By Michael Patterson
(Bloomberg) — Russia is the top investment pick for the biggest emerging-market stock funds in 2010, even after the RTS Index's world-beating 126 percent rally prompted Finance Minister Alexei Kudrin to say shares are too expensive.
Russia is the leading "overweight" holding among the world's largest developing-nation mutual funds, EPFR Global data show. More than 95 percent of analyst ratings on Russian stocks are "buy" or "hold," the highest level since Bloomberg began tracking the data in 1997. Goldman Sachs Group Inc. (GS) says Russia is the most attractive emerging market for 2010 and Troika Dialog, the nation's oldest investment bank, predicts equities will climb about 40 percent.
While Kudrin said at a Nov. 25 conference in Moscow that "speculative capital" led to "overheating" in the market, the RTS trades at 9 times estimated profits, a 30 percent discount to the MSCI Emerging Markets Index. Earnings will surge 43 percent next year, almost twice the gains in China, India and Brazil, as a rally in oil lifts Russia's economy from its worst recession in a decade, forecasts compiled by Bloomberg show.
"People are waking up to the fact that here's a place you can't overlook," Mark Mobius, who oversees more than $30 billion as the chairman of Templeton Asset Management Ltd., said in an interview. "If you compare Russian valuations now with other major countries, it's not overpriced. There are still opportunities there."
Mobius's Templeton Emerging Markets Investment Trust rose 109 percent in dollar terms this year, compared with a 71 percent gain in Bloomberg's index of the biggest emerging-market mutual funds. The Singapore-based investor, who predicted this year's rally in developing-nation stocks in December 2008 after a 56 percent loss to his main fund, said he will probably hold more Russian shares than are represented in benchmark gauges in what will be a "very, very good" year for emerging markets.
Adrian Mowat, JPMorgan Chase & Co.'s (JPM) 43-year-old chief emerging-market strategist, expects a 34 percent rally in the MSCI emerging index in 2010 following this year's 72 percent advance, while Morgan Stanley's (MS) Jonathan Garner forecasts a 23 percent gain. Credit Suisse Group AG's (CS) Andrew Garthwaite, 47, says the gauge will rise 18 percent by mid-2010.
All three strategists predicted emerging-market stocks would climb this year, though they underestimated the rally. Mowat said in April that the MSCI index would rise to 900, while Garner predicted in December 2008 the gauge would advance to 810. Garthwaite's estimate in January was 630, compared with the index's closing level of 980.79 yesterday.
The MSCI gauge posted its best performance this year since its inception in 1987, as developing nations accounted for the top 12 gains among the world's benchmark equity indexes. The index has climbed 73 percent this year and doubled in value over the decade. Emerging markets surged after banks avoided most of the $1.7 trillion of credit losses and writedowns worldwide and investors speculated economic growth would outpace advanced countries.
Developing-nation economies will expand 5.1 percent as a group next year, compared with 1.3 percent in developed nations, according to the Washington-based International Monetary Fund.
The Shanghai Composite Index in China, the biggest emerging market, advanced 79 percent this year, Brazil's Bovespa climbed 82 percent and India's Bombay Stock Exchange Sensitive Index rose 80 percent. The MSCI World Index of advanced-nation shares rose 27 percent.
Company analysts estimate Russian shares will increase an average 21 percent in the next 12 months, led by gains of at least 30 percent in Moscow-based oil producer OAO Rosneft (ROSN:RU) and cellular provider OAO Mobile TeleSystems (MBT), according to forecasts compiled by Bloomberg. That compares with an average projected advance of 18 percent in Brazil and 13 percent in China, and a 0.4 percent loss in India, the estimates show.
Twelve months ago, the biggest emerging-market mutual-fund managers ranked Russia as the least attractive of the largest developing economies.
Investors pulled at least $290 billion from Russia, the world's biggest energy exporter, between August 2008 and February 2009 as the economy sank into its worst financial crisis since the government's 1998 default on $40 billion of domestic debt. Russia's dollar-denominated RTS Index tumbled 63 percent in 2008 and the ruble-based Micex Index tumbled 67 percent, the biggest decline among benchmark indexes in the 30 largest stock markets. The Micex fell for the first time in a week today, dropping 0.5 percent for a 2009 gain of 120 percent. The gauge has added 308 percent in the past decade.
Investors are returning to Russia after the government pledged more than $100 billion in emergency aid, mainly for banks, and oil prices rallied 77 percent this year. Oil and gas production accounts for about 30 percent of Russia's gross domestic product, according to the country's energy ministry.
Borrowing costs have plunged as the yield on the government's benchmark dollar bonds maturing in 2030 almost halved to 5.4 percent yesterday from this year's peak of 10 percent on March 3. Yields on $1.25 billion of five-year notes sold by OAO Gazprom, the country's biggest company, have dropped to 6.4 percent from 8.125 percent when they were sold in July this year. The average price of ruble-denominated corporate bonds is the highest since October 2008, according to the Micex Corporate Bond Index of securities traded on the Micex Stock Exchange, recovering from an all-time low of 78.3 in January.
The prospects for a retreat in Russian stocks are growing because the market is a "consensus trade" and gains in the U.S. dollar may derail this year's rally in oil, Russia's biggest source of export revenue, according to JPMorgan's Mowat. The Hong Kong-based strategist downgraded Russian shares to "neutral" from "overweight" in a report this month.
