RSX: The Bear Thesis
Summary Ruble will continue to weaken. The economy is in bad shape, and production was not helped by the weak ruble. The oil is looking weak too, which is very dangerous for the Russian oil producers and the economy. Despite recent weakness, the Russian Stock Market (NYSEARCA: RSX ) is still up almost 25% year-to-date. The wild moves seen in last December are almost forgotten. However, I see several reasons why RSX can go lower. The Russian Ruble The Russian currency has somewhat stabilized after falling to as much as 80 rubles per dollar in December of 2014. Currently, you can buy a dollar with 55 rubles. However, I see reasons why the ruble could go lower, hurting the dollar-denominated RSX. The first reason is the key interest rate. The key rate, which was increased to 17% by the Russian Central Bank at the height of the crisis, was recently lowered to 11.50%. This move helped the bank stop the rally in the Russian ruble. The Central Bank also started buying $200 million per day in order to bring the reserves back to $500 billion. At the end of May, international reserves stood at $356.8 billion. In my view, the key rate will be lowered further, because the economy is in a bad shape. In April, industrial production fell ( Google translate link ) by 4.5%. In comparison, industrial production fell by just 0.6% in March. This means that the ruble is not weak enough to help local producers, which will make the Central Bank more eager to bring interest rate down and push the ruble lower. The Economy As I mentioned above, production is stagnating. So is consumption. In May, real earnings of Russian citizens contracted ( Google translate link ) by 6.4%. According to official estimates, it would take three years to bring earnings back to the level of 2014. This fact means problems for the consumer-oriented part of RSX holdings like Sberbank ( OTCPK:SBRCY ), Magnit (retailer), VTB Bank, and Mobile Tele Systems (telecom). The decrease of consumer spending could especially hurt Magnit, which has been growing very fast and opened 1,618 new shops last year. The budget is stretched, and the Russian Ministry of Finance is even ready to cut the sacred cow – military spending. Oil Russia is still overly dependent on oil prices, and I’m bearish on oil. Brent oil managed to make a spectacular run from under $50 per barrel to almost $70 per barrel. The decline in the number of U.S. rigs and conflicts in the Middle East help oil gain ground. In my view, oil has run out of upside catalysts. The conflicts in Yemen and Iraq are very far from being resolved, but this does not lead to an upside in oil. The number of working rigs in the U.S. has dropped by more than 50% compared to 2014, but this fact no longer helps oil. Despite recent cuts, supply still exceeds demand, and this means more pressure on oil prices. Pressure on oil hurts the economy, and hurts Russian oil producers, like Surgutneftegas, Lukoil ( OTCPK:LUKOY ) (and Tatneft ( OTCPK:OAOFY ), which are heavily represented in RSX. Bullish Argument The eternal bullish argument for the Russian market is its undervaluation based on different metrics. Interestingly, in Russia, this argument, which was widely used five or ten years ago, is now stated with sarcasm. Yes, you can still choose the metric that you like, choose the peers and find out that Sberbank, Gazprom ( OTCPK:OGZPY ) and others are relatively undervalued. In fact, they have always been. This undervaluation is chronic and, in my view, nothing will change on this front unless the country goes through serious structural changes. Bottom line I am bearish on RSX. I believe that the combination of weaker oil, sluggish economy and falling ruble will send RSX closer to lows seen in December of 2014. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in RSX over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.