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Russian Headlines May Return

11/12/2014

This week’s Asia-Pacific summit in China provided several photo opportunities for global leaders. Most focused on President Obama and Russian President Vladimir Putin. In most of those pictures Mr. Putin appeared cheerful, confident, and relaxed. However, given recent economic developments, in private he may be anything but cheerful. What it means for investors is the potential for some negative headlines to emanate related to Russia as the year-end approaches. I suspect those headlines are likely to center on saber rattling in Ukraine, similar to the headlines from this past summer.

Based on the following recent conditions, I have some elevated concern that Russian headlines could impede the appreciation of global risk assets, even if only temporary. Most importantly, investors should not give in to the temptation to allocate toward Russian equities, bonds, or currency. During the summer I offered that “take a pass” strategy, and despite cheaper values, I still would not assume the significant allocation risk associated with those Russian assets.

  • The Russian ruble (Figure 1) is down over 30% year to date relative to the U.S. dollar, fostering significant capital outflows

Figure 1: Russian Ruble versus U.S. Dollar, November 2011 to Present
Figure 1: Russian Ruble versus U.S. Dollar, November 2011 to Present
Source: Bloomberg 

  • Russia must defend its free falling currency, and unfortunately, capital controls is the most likely weapon. Although not implemented yet, its use would isolate Russia even further in the global economic system.
  • Russian GDP for 2015 is forecast at 0%, and more than likely will be worse than that and heading deep into recession
  • Russian inflation has now surged above 8%
  • The 10-year yield on a Russian government bond is above 10%
  • Oil prices have declined nearly 20% over the past four months, contracting a significant source of revenue
  • Russian equities have declined to five-year lows in the past few days (Figure 2)

Figure 2: Russian Equities via RSX ETF, prior 5 years
Figure 2: Russian Equities via RSX ETF, prior 5 years
Source: Bloomberg

Dramatic domestic fiscal and financial reform is needed in Russia. However, I have limited confidence that President Putin and his Kremlin counterparts will choose that path. More likely, the Kremlin will address its economic crisis beyond its borders, through actions in Ukraine similar to this past summer. It appears that in Russia, the more things change, unfortunately, the more they remain the same.

Past performance is not a guarantee of future results.

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