Will 2015 be the year of 'Russian' stocks?

Dec 18, 2014

In this issue:
» Wealth gap divide between India and rest of the world narrows
» Can PM Modi, India's agent for change, deliver?
» Fed believes in maintaining status quo on interest rates
» ...and more!

2014 is like the new 1998 for Russia. If you don't believe then check this out.
  • In 1998 oil was down 40% & Russian stocks were down 90% from peak
  • In 2014 oil is down 40% & Russian stocks are down 75% from peak
Both the years are kind of mirror image of each other. Also, oil was the main culprit in both occasions that led to the crisis. The only difference being that the 1998 crisis was also plagued with fiscal imprudence, declining productivity and debt default. 2014 is different in that sense. Structurally, Russia is not facing any issue. It is the oil price debacle that is hurting the most.

Basically, Russia is an oil economy. Hence, whenever crude prices fall, the economy stagnates. Until now, oil cartel OPEC was a natural hedge to this risk. Whenever oil prices fell, OPEC used to cut the output to support prices. However, this time around it has chosen not to do so. This has hurt oil exporting countries including Russia.

In fact, investors are so worried about the economic state amidst falling oil prices that they have exited the country lock, stock & barrel. Such is the fear on the streets that Russia is by far the cheapest stock markets in the world today with a P/E of 3-4x. Yet investors are unwilling to touch it with a six feet rod! In other words - stocks are on sale in Russia but investors are running out of the store.

Let us return to our similarity analysis between 1998 and 2014 to understand why investors could be making a grave mistake! Well, the facts that we displayed in our comparison earlier were incomplete. Here is the true picture of stocks, oil and Russia.

  • In 1998 oil was down 40% & Russian stocks were down 90% from peak
  • In 1999 Russian stocks were up 150%!
  • In 2014 oil is down 40% & Russian stocks are down 75% from peak
  • In 2015 Russian stocks will be up by ___%?
As seen, 1999 was a golden year for Russian stocks. And investors who had the courage to invest in 1998 emerged as true winners. They bought when nobody was investing; valuations were dirt cheap and made a fortune.

So, can 2015 be the new 1999 for Russia? The conditions today are similar to what they were in 1998. In fact, they are better when one considers that Russia isn't facing any structural issue as was the case in 1998. Valuations too are cheap and there is blood on the street. Perhaps, a fortune similar to 1999 is in the making. One just needs to have the counterintuitive knack to invest now after knowing that valuations are not expensive. And not worry too much about near term risks.

As Howard Marks once said, sometimes low quality assets can be safer than high quality assets. And considering the margin of safety in valuations, that could be the case with Russia now when compared to other BRICS nations.

A true value investor is someone who can recognize this anomaly so as to invest at the right juncture before valuations become pricey. To be honest, there were many Russia type stocks in the Indian stock markets a couple of years back. That was the time when we too had BUY calls in majority of our services. Currently, valuations have become a bit pricey and hence investors need to be a bit cautious.

Have you ever bought a dirt cheap low quality stock that delivered handsome return in the process over the year? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Let's move from the topic of wealth creation to wealth concentration. The latter has been widespread phenomenon not only in India but across the globe. As can be seen in today's chart, the wealth share of top 1% in India is 49% as against 48.2% for the world. In other words India's richest 1% people own close to half of the country's wealth. Same goes with the world's richest 1% people.

Such, a massive wealth concentration signifies the kind of income inequality India and the rest of the world faces. In order to eradicate the same, government must take some serious measures like taxing rich a bit more. True, that the wealth earned by the rich people is through their own skill & labour and they may not appreciate higher taxation by the government but of late quite a few billionaires have taken to philanthropy as a social measure to help the less fortunate ones. Such measures can definitely help in bringing down income inequality which has become a social evil.

Wealth gap divide in India and rest of the world

Talking about wealth creation how can we not mention about Fed's monetary policies that have created artificial wealth in stock markets by forming price bubbles. You may probably know that the all important announcement from the Federal Open Market Committee or the FOMC as it is popularly known, has finally been made. Those who were expecting surprises will be in for a disappointment, we reckon. We for one weren't certainly expecting any. For we knew far too well that the Fed is not going to diverge from its stated objective. Consequently, the low interest rate regime stays. In fact, even if the rates rise, the Fed is of the view that monetary policy is likely to stay accommodative for a long time.

Clearly, the Fed believes that either its formula is working or is likely to work over the long term or both. But is a forced lowering of interest rates an answer to most of the economic woes? Certainly not. All that this policy does is lulls people into believing that this is for real and makes them take all the wrong capital allocation decisions. Consequently, when the rates rise, projects that were deemed profitable at near zero rates are certainly not profitably anymore, thus leaving huge losses in their wake. And the sooner the Fed realise this the better it is. Otherwise, the bubbles will keep getting bigger and bigger and the eventual catastrophe will be that much worse.

As per one of Buffett's famous quotes, if one finds oneself in a boat that is chronically leaking, the better use of one's efforts is by way of switching the boat rather than spend time in fixing the leaks. This is of course a metaphor for saying that if a business has structural issues, there's no use trying to fix those issues. Instead, seeking out a better business model would be a much better use of the management's time and energy. Can this be said about India's perceived agent of change, Mr Narendra Modi? At least this is what noted journalist and ex-Union Minister Arun Shourie seems to be thinking.

In an interview to a leading business daily, Shourie has opined that Modi may be an agent of change as an individual. But no matter how big your oar is, you have to change, reshape an ocean. The ocean of course being India's famous bureaucracy and its economy. Reforms are of course good. But the depth and pervasiveness of those reforms have to be great, he further added. Indeed. Mr Shourie couldn't be more correct according to us. No long lasting change is going to occur unless things change structurally. And sadly, very little of it has been on display so far. Most of the big bang announcements have a firm action plan behind them missing. For a Government that came to power on the pretext of changing things at a level deeper than most of its predecessors, it will quickly have to get its act together we believe.

The Indian stock markets are trading positive today. At the time of writing the BSE-Sensex was trading up by around 401 points, while the NSE-Nifty was up by 121 points. Gains were largely seen in consumer durables stocks. Most Asian stock markets were trading in the positive at the time of writing. European markets too have opened the day on positive note.

 Today's investing mantra
"Real knowledge is knowing that you don't know anything." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Rahul Shah and Jinesh Joshi.

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2 Responses to "Will 2015 be the year of 'Russian' stocks?"

sachin g kawde

Jan 14, 2015

yes it is petronet lng bought at 33.
tech mahindra at 340.
axis at 420 before the split.
advanta at 240 before the split.



Dec 20, 2014

I have invested in this company Vertex Spinning Ltd from 2010-2013 with average purchase of 4.70/- per share nd finally booked profit in this month when i sold at 22/- per share.

Equitymaster requests your view! Post a comment on "Will 2015 be the year of 'Russian' stocks?". Click here!
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