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After Crimea, where do Russia ETFs go now?

The past few months have been extremely choppy for Russian equities as the ban imposed on the nation by the West following its Crimea (erstwhile Ukrainian territory) annexation compelled many investors to flee in apprehension of some significant economic losses (read: Is It Time to Flee Russian ETFs?).

Russia has been in the news since the start of this year thanks to its military move and the resultant standoff with the West as the Crimean maneuver was viewed as an utter violation of international law by the West.

In protest, the U.S. and the European Union (EU) imposed minor bans on some Russian diplomats. The S&P downgraded its credit, foreign and local currency ratings for the nation, while Fitch ratings cut Russia’s credit rating outlook to negative in March, for the same geo-political reasons.

If these were not enough, the central bank hiked key interest rates in April to contain inflationary pressure giving another round of blows to the nation’s growth profile. Thanks to all these negative reactions, the biggest Russia ETF – Market Vectors Russia ETF (RSX) — lost about 14.11% in the first quarter. Russian stocks witnessed the most volatility in five years during this period.

Recent Advancements

Things took a turn in the second quarter with RSX gaining about 17% and erasing some of its prior losses. On a YTD basis, however, RSX shed about 7.9% (as of July 14, 2014). Dirt cheap valuation, betterment in service sector activity in June and cooling tension over Ukraine were the primarily the reasons behind the advancement.

Investors should note that the trailing-12 months P/E for RSX stood at 7 times while one of the biggest broader emerging market ETFs – iShares MSCI Emerging Markets (EEM) – has a P/E ratio of 12 times. Fear-induced selling pressure without any severe economic setback took the stocks in this benchmark to fresh depths.

Optimism came in the form of economic data too. Russia's service sector activity shrank at a decent pace in June, after exhibiting a steep decline in five years in the preceding month. The seasonally adjusted HSBC purchasing managers' index for the sector increased to 49.8 in June, up from 46.1 recorded in May.

Equities got some boost from the mega gas deal signed between China and Russia this May. After a decade of negotiation, China and Russia entered into a 30-year natural gas deal wherein Russian natural gas giant Gazprom will supply 38 billion cubic meters of natural gas to China National Petroleum Corp, China’s largest oil company, every year starting in 2018.

The biggest boost came from the renewed truce between the Kiev government and pro-Russian separatists on July 2 that brought some relief for the stock markets of both countries. Helped by this newly built optimism, Russian ETFs like RSX, Market Vectors Russia Small-Cap ETF (RSXJ) and iShares MSCI Russia Capped Index Fund (ERUS) returned about 17%, 15% and 17%, respectively, in the last three month period.

Will the Uptrend Last?

Although some signs of improvements have been noticed in the Russia ETFs of late, the turnaround might fail to sustain itself. The economy almost slipped into a recession. The consumer price index grew five months in a row to touch the highest level since August 2011. If we go by a recent Bloomberg report, destruction is taking place in East Ukraine by the pro-Russian rebels, which could cancel out the cease-fire.

While we believe that Russia will ease its stand over Ukraine in view of mounting financial losses and capital outflows, we suggest investors be hawk-eyed about the nation and its related ETFs. 

Investors should note that Russian equities and the related ETFs are known for high dividend payouts. However, the state-controlled natural-gas producer OAO Gazprom will likely pay smaller dividends in 2016. Given how important Gazprom is to the holdings profile of RSX, it will be hard for the other holdings to make up for this bearishness. RSX lost 1.41% last week (as of July 14, 2014).

Presently, all the above-mentioned Russia ETFs carry a Zacks ETF Rank #4 (Sell), though that is an improvement from their recent strong sell rank. Still, there are plenty of reasons to be bearish on Russia, though the trends are encouraging and especially so if tensions cool down soon.
MKT VEC-RUSSIA (RSX): ETF Research Reports
MKT-VEC RUS SC (RSXJ): ETF Research Reports
ISHARS-EMG MKT (EEM): ETF Research Reports
VANGD-FTSE EM (VWO): ETF Research Reports
ISHARS-MS RUSSA (ERUS): ETF Research Reports
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Zacks Investment Research is characterized by a team of experts who are passionate about your investing success and is focused on sharing the same reliable investment research they would want for themselves.

Zacks Investment Research

Zacks Investment Research is characterized by a team of experts who are passionate about your investing success and is focused on sharing the same reliable investment research they would want for themselves.