Why You Won’t Invest in the World’s Top-Performing Stock Market

While Mitt Romney and Rick Santorum battle it out in today’s Super Tuesday primaries, the elections in Russia this weekend offered no surprises. After a four-year absence (and an intervening stint as Prime Minister) ex-KGB spook Vladimir Putin returned to the Russian presidency with more than 63% of the votes. Not that there was ever any doubt about the outcome. Russia’s election was more a “coronation” — even as the government boasted that it was the most transparent election in history, monitored by a network of 95,000 webcams across nine time zones. My Stanford University classmate — Michael McFaul — certainly chose an interesting time to take the job of ambassador to Russia.

The Russian Elections: Putin 3.0

Back at the time of the last election in 2008, the Russian people were grateful to Putin for reasserting Russia’s position on the world stage. The collapse of the Soviet Union in 1991 had traumatized the Soviet psyche. The overnight implosion of the “Evil Empire” was more than the end of Soviet Communism. Russia had gone from global superpower to laughing stock of the world overnight. Russians were instinctively attracted to the nostalgic comfort of Putin’s authoritarian streak.

But as the recent protests in Moscow have shown, Russia’s increasingly Western-educated middle class is suffering “Putin fatigue.” That’s not surprising. When a country hits a per capita gross domestic product (GDP) of $15,000 — just about where Russia is today on a purchasing power parity basis — political discontent starts to rise and macho, bare-chested political heroes become more “laughing stock” than “liberator.”

Why Russia Irks Us So

Edward Lucas of the Economist has argued that since 2000, Russia has fallen under the control of a team of former KGB thugs who have abandoned threats of nuclear annihilation in favor of Machiavellian political and economic pressure. The outcome of this weekend’s election simply confirms this situation. In reality, Lucas believes Russia is in dire straits. Crime, corruption, drug addiction and alcoholism are rampant. Public services are decrepit. Russia’s population is plummeting as male life expectancy has fallen below that of Bangladesh.

Russia’s wrong side of the railroad track, gangster-style image has always attracted particular animosity from the West. After Russia’s collapse in 1998, one Western analyst said that he’d rather eat nuclear waste than invest in Russia. Jim Rogers and George Soros agreed. And as Warren Buffett’s partner Charlie Munger put it: “We don’t invest in kleptocracies.” American kids want to grow up to be Mark Zuckerberg. In Russia, it seems, kids want to grow up to be Al Pacino in “Scarface.” But that image is woefully out of date. Ironically, a Russian investment firm, Digital Sky Technologies, invested $200 million in Facebook in return for a 1.96% stake in 2009.

Why You Should Invest in Russia…

For all of Putin’s bare-chested shenanigans, and the country’s famous corruption, Russia is hardly a basket case. The economy grew at 4% last year. Forecasts are for 2.6% growth this year. Government debt is just 11% of GDP. Consumer debt is only 10% of GDP. Unlike China, there is no sign of a financial bubble in Russia that is ready to pop. And with oil prices soaring, government coffers are filing back up at a quickening pace.

Investors have a hard time accepting that Russia has been by far the best investment among the BRICs (Brazil, Russia, India, and China) over the past decade. Had you invested in Russia when it bottomed in October 1998, you’d have made more than 60x your money from the bottom to its peak in May, 2008 — though the market is trading at half of those levels today. That’s much more than you’d have made in emerging market darlings China, India or even Brazil.

This year, Russia is, once again, the best-performing major emerging market in the world. After its 25.91% run up this year, the Market Vectors TR Russia ETF (RSX) — a current recommendation in my Alpha Investor Letter investment service — has outperformed the S&P 500 by almost 4:1.

Despite its strong gains, Russia still remains by far the cheapest major emerging market in the world. Trading at a price-to-earnings (P/E) ratio of around 6, Russian equities are cheaper today than in 1999, just after Russia defaulted on its debt. That valuation also is less than half of BRIC rivals Brazil, India and China.

Meanwhile, the outlook for Russian companies is surprisingly strong. Goldman Sachs expects profits at publicly listed Russian companies to leap an average of 27% a year by 2013. That performance would beat expected average earnings growth of 24% in China and 18% in India during the same period.

Valuations notwithstanding, I bet you’re not clamoring to get into the Russian stock market. And that’s too bad. Vladimir Putin’s weekend coronation notwithstanding, Russia offers the best value — and highest potential upside — in global stock markets today.

Sincerely,

Nicholas A. Vardy

Editor, The Global Guru

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