Kudrin, 49, said on Dec. 8 that Russia is a "weak link in global finance" and the economy still isn't strong enough to attract investment when the U.S. and Europe start raising interest rates. GDP will probably contract 8.7 percent this year and a recovery may spark faster inflation, Kudrin told reporters in Moscow on Dec. 23.
The government is considering taking steps to reduce "speculative inflows" of capital, including ending central bank interventions in the ruble market, Prime Minister Vladimir Putin said yesterday. Creating better conditions for foreign investors and luring more long-term capital would help deter so- called hot money, Putin told reporters. The ruble dropped 0.5 percent today to 30.2350 per dollar, leaving the currency down 2.7 percent from its closing 2008 level of 29.4065.
Carret & Co.'s Don Gimbel said he's wary of investing in Russian stocks because the government is too unpredictable. The Micex tumbled 23 percent in July and August of 2008 as Prime Minister Vladimir Putin accused Moscow-based steelmaker OAO Mechel of price fixing and waged a five-day war with Georgia. OAO Yukos Oil Co. was bankrupted during Putin's presidency in 2006 after the government claimed more than $30 billion in back taxes.
'Law and Order'
"My faith in the government in Moscow is almost zero," said Gimbel, who helps oversee about $1.5 billion as a senior managing director at New York-based Carret and has no Russian holdings.
Russian President Dmitry Medvedev said last month the country needs to improve the "primitive structure" of the economy and pledged to "reduce corruption and to punish those responsible for it."
"There is a debate within Russia about how to go forward, but statements from Medvedev are quite encouraging in the sense that they want to move towards a market economy, want to emphasize law and order," said Templeton's Mobius, 73.
The lack of transparency in corporate governance is already reflected in equity valuations, said Antoine van Agtmael, who oversees about $12.5 billion as the chief investment officer of Arlington, Virginia-based Emerging Markets Management LLC.
"We are investors in Russia, and we are on the whole overweight," said Agtmael, who coined the phrase "emerging markets" in 1981.
Nineteen of the 48 largest emerging-market mutual funds have boosted Russian stock allocations to more than 2 percent above their benchmark, JPMorgan's Mowat wrote in a Dec. 4 research report, citing data from Cambridge, Massachusetts-based EPFR Global. Developing-nation funds attracted more than $75 billion this year, set for a record, according to EPFR.
Money is likely to keep flowing into Russian stocks as investors shift some of the $3.3 trillion they stashed in U.S. money-market mutual funds into equities, according to Gareth Morgan, an emerging markets money manager at F&C Asset Management in London, which oversees about $150 billion. Investors fled to the safest assets last year as the global economy had its worst recession since World War II and the Standard & Poor's 500 Index sank the most in seven decades.
"At some point next year it will be difficult to see where the marginal money comes from, but we don't think we've reached that point yet," said Morgan, whose Russian Investment Company SICAV fund returned 142 percent this year according to data compiled by Bloomberg, beating the Micex by 14 percentage points.
China's Shanghai index is twice as expensive as the Micex at 19 times estimated 2010 earnings, while India's Sensex is valued at 17 times and Brazil's Bovespa trades for 14 times, according to data compiled by Bloomberg. The MSCI emerging index trades at 13 times.
Russia's "market is unfairly cheap, one of the cheapest in emerging markets," said Sam Vecht, a London-based money manager at BlackRock Inc., which oversees about $3.2 trillion and has Russia as the biggest overweight holding in emerging-market stocks. "The country can grow a lot faster than people think," said Vecht, whose Emerging Europe Fund climbed 85 percent this year, beating 88 percent of its peers.
Russia's economy will expand 3 percent next year after a 7.7 percent contraction in 2009, the widest swing in gross domestic product worldwide, according to the median of economists' estimates compiled by Bloomberg. The last time Russia began recovering from a recession as deep, in 1999, the Micex surged 235 percent during the year.
OAO Sberbank (SBRBF), Russia's largest lender, is poised to extend this year's 253 percent advance in Moscow trading as a peak in bad loans near the middle of 2010 and rising demand for credit boost earnings, Morgan said. Profit at Moscow-based Sberbank may surge more than sevenfold next year, compared with a 30 percent increase for companies in the MSCI Emerging Markets Financials Index, analysts' estimates compiled by Bloomberg show.
Moscow-based Mobile TeleSystems, Russia's largest cellular company, is one of the most attractive stocks in emerging markets because it's adding revenue faster than peers and trading at a discount relative to earnings, according to Garner, Morgan Stanley's chief emerging-market strategist in London. He cites cheap valuations and rising commodity prices for an "overweight" rating on Russian shares.
Goldman's global strategy team led by London-based Jim O'Neill, who coined the BRIC moniker in 2001, predicts buying Russian stocks will be one of the "top trades" of 2010 as earnings grow an above-consensus 60 percent next year.
Troika's Kingsmill Bond, the top-ranked Russian stock strategist in this year's Thomson Extel survey, expects the rally to be driven by slowing inflation and oil prices near $70 a barrel. Crude for February delivery was at $78.70 a barrel, 14 cents lower today.
"Russia is our top bet for 2010," said Marcus Svedberg, who helps manage about $4 billion as the chief economist at East Capital in Stockholm. "Growth will surprise on the upside."
To contact the reporter on this story: Michael Patterson in London at email@example.com.