Russia has turned the corner, thanks in part to the recent candid, public appearances by its president, Vladimir Putin. The Sept. 29 interview with Charlie Rose in the suburbs of Moscow, his United Nations General Assembly speech about fighting terrorism in Syria, and Germany and France suddenly leaning more towards Russia on the Ukraine variable means Russia is looking less gnarly than it did a few months ago. For investors, this may be a time to start dipping into Russian stocks.
Politically speaking, it appears that Germany and France have grown tired of Ukraine’s bitter divorce from Russia. Once in the middle, they are now picking sides. And it is Russia, they say, that is abiding by the Minsk II cease-fire agreement in east Ukraine and not the out-of-favor leaders in Kyiv. All of this bodes well for the lifting of sanctions perhaps as early as the first quarter, says Vladimir Signorelli, head of macro-research firm Bretton Woods LLC in Long Valley, NJ.
"There was news out of Russia on Friday that (German chancellor Angela) Merkel had basically acknowledged that Crimea would stay Russian. While I haven't seen any verification of that in the West, Crimea was never addressed in the Minsk II Accords. So if the rescission of sanctions on Russia simply requires adherence to Minsk II and given the popular discontent with the sanctions in Europe, I wouldn't be surprised to see pressure build against extending sanctions in January," he says. "An optimistic case might see the sanctions regime breaking down by March, certainly June 2016. And because markets are always keyed on the future, and this optimistic scenario looks increasingly likely, one could begin to position for this now."
One of the easiest trades into Russia is Van Eck's Market Vectors Russia (RSX) exchange traded fund.
On the economic front, Barclays Capital analyst Dan Hewitt said he expects inflation to collapse by 50% at least next year to 7%. That will give room for a rate cut by the Central Bank and give Russia's range-bound equities a bust, regardless of oil's direction.
Manufacturing PMI rose to 49.1 in September from 47.9 in August. This was the highest level since February and well ahead of expectations.
What's Changed?
Russian individuals were sanctioned immediately following the March 2014 annexation of Crimea. Sectoral sanctions began four months later, hitting Russia’s most important companies – namely Rosneft, Gazprom, and Sberbank. Sanctions have been in place now for over a year. But this might be the beginning of the end.
On Friday, French president Fraçois Hollande, Merkel, Putin and Ukraine’s president Poroshenko met to discuss a plan by French diplomat Pierre Morel to hold local elections within three months in rebel-held eastern Ukraine. Poroshenko is nervous about the idea, thinking the prospects of a future Crimea will bear fruit instead. Ethnic Russians there have set up self-proclaimed independent republics. Some have even begun converting to rubles. What's happening with the European mediators in this fight is they want a vote. They want nothing to do with Poroshenko’s fears of autonomous republics seceding. Secession, by the way, is against the Minsk accords so Russia cannot agree to it. Merkel and Hollande want Poroshenko to work with Russia, get elections over with, and deal with the results. If Poroshenko fails to do this, it means Ukraine is in breach of the Minsk II accord, as Putin said on Charlie Rose in his charismatic plea for innocence.
Elections will unlikely go Kyiv’s way. Poroshenko’s support is less than 30% of the country. His Prime Minister, Washington backed Arseniy “Yats” Yatsenyuk, is in even worse shape. But if elections are not allowed within an 80 day time period, the Ukrainian government will be made to look like the bad guys. If they are held, the results will clearly be pro-Russian and we will have no reason for separatists to continue blowing things up.
While it is unclear if Ukraine will permit a pro-Russia Donetsk and Luhansk, fighting the rebels after the election will not look good for the Poroshenko government. Ethnic Russians, and Putin by default, could look oddly like victims allow Putin to press his case for a quick end to sanctions.
Poroshenko has little choice. The economy is in a shambles. Ending the civil strife in the east is their best foot forward, considering the region accounts for nearly a quarter of Ukraine's GDP. Moreover, such a move would give incentives to Europe to support Ukraine financially, seeing that Kyiv has been willing to play the tough democratic game of letting the people decide their own fate, even if it goes against the president.
Later this week, Ukraine and Russia Finance Ministers will meet to discuss a $3 billion debt owed to the Russian government. If Ukraine defaults, it will make the country’s life harder in relation to its IMF terms. An agreement will be political (as everything in Russia is political), and may very well be subject to Ukraine's full adherance to Minsk II.
So Putin has Poroshenko by the “yaytsa”.
Ending Sanctions Good For Ukraine
The country’s new American-Ukrainian Finance Minister, Natalie Jaresko, recently contracted supply-side guru Arthur Laffer as a consultant. This is a country that is getting serious about its financial problems. Wars, rumors of wars, and defaults on Russian bonds is not where the path this country wants to tread.
The French plan to give Ukraine 80 days to hold elections in the eastern provinces its been battling for a year now provides a path for the rescission of sanctions. The end of sanctions opens the door again to better Russian-European relations. This is good for Russia and Russia-bound investors. But it is also good for European companies that have been sanctioned in retaliation by Russia, and it is good for Ukraine. No more war is good for Ukraine.
Ukraine may very well turn Westward. But Kyiv's lobbying efforts, depicting a war-torn Ukraine in Western Europe’s backyard have had no real return on investment. Ukraine, for the time being, will have to live with Russia.
"This is an emerging win-win," Signorelli wrote in a note to clients on Tuesday. "It's positive for Russia and for Ukraine."
With Russia, there's always political risk involved. The government's involvement in bombing anti-Assad forces in Syria is ticking off Europe and Turkey, a country they need on their side if they want the Gazprom pipeline deal to go through.
"I think Russia's third quarter numbers from their oil exporters are going to be terrible," says Phil Davis, founder of PSW Investments. "If you trust Vladimir Putin -- you simply haven't been paying attention. Bombing Syria and violating Turkey's airspace makes it less likely that sanctions will be lifted any time soon."
Maybe not, though, as sanctions on Russia have everything to do with Ukraine and nothing to do with Syria and Turkey. Russia investors won't be bullish, but in the months ahead, if the Ukraine variable settles down, we could see a move to neutral weight or even overweight on the hedge fund side.
RSX is up just 7% over the last month, underperforming the MSCI Emerging Markets Index by about 200 basis points.
