At Least These Sky-High Energy Prices Are Good For One Country’s Stocks…

At Least These Sky-High Energy Prices Are Good For One Country’s Stocks…
Reda Farran, CFA

over 2 years ago5 mins

  • Rising energy prices are fueling Russia’s economic growth and boosting the country's finances – already among the safest out of all emerging markets.

  • Analysts have been upping their earnings forecasts for Russian companies, whose stocks are cheap and seeing increasing investor flows.

  • Many traders are expecting the Russian ruble to keep getting stronger, and that could boost international investors’ returns even more.

  • You can easily invest in the Russian stock market via cheap ETFs but just be aware of their main risk: they’re heavily exposed to energy companies.

Rising energy prices are fueling Russia’s economic growth and boosting the country's finances – already among the safest out of all emerging markets.

Analysts have been upping their earnings forecasts for Russian companies, whose stocks are cheap and seeing increasing investor flows.

Many traders are expecting the Russian ruble to keep getting stronger, and that could boost international investors’ returns even more.

You can easily invest in the Russian stock market via cheap ETFs but just be aware of their main risk: they’re heavily exposed to energy companies.

The global energy crunch is fueling a debate that we could be entering a new energy supercycle – a sustained period of sky-high demand and struggling supply that spells higher prices for years to come. And if that’s the case, Russia should be your top emerging market (EM) investment destination for a whole handful of reasons.

1. Russia’s economy has done well out of rising energy prices

As the largest exporter of natural gas in the world and the second-largest exporter of oil, Russia is an energy superpower. So it’s no surprise that surging energy prices are a boon to the country’s economy and, in turn, its asset prices and currency. According to the International Monetary Fund (IMF), Russia’s economy is expected to grow by 4.7% this year. That’s two-thirds faster than fellow energy superpower Saudi Arabia, whose economy is expected to grow 2.8% this year.

2. Russia’s finances are among the safest of all the EMs

Russia has over $600 billion in foreign exchange reserves – the fifth-highest amount in the world. That’s especially important when investing in EMs because reserves are a good way to assess a country’s creditworthiness: they’re used to support foreign obligations (like imports or debt denominated in foreign currencies), stabilize the country’s currency, intervene in markets during times of crisis, and more. Also, Russia’s national debt-to-GDP ratio of less than 20% makes the country one of the least indebted in the entire world.

3. The Russian ruble is getting stronger

The ruble is the best-performing emerging markets currency so far this year, partly because of the factors we touched on above. And many traders are expecting the currency to continue to strengthen as Russia’s central bank pushes ahead with aggressive interest rate increases, even as they sit at around 7.5% – the second-highest level out of a group of major central banks. The prospect of higher returns, after all, makes the country’s currency more attractive to international savers and investors.

The Russian ruble is the best-performing emerging markets currency this year
The Russian ruble is the best-performing emerging markets currency this year

The performance of a country’s currency matters when you invest internationally because it can add to or detract from your overall investment returns. For example, let’s say you’re a US-based investor who decides to put some money into the Russian stock market. Then let’s say the market goes up by 10% over the next year, while the ruble also strengthens by 5% against the dollar. In that scenario, your overall investment returns – measured in dollar terms – are 15%. Of course, this can go the other way if the ruble gets weaker, but at least it’s not as volatile and prone to big drops as some other EM currencies (we’re looking at you Turkish lira…)

4. Analysts are turning more bullish on Russian companies

According to calculations from Bloomberg, twelve-month earnings projections for Russian stocks have surged 15% since the second half of the year. In comparison, profit forecasts have increased 6.7% in Saudi Arabia, barely changed in Asia, and fallen in Latin America. That matters because one of the main drivers of stock returns is earnings growth, so it follows that improved earnings projections should lead to stronger stock market performance, all else being equal.

5. Russian stocks are looking cheap, and investors are starting to get wise

The MSCI Russia Index trades on a forward price-to-earnings (P/E) ratio of just 7x. That’s 50% cheaper than the MSCI Emerging Markets Index, but Russian stocks have admittedly always traded at a discount to their EM peers. So let's look at a different valuation metric: the index’s forecasted dividend yield over the next 12 months, which, at 7.5%, is near its highest level in more than 15 years. And thinking about this level in absolute terms, an investment that generates 7.5% a year in income is very attractive in a world with rock-bottom bond yields.

The MSCI Russia Index’s forecasted dividend yield is near its highest level in years. Source: Bloomberg
The MSCI Russia Index’s forecasted dividend yield is near its highest level in years. Source: Bloomberg

Throw in the problems in China – the fears of contagion in the country’s troubled property sector, coupled with the government’s intensifying crackdowns on several other industries – and investors are looking for another EM – like Russia – to invest in instead.

What’s the opportunity here?

You don’t have to speak Russian or analyze individual stocks to benefit from this opportunity: you can easily invest in the Russian stock market through cheap exchange-traded funds that provide diversified exposure to the country’s stocks. The two biggest are the VanEck Russia ETF (ticker: RSX) and the iShares MSCI Russia ETF (ticker: ERUS). Of the two, I personally prefer RSX because it’s more diversified: it holds 29 stocks versus ERUS’s 25. Also, the three biggest Russian stocks – Gazprom, Sberbank, and LUKOIL – make up 25% of RSX’s total value, versus 46% in ERUS.

One thing both ETFs have in common is that they’re heavily exposed to energy companies, because that happens to be the make-up of the Russian stock market. And that’s the risk you have to be aware of: an ETF heavily exposed to the energy sector will naturally underperform if oil and gas prices plunge. But the opposite isn’t necessarily true, in that energy prices don’t have to keep going up for Russia’s stock market to keep doing well. After all, even if the local currency value of Russia’s oil exports – which hit a record high of 6,000 rubles a barrel last week – stays put, that sort of money will keep providing a huge windfall to the country’s economy, stock market, and currency for years to come.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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