RSX: High Risk, Even Higher Reward

By | November 24, 2015

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Summary The Russian stock market has the lowest CAPE globally. Geopolitical events have had a massive negative impact. Oil price and the Russian rouble are trading close to their historic lows. This is exactly the time when a contrarian value investor may want to enter the market. While US stocks are flirting with all-time highs, investors are prompted to seek more attractive opportunities abroad. Of course, foreign markets are in different states, and one needs to be selective. I have been keeping an eye on Russian equities for a while , and am getting close to pulling the trigger. There are four main reasons why I am bullish on Russian stocks. Valuation The Market Vector Russia ETF (NYSEARCA: RSX ) is down 65% since its peak in summer 2008. According to StarCapital , it has the lowest cyclically adjusted price earnings ratio (“CAPE”) globally of just 4.7. For a comparison, CAPE stands at 25.1 in the US. Obviously, there is no guarantee that Russian stocks will not go even lower, but from a value perspective, an investor always feels more comfortable buying something at a reduced price rather than paying more than anyone has ever paid. Furthermore, after a free fall in 2014 when it lost 47%, RSX has started showing signs of recovery and is up 20% year to date in 2015. Oil price As discussed in one of my previous articles , Russia is one of the countries most dependent on the oil market. Online investor resource InvestSpy estimates that the correlation between RSX and the United States Oil ETF (NYSEARCA: USO ) has been 0.55 since RSX’s inception in May 2007. This relationship is nicely illustrated by the following chart, which clearly illustrates how closely linked the two funds are: (click to enlarge) Source: Google Finance Although the oil market may be a long way from recovery, the current Brent crude oil spot price is pretty much where it was trading at the height of the financial crisis in the beginning of 2009. Again, this does not guarantee anything, but at least gives the impression that the bottom could be not too far. C urrency RSX is naturally strongly linked to the performance of the Russian rouble. The correlation between RSX and USDRUB over the last couple of years has been negative 0.76. This implies that in most cases, RSX goes up when the rouble strengthens against the US dollar. The inverse relationship is also visible on the following chart: (click to enlarge) Source: Google Finance In addition, a simple linear regression with RSX as an independent variable and USDRUB as the explanatory variable indicates that the fund tends to go down 1.06% for every 1.00% increase in USDRUB. As USDRUB has more than doubled in the last two years, I would argue that there is a higher probability of retracement rather than continuation to new highs. Geopolitics Thinking about the worst geopolitical events, Russia appears to have taken almost every hit possible. Its military intervention in Ukraine in the beginning of 2014 was followed by international sanctions that are now taking toll. It has been later accused of involvement in downing a passenger plane, further damaging the country’s reputation internationally. Most recently, Russia started carrying out air strikes in Syria, which resulted in a retaliatory act of terror. My take on this is that investors now firmly believe one can expect anything from Russia. The actions of its government are hard to predict, and events can quickly take a turn in the least anticipated direction. All this risk gets discounted into the stock prices, offering opportunities for those who are prepared to stomach it. Summary I believe RSX presents an attractive investment opportunity at a time when US equities are trading near their highest levels ever. Russian stocks have the lowest valuations worldwide. The oil price is close to the lows seen at the peak of the financial crisis. The Russian rouble is as weak against the dollar as ever. And the geopolitical picture for the country is so gloomy that it is not easy to come up with a worse scenario. Combining all these elements together, Russia does look like a top pick for a reversal play. It may not be a suitable option if you are a light sleeper, though. Scalper1 News

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