Russia is still showing “value”

Rising volatility is certainly a theme of 2018, and perhaps more so in Russia than anywhere else. We benchmark the recent market moves with historical episodes  and seem still fair value. Although these can shift meaningfully if fundamentals deteriorate, we aim here to mark overweight  for Russia’s asset class.

The signal has shifted to “inexpensive” in FX and credit. The recent moves in the RUB (-12%) and in CDS (+40bp) suggest that, all else equal, the value signal has shifted to “inexpensive” compared with our fair value models. Equities remain a low-P/E market, but vs. EM peers, Russian equities trade at 2x the relative P/E compared with December 2014. That said, equities have a natural FX hedge given USD revenue exposure (commodities) and have historically weathered bouts of Russian market volatility the best. Local bonds continue to screen as inexpensive (on a real rate basis) as they have done since 2014, particularly vs. EM peers (Russia vs. EM real rate differential of 1.8% vs. 1.3% “post-Crimea” average), but this signal can shift if FX depreciation results in inflation pass-through.

However, the signals were much more severe in 2014. While it is difficult to compare today with 2014, particularly given a vastly different global backdrop (namely oil prices), we look at both fundamental-driven fair value and relative market pricing to contextualize current Russian asset pricing. In short, we would need to see much more significant moves in Russian assets to find similar premia as witnessed in 2014 (i.e. 20% further decline in the RUB, 100+bp sell off in fixed income).

Heavy positioning and near-term uncertainty risks keep us on the sidelines, but local rates have been the best “bounce back” trade historically. Given the highly fluid situation, we refrain from a tactical trade recommendation here, but we note that local bonds have historically posted the sharpest “bounce back” relative to other Russian assets and continue to screen significantly ‘inexpensive’ compared with recent history. Another near-term concern is that EM-benchmarked investors appear quite overweight Russian assets .