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EM Strategy Views - Russia Summary

Core Content

This report analyzes the current valuation and performance of Russian assets within the context of emerging markets (EM), comparing them to the historical 2014 crisis and assessing the potential for a "bounce back" based on fair value models and market trends.

Main Points

• Volatility and Value Signals:
  Russian assets have shown signs of being "inexpensive" compared to fair value models, particularly in FX and credit. However, the value signal is not as strong as during the 2014 crisis, which was marked by more severe declines in RUB and fixed income.

  • FX: RUB is currently 3% inexpensive, but would need a further 20% depreciation to match the 2014 premium.
  • Credit: 5-year CDS is 33 bp inexpensive, compared to 250 bp in 2014.
  • Equities: Trade at 2x the P/E multiple relative to EM peers, which is higher than the 2014 trough.
  • Local Bonds: Remain inexpensive on a real rate basis, historically showing the best "bounce back" performance.

• Market Performance (January 1 – April 10, 2018):

  • Russian assets have performed poorly in the short term, with RUB and local bonds being among the worst performers.
  • Equity and credit have shown relative resilience, with equities still trading at a discount to EM peers.

• Investor Positioning:

  • EM-benchmarked investors are significantly overweight Russian assets (3rd most overweight EM, behind Brazil and India).
  • This overweight positioning may contribute to near-term uncertainty and risks.

• Historical Comparison (2014):

  • The 2014 crisis was a Russia-specific event, unlike the more global nature of the 2015-16 sell-off.
  • The 2014 sell-off was more severe, with much larger declines in FX and local rates.
  • Equities were relatively insulated due to USD-based revenue exposure and oil price stability in RUB terms.

• Macroeconomic Context:

  • Inflation in Russia has fallen significantly, from 17% in 2015 to 2.5% in 2018.
  • Real rates are currently at 3.4%, which is elevated compared to the 2014 peak of 4.7%.
  • Oil prices have risen 27% since 2017, compared to a 48% decline in 2014.

• Credit Spreads:

  • Russian CDS has compressed to post-GFC tight levels, still tighter than EM peers by 170 bp.
  • The 2014 credit spread was much higher, with the model-implied spread reaching 400 bp.

• Fair Value Models:

  • The current fair value of Russian assets is significantly lower than in 2014.
  • The model suggests that Russian 5-year CDS is currently 33 bp inexpensive, while it was 250 bp expensive in 2014.

• Tactical Recommendations:

  • Due to the highly fluid situation, the report refrains from a tactical trade recommendation.
  • Local bonds are highlighted as the preferred asset class for a potential "bounce back" due to their historical performance and current valuation.

Key Information

• FX: RUB has depreciated significantly, but not enough to match the 2014 premium. It would need to depreciate ~30% to achieve similar levels.
• Equity: Russian equities trade at a discount to EM peers, but not as significant as in 2014. They are naturally FX hedged.
• Credit: Russian CDS is currently 33 bp inexpensive, but still tighter than EM peers.
• Local Bonds: Remain inexpensive and historically show the best recovery, making them a potential "bounce back" trade.
• Investor Overweight: EM-benchmarked investors are significantly overweight Russian assets, increasing near-term risks.
• Inflation and Policy Rates: Inflation has fallen, and real rates are currently elevated, suggesting better value in Russian bonds.
• Oil Prices: RUB oil prices have risen 20% since end-February 2018, contrasting with the 48% decline in 2014.

Asset Class Performance (January 1 – February 28, 2018)

Asset Class Performance (February 28 – April 10, 2018)

Conclusion

While Russian assets currently screen as "inexpensive" relative to fair value models, the magnitude of the value signal is not as pronounced as during the 2014 crisis. The report highlights that local bonds are the most promising for a "bounce back" and remain significantly undervalued compared to historical levels. However, due to the uncertainty surrounding political and macroeconomic risks, a tactical trade recommendation is not made at this time.