Opinion: It’s time to buy Russia

5 reasons to go long on investments in Russia

Yes, Russia has a litany of negatives against it — from stagflation and recession, to open conflict with neighboring countries, economic sanctions, ratings agency downgrades, a sharply declining currency, and a megalomaniacal leader.

So you might be wary. But Russian market exchange-traded funds (ETFs) are among the best performers year to date. They’re up 20% — and 40% from lows in December. These kinds of returns show the value of thinking outside the box as an investor, and going against the crowd.

But it’s still not too late to buy Russia.

The gloom and doom on Russia still runs deep and the stock market still looks cheap, with a price-to- earnings ratio of about 5. If you buy Russia now, you’re very likely to outperform U.S. stock markets over the medium term.

"I am sure that everybody will look back in five years and say ‘Oh my gosh, it happened again,’” says investor Jim Rogers. "I have seen this many times. Today’s country that is a disaster, is very different five years from now,” says Rogers, author of "Street Smarts: Adventures on the Road and in the Markets.”

Sure there’s going to be some more downside volatility near term, as tensions around Ukraine flare up and energy prices bounce around. Nothing ever goes straight up.

But just average in.

I personally own the iShares MSCI Russia Capped Index Fund ERUS, +1.22%, an ETF. Other options include the Market Vectors Russia ETF RSX, +2.09% and the Market Vectors Russia Small-Cap ETF RSXJ, +2.02% Also consider three stocks favored by Russia expert Kanwal Masood of the T. Rowe Price Emerging Europe Fund TREMX, -1.82% or shares of that fund.

I’ll get to her three Russian stocks, which look really cheap, in a second.

But first, here are the five reasons to get long Russia now.

Reason #1: Investors are pricing in the worst on Ukraine, but it won’t happen.

Wealth Enhancement Group chief investment officer Jim Cahn thinks there are three possible scenarios with Ukraine. 1) The conflict drags on without escalation. 2) Russian oligarchs get tired of losing money because of sanctions, so they pressure Russian President Vladimir Putin to back down. 3) Putin escalates by sending more troops to the area, making it look like he might attack a nearby NATO member, and the whole conflict escalates.

Part of Putin’s strategy is to use the Ukraine conflict as a wedge issue to separate the U.S. from Europe, and European countries from each other, by appearing to force a conflict. But Cahn doubts Putin will ever push things to the point of outright war with the West, or that the West would take the bait.

If he’s right, the Russian stock market looks cheap, because this kind of escalation is what’s priced in.

"There is a lot of job preservation going on,” says Cahn. "A lot of investors are pulling money out so they don’t get stuck in a situation where they look stupid. If we get to the point where there is no further escalation, you could have 30% to 50% return in Russian equities.”

Masood, at T. Rowe Price, agrees. "The Russian market is priced for the worst-case scenario, which is war,” she says. "We don’t think Russia or Ukraine will go to war. It is in neither country’s interest. If there is any sign of resolution, and stabilization in oil prices, we could see a very quick recovery in the market.”

Reason #2: The magazine indicator is flashing a buy signal.

A favorite way to judge sentiment for contrarians like me is to observe the media. Often they get the most negative right at the bottom of a trend. And you often see that via the magazine-cover indicator — when the negative story is brought out as the cover story.

This recently happened with Russia when The Economist put a sinister image of Vladimir Putin on its cover for a story called "Putin’s War on the West.” In fairness to the media and editors, please keep in mind that their habit of serving as contrarian market indicators does not mean they are dumb. It just means they are great at doing their jobs. The media try to serve up stories that will get the most attention. So they have a keen awareness of when negativity is peaking on a theme. That’s when they highlight the theme on the cover, and it naturally corresponds to when investors are most negative on the theme.

Reason #3: It’s hard to find anyone who is bullish on Russia.

I’ve tried to round up the usual suspects, but just about all my sources came back negative. "Bullish on Russia? No dice.” Contrarian signal confirmed. Plus Standard & Poor’s and Moody’s recently cut their ratings on Russian debt. Another great contrarian signal.

Reason #4: Putin actually wants to get along with the West. No, really.

Jim Rogers has been bullish on Russia for months, in part because of what he describes as a key change at the Kremlin. He thinks Russia has shifted gears and chosen to be more open and friendly towards doing business with the West.

He cites the country’s commitment to a convertible currency; infrastructure improvements like upgrades to communications systems and the Trans-Siberian railroad; the completion of a railroad to the North Korean port of Rason; the country’s relatively low debt level; and government programs offering co-investment alongside foreigners who put money into local startups and other companies.

"There is not a lot of money flooding into Russia at the moment. But the mechanisms are there, and the change in attitude is there,” says Rogers. "Putin wants to make Moscow a major world financial center.”

How does this jibe with what’s going on in Ukraine? Rogers believes Putin has little choice but to get defensive with Ukraine, because of its perceived economic importance, and its strategic significance as a buffer against incursions from the West, historically. But the background attitude change in doing business with the West is still alive and well.

Reason #5: Oil is going up.

Energy is key to Russia’s economy. It accounts for 25% of its gross domestic product, 68% of exports and 50% of federal budget revenues, points out Barclays economist Eldar Vakhitov. So to buy Russia, you have to believe energy prices are going up. That will likely be the case as supply destruction caused by lower prices, natural declines in reserves globally, and economic growth tilt the balance in the oil market to support higher prices. Jonathan Waghorn, of the Guinness Atkinson Global Energy Fund GAGEX, -0.94% thinks Brent oil LCOK5, +0.75% will move up to $70 a barrel by the end of the year, and higher after that.

Stock and bond plays

Unlike me, Masood is not bullish on Russian stocks in general. She thinks there are too many risks.

But lots of quality companies now look really cheap. "Valuations are back at 2008-09 levels,” says Masood.

She favors high-quality companies that have the strength to come out of the slowdown much stronger, because they have taken market share from weaker competitors along the way.

A good example is Sberbank of Russia SBRCY, +2.95% the largest retail bank in Russia, and one of the cheapest banks in the country. It trades at 0.6 times book value even though it has a healthy return on equity of 20%. She expects the bank to stay profitable this year, despite the recession in Russia. One risk here is that the bank is shut off to foreign capital markets because of Ukraine-related sanctions. But she doesn’t think the bank, which is 50% owned by the state, needs to raise capital. And if it does, it can do so in Russian capital markets, says Masood.

Next, she likes Yandex YNDX, +0.62% the Russian Google. Yandex is popular in Russia, one reason Google GOOG, +0.54% has had a hard time getting into the market. Yandex faces robust growth prospects, because Internet usage still has a lot of room to grow in Russia. The company looks cheap for an Internet stock, trading at 19.5 times 2016 earnings.

Masood also likes Magnit MGNT, -2.65% the largest food retailer in Russia. "We have held it for many years. It has an excellent management team,” she says. It trades at 19.7 times 2015 earnings. That looks cheap considering it will probably post 30% annual earnings growth for several years, as it continues to take market share.

There’s a bond play in this, too. Rogers likes Russian government bonds for two reasons. First, they pay yields in the 10% to 14% range. Next, he doesn’t think the ruble USDRUB, -1.49% will stay weak forever. As it eventually strengthens, earnings on Russian bonds will get translated into more dollars, or whatever your preferred local currency is.

At the time of publication, Michael Brush held shares of ERUS and the T. Rowe Price Emerging Europe Fund. Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks.

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