War is good for absolutely nothing (c)

Apart from wrecking your trading account...

Hi, I wrote most of this over a week ago, but was not able to finish, since I have actual work (trading) to do and the markets were lit. Some info/views might look stale, although this is not intended as a real-time commentary obviously. A question for the readers: would you like to get a more regular market color in short notices? Maybe Telegram channel? You can also check out my Twitter @gregisaev

Recently Russian market again found itself in the midst of geopolitical tensions. This is hardly anything new - the fears about imminent continuation of hostilities in Ukraine are ongoing with very little pause from 2015 to this day.

If not Ukraine, we regularly have reasons for concerns in Belarus. And now we can add Kazakhstan to the list. Political situation in CIS is unstable to say the least. If you operate in local markets at all, you should understand that perfectly well and decide if those risks are worth the risk premium you are getting.

This is a personal decision and some are choosing not to invest in Russia at all, even Russians. My personal view is that everything has its price and having zero exposure is just irrational. Especially for people who take those country risks anyway. Owning shares in Russian businesses can be rewarding, as a long line of oligarchs can attest. But it is not for everyone.

On top of political instability we have a large commodity dependence and a Central Bank which is completely not gun shy and did once raise benchmark rate by 650 basis points over the weekend.

Of course in such fluid environment the optional value of cash/bond position preferably in hard currency and some appropriate hedges from time to time is much higher than in a more stable market. And that makes leveraged trading much more dangerous. International diversification is also paramount.

This letter will operate on the assumption that you have some allocation to Russia and are looking for some color on what’s going on and maybe some ideas from time to time. We will try to avoid hot political takes as much as possible, but as can be easily seen – in a country like this they are inevitable. We will strive to be as impartial as possible and provide objective analysis.

THIS IS NOT AN INVESTMENT ADVISE AND DOES NOT REFLECT VIEWS/OPINIONS OF MY EMPLOYER.

Now that we are done with banalities, let’s get to business.

At the moment we have: Russia – NATO standoff (which is more about Russia – US relations than NATO), global energy crisis (which strengthens Russian hand for now), and Kazakhstan crisis (which looks like dissipating). There are plenty of political analysts who spend an inordinate amount of time analyzing all of this and penning detailed articles, so we will try to make political discussions as short as possible. I’ll try summarize my view on all recent developments in some bullet points:

·       Russia is raising stakes on purpose to force US to negotiate on security and other topics (NS2) and US has been responding in kind quite aggressively as well.

·       Russia has no real intention to launch a large scale attack on Ukraine NOW, it is not feasible at the moment (or ever). Ukraine is a bargaining chip/way to extort pressure. The local propaganda channels are not prepping the country for war as of now.

·       Military relocation is partially a surge, partially permanent. If US continues to provide weapons to Ukraine, or talk about NATO membership, Russia will be forced to keep an army on Ukrainian border to protect Donbass.

·       The crisis should drag for some time and reach a climax after which there will be a compromise or relations will be completely broken (but that does not automatically mean a hot war in Ukraine)

·       There is an option to put military in Belarus or Cuba and Venezuela (provided they allow that), but that will cost Russia both economically and politically, so those are measure of last resort. Nobody wants a new Cuban missile crisis I guess. South America presence is mostly theoretical, but worth reminding that it was Putin, who closed Russian base in Cuba 20 years ago.

·       Escalation at the moment is beneficial local politics wise for everyone – Biden gets to be tough on Putin and distract from inflation. Putin gets to mobilize the country and distract from Russian disastrous pandemic response etc. EU distracts it’s populace from energy crisis. Ukrainian leadership can continue to loot the country or try to put ex president  Poroschenko in prison (the guy who actually stood up to Putin in a twist of irony) without any objections from the West.

·       Another reason why I think any aggressive action from Russia will be delayed – Putin is unlikely to let down Xi and starting something while Beijing Olympics are not over and after that it will be too late, the troops will need to be moved to winter quarters. 

      Worst logical case for hostilities imo are some special ops inside Ukraine or formally putting boots on the ground in Donbass, turning it into Abkhazia or both. This could lead to sanctions, question is what kind of sanctions. Russia is now showing it is willing to accommodate some US demands and Putin keeps his word to Biden – just yesterday FSB arrested a bunch of hackers US complained about. In this case imho US is likely to sanction new state debt which is completely manageable for Russian treasury and probably one or two second tier banks. Hard sanctions on SBER or VTB are not that likely in this scenario.

    “Blue sky” scenario: Russia and US agree on some sort of compromise for missiles placement (I strongly believe this is one of the main reasons and driver for the ongoing crisis – Russian leadership is very worried US could put some advanced missiles in Ukraine in the future), there are no or token sanctions and everybody explains to their domestic auditory what a fabulous achievement it is. Ukraine keeps potential for NATO inclusion but that stays that way for a very long time, same as Georgia etc. Russia finishes NS2 and adds gas volumes to EU. A long time moratorium on NATO expansion would be ideal, but unlikely.

