Since Donald Trump’s election, investors have embraced his tax-cutting, regulation-ripping agenda, and have been resolute in backing perceived winners and dumping losers. Developed markets are in; emerging ones are out – the obstinate tycoon must be pleased.
Since 9 November, the promise of higher fiscal spending in the US has raised bond yields, and caused the dollar to appreciate in expectation of higher interest rates this year. Almost $70bn (£58bn) has poured into US equities since the presidential election, Bank of America Merrill Lynch (BAML) reported and relative currency weakness is expected to benefit stock markets in Japan and Europe this year as well.
Emerging markets (EMs) have drawn the short straw in this zero-sum trade. Last week, Turkey’s lira and Argentina’s peso plumbed new depths, and BAML reported that $10bn has fled emerging market bonds and equities since the election. As the greenback rises, the dollar debts of EM corporates and governments become more expensive to pay down.
Russia’s currency, the rouble, is one EM currency which has not only resisted this trend but has actually appreciated against the dollar since September. Enticed by higher local-currency returns, foreign investors have bought Russian stocks and bonds, leading the Micex index to rise 32 per cent in the last 12 months and making borrowing cheaper for Russian companies and its government.
The price of oil
Much of these gains are owing to the price of oil. Last year, the black stuff made its largest annual gain since 2009 as the Organisation of Petroleum Exporting Countries (Opec) and 11 other oil-producing nations – including Russia – finally agreed to curb production and end the global glut in supply.
Russia is expected to emerge from recession later this year, and with the roubles in its citizens’ pockets worth relatively more, analysts and fund managers say that domestically-focused stocks could keep rising, even if export-dependent ones don’t.
“The market was up quite a lot last year, but that doesn’t mean it won’t go up more in 2017,” says Colin Croft, manager of the Jupiter Emerging European Opportunities fund. “There are many areas of the market which haven’t seen earnings upgrades yet, such as consumer-focused companies and telecoms.”
If the signatories of last year’s agreement can stick to the bargain (and many suspect they will not), the price of oil could hover between $50 and $60 per barrel. This would be good for Russia, which recently passed a Budget for 2017-19 based on the oil price staying between $40-45 per barrel, and for the Saudi-led Opec, which wants to keep the oil price low enough that its shale-producing competitors in the US cannot bring too many of their rigs back online.
Central bank stability
But the rouble’s strength is down to more than just dearer oil, namely a credible central bank which has kept monetary policy tight, halving the rate of inflation in 2016 and ensuring that Russia is one of a handful of countries where interest rates may fall this year.
In December, the Central Bank of Russia (CBR) voted to keep interest rates on hold at 10 per cent, and is targeting inflation of 4-5 per cent this year. “This would provide a very attractive yield on local currency bonds,” says Croft. It also provides an eye-catching “carry trade” opportunity, thinks UBS Group, which could yield a 26 per cent return in 12 months. A carry trade involves borrowing in a currency with a low interest rate and buying one with a high interest rate – the rouble, in this case.
“A lot of things are clicking for Russia right now,” says Matthias Siller, manager of Baring Emerging Europe fund. “But the CBR has dealt with challenges such as energy prices and political issues has convinced market participants that its approach is very orthodox and there is no shying away from short-term pain.” Russia allowed its currency to float freely in 2014, making it the only former dollar-pegged oil exporter which has allowed its currency to bear the brunt of the oil price collapse from $115 per barrel in 2014 to $28 in February last year. The 2017-19 Budget contains big cuts to defence and healthcare spending and tax rises, with the government showing little appetite for fiscal imprudence, says Siller. “Even before the Saudi experiment, the Russian stock market was up, proving to a lot of sceptics that it can cope with lower oil prices.”
Will Trump ease sanctions?
With Trump set to enter the White House next week, there is speculation that economic sanctions imposed by the US and the EU on Russia over the Ukraine crisis and its annexation of Crimea could ease. The US President-elect has refused to acknowledge Russia’s sponsorship of hacking during the election, and makes no secret of his admiration for Russia’s strong-man leader.
Such thinking may, however, be premature, not least because the EU views Putin more dimly than ever. “Sanctions will be difficult to lift unless Russia radically changes its Ukraine strategy,” says Peter Kisler at North Asset Management. “Although anything is possible,” he adds.
Sanctions themselves have not hampered the performance of Russia’s economy, thinks Croft, but their removal could provide a further boon to investor sentiment. Siller agrees, but thinks that the reaction might be overly bullish. “I wouldn’t be surprised if it increased demand for Russian stocks. But quantifying its impact in performance terms is more complicated. I’d be surprised if that, in itself, justified higher prices.”