Russian roulette
There are signs of progress, but Russian stocks still carry a significant risk.
By Michael Brush
moneydaily.com
Since an IMF aid package for Russia was announced last weekend, the government has wasted little time in taking the first steps to make some of the economic reforms that would turn things around.
And the Russian stock market has responded nicely. By the close of trading Thursday, it had tacked on 26% since last weekend.
That kind of gain -- against the backdrop of a massive $22.6 billion international aid package and the promise of true reform -- is the type of thing that can make the average investor sit up and take notice.
What's more, if you dig around a little bit, you will find that Russian stocks look incredibly cheap. Among the major emerging stock markets, Russia's has the lowest price to book and forward price to earnings ratios. By other valuation measures, it seems like a screaming buy as well.
Does all this mean you should be buying funds that invest in Russian stocks?
Probably not. Unless you can stomach lots of volatility.
Like many of the economically troubled countries in Asia, Russia has some serious structural problems that will take at least a year to work out. And the fits and starts that will occur as Russia makes real reform -- or fails to -- will guarantee a rough ride in stocks along the way.
"Russian stocks are for people who can really handle a very high amount of volatility," says Desmond Lachman, the head of emerging markets economic research at Salomon Smith Barney. "They are the kinds of stocks you buy for your children, if not your grandchildren. These stocks have long-run value if Russia does come right. But it will be a bumpy ride along the way."
Before the IMF aid package was announced, Russian stocks were taken down to levels that discounted the worst case scenario for the country. So you would expect the nice short-term bounce that just occurred. But don't let that fool you into thinking it will be a smooth ride up from now on. It won't.
Here are the likely pitfalls that will cause lots of volatility along the way, according to Salomon Smith Barney analysts who follow international stock markets.
* Devaluation. The Russian currency is overvalued by about 30%, estimates Leila Heckman, an international market strategist at Salomon Smith Barney. At the moment, there is lots of international support for the currency. But as that wears off, you are likely to see a devaluation before the end of the year.
* There could be another government debt crisis. Even with the IMF loans coming in, shortcomings in the way Russia collects taxes and other problems mean the government may be insolvent at some point soon, says Heckman.
* Stutter-step systemic reform. Russia has to improve the way it collects taxes, its bankruptcy laws, the accounting rules, and other parts of its legal system where ambiguities often make it hard to pin down or enforce business deals. "You don't have the institutional structures that you have in a normal advanced economy," says Lachman "Russia is very primitive in this area." Will the powers that be accept change? Lachman estimates that seven oligarchs control 50% of Russia's productive assets. They may resist reforms that would cramp their style.
* Political and social confusion. There will be parliamentary elections next year, and a presidential election in 2000. Who will succeed President Boris Yeltsin? And there are mounting social problems -- stemming from the ire of miners who are not being paid back wages, for example. And will anything be done to limit the power of organized crime? "It is as if General Motors and all of the top corporations in the U.S. were controlled by groups that are behaving above the law," says Lachman.
* Suspect accounting practices. Earnings are often suspect, and many companies fail to conform to international accounting standards, says Heckman. Shareholders are offered little real protection. So companies can easily make changes that dilute earnings. These things increase the potential for nasty stock blowups.
* Business restructuring may come up short. Many of the public companies that were taken private recently are uncompetitive in the international market because they have old equipment. Will they upgrade fast enough?
* Bad fundamentals. Finally, forecasted GDP growth is around zero, says Heckman. This helps explain why more earnings estimates are being taken down than up -- another sign of weakness in the market.
All of this does not mean the Russian market won't come up with more stunning surprises. After all, who would have predicted the 200% gain in the stock market between September 1996 and a year later? Likewise, few investors expected the 70% drop that has returned the market to those September 1996 levels.
It is precisely this kind of wild volatility that you better be prepared for if you move money into Russia. "You can buy Russia and it can be a small portion of your portfolio," says Heckman. "But you have to put it under your mattress and not look at it." |