Update: Last week the picture did not get actually better – negotiations wise Putin delivered something (two hacker groups got arrested) and US side has not only delivered nothing, they and their allies have increased their involvement in Ukraine. Basically from what I saw last week: Russia is telling US that if NATO is expanding into Ukraine, Russia is willing to stop this by force. US so far is ignoring those demands at least publicly. The probability of immediate war is not high, but it is not zero either, but again – imho anything bad, if it happens, will happen much later if negotiations completely breakdown .

Ok, let’s get back to stonks. Russian markets often be like: “Come for a local geopolitics driven sell off, stay for a general global markets risk-off”. And that’s exactly what happened last two weeks. The froth in tech is vaporizing especially fast.

 Russian tech has long amused me, and not because I am a generally value/special sits guy. I found the concept that you could pay DM-level multiples for EM (and with large geopol risks) stocks as illogical and has been musing about that for a while on FB and Twitter. Call me a Boomer, but I do not think Yandex ever deserved a premium over blended Google-Uber valuation.

Now that we got a dose of 2008/2014 price action things are looking much better valuation wise even in tech land. I think VKCO might be interesting there. The stock got completely annihilated, thanks to general tech sell off, Russian tensions and change in ownership/management. Now the last thing is interesting – new shareholders are toxic for global investors, but new CEO from what I heard is: a) good professional b) obviously incredibly well connected. I do not think a person like him would jump on this sinking ship and buy stock (not a great amount but still) if there was not a concrete plan in place to increase revenue and earnings leveraging perhaps his and his new shareholders connections. He would go there only if he knew how exactly this will benefit him carrier wise. The situation in general has echoes of Magnit, with market reacting similar. But in Magnit case we had a genius founder leaving, whereas former VKCO management did not a great job at least from the shareholder value creation standpoint. The safe and consensus bet on Russian tech is of course Yandex and valuation is looking much more compelling now.

The broad market (I will refer to essentially RTS index) now offers >10% div yield and since the bulk of the index consists of exporters – it is actually benefiting from lower FX PnL wise.

Russian energy will print gobs of cash with gas prices high and Brent in rubles fast approaching 7000, which is unheard of. Also dollar in general was weaker recently and most metals and ore got a bid, so Norilsk for example is trading at highest discount to its revenue basket since 2018 and you get low FX benefit on top of that. For the first time in a while I think basically all stocks in RTS are cheap with an exception of may be TCS, but that thing also has almost halved already. Stuff like HHR and FIXP is questionable even at these levels, but their weight in index is negligible. All primitive indicators I am tracking show that we are back to 2018 level valuations, when the sanction risk was perceived as very high.

 In energy obvious plays are GAZP and LKOH. Less obvious but potentially a catalyst emerging – TATN&P  (the catalyst I think will be ministry of finance panicking about lackluster Russian oil production and giving the Tatars back their tax breaks on unconventional oil fully or in part. TATN also behaved by slashing payout which irritated the government and investing more domestically in petrochemicals, so MINFIN should be pleased with that as well). BANEP is deep f..in value but lacks an immediate catalyst. Some will argue that this is a value trap similar to IRAO for obvious reasons, I would agree in principal, but even at current dividend policy BANEP would likely offer a 15+% dividend yield, potentially 20% at current Brent-ruble combo. So, while full value unlock might not be in the cards anytime soon, those shares are clearly no Surgut ordinaries.

Globally I think a lot about FX thing. Russian authorities are playing with fire as recent events in Kazakhstan showed. Suppressing FX and executing an incredibly austere budget policy looks great for reserves and exporters but the reality is that most of the country is sinking into objective poverty fast. Drive like 300 km from Moscow and the picture is very bleak. People are very poor. Now there are signs that those in charge wised up after Kaz a bit and are looking to try to equalize wages for federal workers etc, we will see if it actually works. Ultimately the budget rule has to be adjusted. (yeah, I am a stonk guy with some firm macro opinions). But for now artificially low FX keeps benefiting exporters and there is no reason for investors not to try to benefit from that…

Overall the situation is very fluid and dominated by headlines and global risk off to boot. I have some strong views on global stonk action obviously, but this is intendent as a Russia-focused newsletter, so I will probably abstain from voicing them here. In general I think Russian investors who are accustomed to high volatility should look more at other EMs outside China and DMs ex US for diversification. (Everyone and their dog is already long US and China tech anyway).

For now we are in a tough market both locally and globally and i think this will continue for a while. Trading bear markets is very hard and exhausting and for most it would be better to just sit it out if you are not a long term buy and hold type of person. Stay frosty out there.