There is a presidential election in Russia next year, and Putin will stand down. However, he has made it clear he will continue to be the power behind the throne. He is passionately committed to restoring Russia to its former position of pre-eminence as a world power, economically and politically. Putin wants to be the modern reincarnation of Peter the Great. Indeed, I am told that in his working office, behind his desk is a massive portrait of the Great Peter.
A poor, rapidly developing country often does best with a benevolent dictator. Democracies, and particularly messy coalition democracies, are ineffective in imposing the kind of discipline and sacrifices that bootstrapping economies require. Rather than criticize Putin’s sometimes heavy-handed tactics, investors and America should embrace Russia and Putin. If we don’t, China will. With luck, Putin’s upcoming visit with Bush at the family compound in Maine will clear the air.
A year ago, emerging-market funds were invested more heavily in Russia than in the general Emerging Markets Index, but now they have reversed and are significantly underweight. The emerging-market indexes are up about 15 percent for the year. Russia, by contrast, is down about 10 percent and is the only index market that shows a loss. Russia is cheap in both absolute and relative terms, trading at about six to 10 times earnings, depending on which measure you use.
Russia is the ninth biggest economy in the world, with GDP growth of about 7 percent, huge reserves of oil and minerals, a large budget surplus, a strong currency and falling inflation. Productivity is growing at 10 percent a year, corporate profits at more than 20 percent, and believe it or not, corporate governance is improving. Admittedly, Russia is rising from the deeply depressed base of the 1998 debt crisis.
However, expansion from a low base is the crux of the Russian investment story. The government wants foreign direct investment to rise, and Russian flight capital to return. To do that, it must raise the economy and markets to G7 standards.
Russia has potential for a consumption boom that should last for years, giving a big lift to retail, advertising, wireless telecom, real-estate and financial-services stocks. Personal income per capita is about 25 percent of that in developed economies, and there is virtually no credit-card debt. Mortgage financing has barely been discovered, with mortgage debt per capita a minuscule $27. The average car in Russia is 11 years old. Most houses look as though they were thrown together (poorly) 50 years ago. Even in St. Petersburg and Moscow, most apartments have two families living in them.
Meanwhile, Russia has the world’s richest trove of minerals, ranging from nickel, copper and gold to vast oil and gas reserves. Until recently, the Russian oil stocks always correlated with the price of crude. Now the energy behemoth Gazprom is down 22 percent and has underperformed the MSCI Global Energy Index by 35 percent this year.
Admittedly, over the next three years, the oil and gas sector is forecast by the Ministry of Finance to expand only 2 percent annually. A major U.S. investment bank in a recent report argues that the big state-controlled oil and gas companies have underspent on infrastructure, development and exploration. It is almost impossible to know if this is true, but we do know that the potential under the ice cap in Siberia is immense.
There is currently a global abundance of liquidity, which, combined with rising economic activity and low inflation, is driving stock prices in general and cyclical assets in particular. Russia has the fastest excess money growth in the world (8.6 percent), and in the past the Russian stock market has had a perfect correlation with money growth. But not this year. Instead, the market has fallen since January, in part because of the tremendous volume of equity issuance, which consumed the liquidity. (With far fewer IPOs scheduled for the remainder of the year, this drag should be eliminated.) But the big reason is that Russia under Putin has far more potential and much less risk than most pundits claim.
