What's Behind the Rally in Russian Stocks

A Look at Why Russian Stocks Have Soared

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The Market Vectors Russia ETF (NYSE ARCA: RSX) has soared more than 45 percent since January 2016 making it one of the best-performing markets in the world. By comparison, the S&P 500 SPDR (NYSE ARCA: SPY) has risen about 11 percent over the same timeframe. The Russian stock market remains more than 20 percent lower over the past five years and more than 45 percent lower over the past 10 years, however, which leaves a lot of ground left to cover.

Let's look at what’s driving the country’s equity market, how investors can participate in the rally, and some important considerations.

What’s Behind the Jump?

International investors have historically considered Russia to be an ‘oil proxy’ since it derives most of its economic growth from its oil and gas sector. According to the World Bank, the oil and gas sector made up 16 percent of gross domestic product (GDP), 52 percent of federal budget revenue, and 70 percent of total exports in 2012. The recovery in crude oil prices from their lows in February provided a boost for the country’s stock market in early- to mid-2016.

Since July 2016, crude oil prices moved lower and have trended sideways, but Russia’s stock market has continued to rise to new yearly highs. Many analysts attribute this ‘decoupling’ to Donald Trump’s victory in the United States presidential election. In fact, the most recent rally occurred when Exxon Mobil CEO Rex Tillerson—who has opposed Russian sanctions—was mentioned as a candidate and then promoted to Secretary of State.

Finally, it’s worth noting that Russian stocks have been significantly undervalued compared to global markets—even when factoring in the high cost of capital due to sanctions—which has made it ‘cheaper’ for investors to speculate on favorable changes to sanctions and oil prices. Russia’s central bank has also been cutting interest rates while reducing inflation to 4.5 percent in a move that has effectively helped boost stocks in the meantime.

How to Invest in the Rally

International investors can gain exposure to Russian stocks in many ways. Exchange-traded funds (ETFs) represent the easiest option for most investors, but American Depositary Receipts (ADRs) and foreign stock purchases are alternatives to consider for specific exposure.

The top Russian ETFs include:

  • VanEck Vectors Russia ETF (NYSE ARCA: RSX)
  • iShares MSCI Russia Capped ETF (NYSE ARCA: ERUS)
  • Direxion Daily Russia Bull 3X Shares ETF (NYSE ARCA: RUSL)
  • VanEck Vectors Russia Small-Cap ETF (NYSE ARCA: RSXJ)
  • SPDR S&P Russia ETF (NYSE ARCA: RBL)

* Data from ETFdb.com as of December 16, 2016.

Most investors may want to consider the VanEck Vectors Russia ETF given its liquidity, stability, and reasonable expense ratio. However, investors looking for maximum exposure may want to consider the Direxion Daily Russia Bull 3X Shares ETF, which provides triple-leveraged exposure to Russian stocks. The added leverage enables investors to better capitalize on the upside, but there is also increased risk in terms of downside risk.

There are also a few Russian ADRs to consider, including:

  • Gazprom PAO (OTC: OGZPY)
  • Lukoil PAO (OTC: LUKOY)
  • Rostelekom PAO (OTC: ROSYY)

These companies provide more specific exposure for investors, including exposure to oil-specific companies like Gazprom or Lukoil.

These companies could benefit the most from higher crude oil prices and reductions in Western sanctions.

Important Risks to Consider

International investors should exercise caution when investing in Russia given its reliance on commodity prices, existing Western sanctions, and other political risks.

Some important risk factors to consider include:

  • Oil Prices: Crude oil prices recovered in the early part of 2016, but the ongoing recovery depends on OPEC’s decision-making.
  • Economic Sanctions: The Western sanctions on Russia have increased the cost of capital for the energy industry and there’s a risk they will remain.
  • Political Risk: Russia’s involvement in the Syrian conflict and intervention in Crimea have increased the political risk surrounding the country.

Investors should take these risks into consideration before investing in the country and ensure that their portfolio is properly diversified.

The Bottom Line

Russia’s stock market has been among the top performers thanks to higher crude oil prices and the prospect of reduced sanctions. Investors interested in capitalizing on these trends may want to consider Russian ETFs, ADRs, or foreign stock, but they should be aware of the many political and economic risks facing the country.