The financial windfall of Russian bonds and equities

(MENAFN- Khaleej Times) The definition of stupidity in investment management is a CEO/CIO who loses 50 per cent of his capital when a bull market implodes and then misses the 50 per cent rise when a bear market explodes to the upside. Russia provided a classic lesson in the value of local market intelligence currency risk and credit cycles in 2013-15. As the world's largest oil and natural gas exporter Russia naturally benefits from spectacular short covering rally in crude oil since late January as Brent rose from $27 to $40. Yet Russia is also a global colossus in natural gas iron ore phosphate nickel diamonds wheat and gold.

While the collapse of the rouble since the Kremlin annexed the Crimea and the West imposed sanctions has led to an inflation nightmare in Russia with the CPI at 12.8 per cent. Yet central bank tight money a fall in retail sales and Federal budget freezes mean inflation could well fall to nine per cent by year end 2016. This means Bank Rossiya's policy rate could fall to 8.5 per cent by year end. The Russian rouble as usual is a wild card and a June Fed rate hike could pressure Brent down to $38 and cause the Russian rouble to depreciate to 72-74 where I would go long rouble again. Russia after all is still in recession with GDP contraction above four per cent.

Rouble denominated debt and eurobonds were a phenomenal winner in 2015 with the VTB Capital debt fund the planet's finest Russian debt manager up a fabulous 35 per cent in US dollar terms! Even now the VTB Capital debt fund has a yield to maturity of 7.4 per cent and a duration of four years in US dollars. Russia's sovereign credit swap is 280 basis points double the pre-crisis average. Corporate rouble debt offers 15 per cent yields. The Russian eurobond market offers the ballast of spread compression in one of the emerging market's less indebted countries.

Russian equities were savaged by the Crimea/Ukraine war the oil/commodities crash draconian rises in inflation and interest rates the highest capital flight since the fall of the USSR recession an exodus of offshore funds and corporate rating downgrades. Russia now trades at 6.4 times forward earnings a price/book value of 0.6 and a dividend yield of 5.9 per cent. These metrics are reminiscent of those just after Lehman's failure and the Georgian war in autumn 2008. This has got to be the most brutal protracted valuation deratings I have ever seen in my life. Russia now trades at an unjustified 50 per cent discount to the valuations of the Morgan Stanley emerging markets index.

Does Russia deserve its Cinderella valuation metrics? Da and nyet. The Russian stock market is denominated by banks oil and gas producers and miners sectors not exactly known for high price/earnings ratios. Yet if oil and commodities have finally bottomed Russia's 50 per cent discount to MSCI emerging markets could well compress to the 10 year average of 18 per cent. This macro scenario would trigger a money making feast in Russian equities in 2016. The catalysts could be a fall in inflation and interest rates a rise in Brent crude to $45 if the output freeze deal with Saudi Arabia holds or a geopolitical event like a Minsk Pact deal happens with Nato.

Sberbank at 0.8 times book value (above Citigroup) has the oldest biggest branch network in the Russian Empire (Ok Federation) a loan/deposit ratio of 100 and a return on equity of 17 per cent is obviously the Russian mega bank most "too big to fail" for the Kremlin elite and the people of the Rodina. Paradoxically the ideal time to buy a domestic proxy like Sberbank is when the Russian economy is in the depths of economic recession. This bank has a pedigree that goes back to the 1860's to the reign of Tsar Alexander II.

March was the best month for emerging markets since January 2012 thanks to a dovish Dr Yellen the crude oil surge a soft US dollar and the imminent impeachment of Brazil's President Dilma Rousseff. The MSCI emerging markets index was up a stellar 13 per cent in March 2016. It was unquestionably time to roll the samba drums in Brazil since the Bovespa is up 18 per cent in only four weeks while the Brazil Real has surged 10 per cent against the US dollar. The US dollar's next twist China growth/PBOC yuan policy and Brazil politics will determine the next leg of the EM equities rally. High yield Russian roubles Indonesian Rupiah Brazil Reals and Indian Rupees are my favourite FX carry trades. The trend is your friend until the trend comes to an end.