Oil Rebound Helps Blunt Sanctions, but Russia Fundamentals Remain Challenged
Art by Pete Ryan
Russia, the perennial bad boy on the international scene, has been slapped with sanctions three times for its behavior, which is not a good thing for its economy and markets. But the world’s 12th largest economy (at $1.5 trillion) has benefited from recovering oil prices, easing the sanctions’ sting.
“If not for the strength of oil prices, Russia would be in big trouble,” said Matt Benkendorf, chief investment officer of asset manager Vontobel Quality Growth, which no longer invests in the country.
This disruption has left Russia, one of the celebrated BRIC (Brazil, Russia, India, and China) up-and-comers, as a problematical place to invest.
As a result of the initial battery of sanctions, four years ago, the Russian economy tanked, losing 2.5% in 2015. Earlier in the decade, gross domestic product growth regularly came in around 4% annually.
By 2015, oil prices also were low, which meant Russia’s main economic driver—oil and gas make up 60% of its exports—wasn’t hardy enough to offset the sanctions. Oil prices fell from over $100 per barrel in mid-2014 to less than $30 in a year. They only started inching up at the very end of 2015, though the recovery has been gradual.
The reason oil came back: Russia caught a break when it allied with the Organization of the Petroleum Exporting Countries (OPEC), also petro-dependent, to cut back on production and thus limit supply. Eventually, oil rose to around $70, which took the edge off Russia’s economic plight to some degree.
The harshest punishments came in 2014, which the US and the European Union placed on Moscow after its annexation of Crimea and its aid to pro-Russian Ukrainian rebels. These sanctions limited Western financing for Russia, and they banned US and EU oil companies from doing business with the nation’s energy sector.
Two other, more symbolic rounds of penalties followed: In late 2016, with President Barack Obama’s expulsion of Russian diplomats amid charges that the Kremlin had interfered in the US election. And in April, after Russia was accused of poisoning a Russian defector and his daughter, the US imposed sanctions on seven of its oligarchs with ties to Russian leader Vladimir Putin along with 12 companies they own or control.
With each round of sanctions, the Russian stock market and the exchange rate for its currency, the ruble, took a pasting. Russia’s climb back has been fitful. Its GDP growth was around 2% last year, and likely will be around the same level in 2018—half what it used to be.
The VanEck Vectors Russia exchange-traded fund, which follows the Russian stock market, fell 60% from its high this decade in 2013 to its low in early 2016. Lately, the ETF has risen, but still lies 10% shy of the high. The ruble has had a similar trajectory, fetching 31 to the US dollar at its recent peak in 2014, then plummeting to 80 to the dollar in 2016. Since, the denomination has crawled back to 50.
Russia’s falling inflation, sturdy currency reserves, and competent central bank have been pluses during its recent economic travail. In fact, the Central Bank of Russia worked hard to combat the ill effects of the sanctions and managed to keep inflation to a relatively low 2.4% in April.
Nevertheless, for some outside investors, the sanctions have taken the shine off Russia as a good place to invest. So has the Putin regime’s belligerent attitude toward the West. There’s even a movement in the Duma, the Russian parliament, to impose counter-sanctions on its own nationals who are perceived as playing along with the US-EU line.
Russian stocks right now are cheap, trading at a thrifty forward price/earnings ratio of 5.6, according to Yardeni Research. “A lot of people can be lulled into believing that Russian stocks are a great value,” said Vontobel’s Benkendorf. “Well, you get what you pay for, and Russia is not a prudent place to invest.”
The harsh truth is that the commodity boom of the past decade has faded, despite a partial rebound lately. “There is no evidence that Russia will adjust to this new reality by finally diversifying its economy,” wrote Ian Bremmer, president of the Eurasia Group consulting firm. “Recent efforts to create a Russian version of Silicon Valley have produced little.”
That said, the bullish view on Russia is that the long-term track for commodities is ever-upward as emerging nations like China become more middle-class and demand grows apace. In addition to energy, Russia has large repositories of minerals, like copper, coal, aluminum, and nickel.
Despite ups and down of commodities, particularly oil and gas, “demand for them, as well as industrial metals, will only increase,” said Chris Gaffney, president of world markets at EverBank.
To bulls such as Gaffney, the current unpleasantness shall pass. “Europe would like to see the sanctions lifted,” he said.
In the meantime, Russia is in the center of all manner of political whirlwinds, especially the US special counsel’s investigation of Russia’s possible connection with the 2016 Trump presidential campaign. This suggest more economic bumps will crop up for it in the future.