news out of Russia lately. The nation’s economy contracted by only 1.9 percent year over year in the first quarter, far less than many analysts were expecting, and the benchmark Russian Trading System index has been on a tear, bolting 22.5 percent year to date through May.
Do these signals indicate an end to the financial crisis that began last year, sparked by falling oil prices as well as the sanctions imposed by Western nations in response to Russian intervention in Ukraine?
Don’t count on it, many market observers warn.
“There have been two main drivers to the rally in Russian stocks — the bounce in the oil price and the success of the Minsk II” cease-fire agreement between the two countries, observes Kingsmill Bond, head of equity strategy at Sberbank CIB in Moscow. “We do not expect the bull market to continue over the summer, as we expect oil prices to fall back.”
Dmitry Dmitriev, global head of research at VTB Capital, adds that bargain hunters have largely driven the current surge. “External shocks reached a climax at year end, as did the risk premium,” he explains. “We believe stock market prices after the recent rally fairly reflect the risk-reward balance, so the market is likely to take a pause to determine the further trend in both risk premium and magnitude of recovery.”
The latter point is very much on the minds of investors, many of whom look to the sell side to reconcile the seeming contradictions between official forecasts made by the Putin government and far more modest outlooks posited by analysts and economists. The firm whose advice they value most is Sberbank, which rises one rung to reclaim the top spot on the All-Russia Research Team, Institutional Investor’s exclusive annual ranking of the nation’s best sell-side researchers. It earns 12 positions in 11 sectors, ranking twice in Corporate Debt but failing to appear in Utilities.
Moreover, fully half of this year’s top-ranked researchers hail from the firm, including all four who lead Economics & Strategy sectors: Bond (Equity Strategy), Alexey Bulgakov (Corporate Debt), Evgeny Gavrilenkov (Economics) and Alexander Kudrin (Fixed-Income Strategy). That’s at least double the number of first-place finishes claimed by any other firm.
Last year’s winner, VTB Capital, slips to second place after losing three positions, leaving it with 11. Deutsche Bank’s total of seven also reflects a loss of three; nonetheless the firm remains rooted in third place for a seventh consecutive year. Rounding out the top five are Bank of America Merrill Lynch, with six spots (one fewer than in 2014); and UBS, whose total of five is unchanged from last year.
These results reflect the opinions of 340 individuals at 240 buy-side institutions that oversee an estimated $121 billion in Russian equity and fixed-income assets.
A total of 13 firms are included on this year’s roster, including two that appear for the first time: Barclays and BCS Financial Group. Click on the Leaders link in the navigation table at right to view the full list.
Moscow-based Kudrin, who in November replaced Paolo Zaniboni as Sberbank’s head of research, believes Russia’s economic recovery faces several threats. “First, I would mention potential mistakes by authorities in the overall management of the situation. Crisis requires quick and balanced decisions, which is not an easy job,” he notes. “The second big risk is the external environment, and here we are mainly referring to oil price dynamics. The third threat is the overall investment climate in the country.”
Deutsche’s head of Russian company research, Yaroslav Lissovolik, agrees. “The greatest risks to economic recovery include the lack of structural reform momentum and external headwinds associated with oil price dynamics and geopolitics,” says the Moscow-based analyst, who ranks second in Economics and third in Equity Strategy. “We see these risks as being still quite palpable and significant in suppressing Russia’s growth momentum in the near term.”
But VTB Capital’s Dmitriev is more optimistic. “The Russian economy has demonstrated a very high ability to adapt to the new environment after severe shocks coincided with the period of structural slowdown,” the Moscow-based research director believes. “Gradual stabilization is to continue in the second half, for a full-year [real gross domestic product] contraction in the 3 to 3.5 percent range. We expect it to turn into a slow recovery in 2016 driven by real incomes and investments encouraged by softer monetary policy.”
Sberbank’s Gavrilenkov, who celebrates his eighth straight year at No. 1 in Economics — the longest winning streak among currently ranked researchers — points out that it’s difficult to anticipate what steps policymakers will take.
“Basically, I call the current situation ‘crisis as usual,’ meaning that whenever the price of oil falls, there is a perception of a crisis,” the Moscow-based economist asserts. Unfortunately, he adds, the government and central bank don’t always fashion appropriate responses. “I won’t mention all of the policy mistakes and experiments, but one reason for the deceleration in recent years was that until 2012–’13, growth was largely fueled by a too-rapid expansion of consumer lending,” Gavrilenkov says. “At one point, it grew at 45 percent year over year, albeit from a very low basis.”
The ratio of total consumer debt to GDP remains low, at roughly 15 percent, he reports, but interest rates are high. “As a result, a combination of low stock — the debt itself — and high flow — interest payments — became such that monthly increases of consumer debt became equal to monthly payments, on the aggregate level. Economic growth slowed, as a result, while banks were doing very well — in real terms, the financial sector expanded ten times faster than the entire economy.”
As for falling oil prices’ undermining the recovery, Gavrilenkov isn’t buying it. “Any price of oil is good for Russia as long as the exchange rate is not affected directly or indirectly by the central bank and as long as monetary policy is orthodox,” he insists. “Low oil prices and a weak ruble are not a threat, as total foreign debt is low.”
And they’re a boon to companies that ship their products to other countries. “Exporters are likely to outperform, as we believe the ruble will weaken along with oil,” says Bond, the Sberbank equity strategist. “Domestics are likely to underperform, and banks are most vulnerable to weak growth and a weaker ruble.”
He sees two especially bright spots for investors. “The first is areas of low penetration such as retailing or homebuilding, where it is possible to get growth in a weak economic environment,” Bond adds. “The second is the well-known observation that returns depend on return on equity, not on GDP growth. In a stable macroeconomic environment with limited competition, it is possible for ROE levels to remain relatively high.”
