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RSX: High Risk, Even Higher Reward

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.

Aerospace And Defense ETFs Flying High On Strong Earnings

The U.S. bourses saw the majority of Q3 earnings releases getting over last week with headwinds from Q2 still at play. A combination of Energy sector weakness, dollar strength and global growth uncertainties weighed on the results. 341 S&P 500 members, accounting for 75.5% of the index’s total market capitalization, have so far reported results. Total earnings for these companies are down 1% on 4.9% lower revenues, with 71.3% beating earnings estimates and 42.7% coming in ahead of revenue estimates. Companies struggled to beat lowered top-line expectations, with the ratio of companies beating revenue estimates being the lowest in the recent past. However, instead of ‘extremely weak’, the Q3 earnings picture is shaping up to be about in line with the preceding quarter, which was by itself a weak reporting season. Despite the headwinds, aerospace & defense, a relatively smaller sector within the S&P 500, held up well this past quarter. They have not only reported better-than-expected results but also lifted their views in the past two weeks. The earnings beat ratio of the entire aerospace and defense companies unfolding their Q3 results is a stellar 77.8%. The U.S. defense sector performed well given the elevated geopolitical risk, a recovering U.S. economy and strong commercial sales. Escalating geo-political tensions in Eastern Europe, the Middle East, North Korea and Syria boosted demand for defense products. Further, nations such as India, Japan and South Korea are raising their budgets in order to make their defense platforms up to date. Below we have highlighted in greater detail the earnings of some of the major aerospace and defense companies which really drive this sector’s outlook. Quarterly Earnings in Focus The Pentagon’s prime contractor, Lockheed Martin Corp. (NYSE: LMT ), opened this earnings season with robust third-quarter profits. It reported better-than-expected earnings along with higher revenues, solid margins, and strong cash flows, buoyed by robust sales of its F-35 Joint Strike Fighter. The solid quarterly results have enabled it to lift its 2015 guidance for sales, operating profit, and EPS. Aerospace giant, The Boeing Company (NYSE: BA ), delivered third-quarter 2015 adjusted earnings of $2.52 per share, confidently beating the Zacks Consensus Estimate by 13.5%. Earnings also increased 18% year over year on the back of strong operational performance. Revenues came in at $25.85 billion for the quarter, exceeding the Zacks Consensus Estimate by 4.5% and improving 9% from the year-ago level on solid commercial aircraft deliveries. Boeing raised its full-year earnings outlook to the range of $7.95-8.15 per share from the prior guidance of $7.70-7.90 per share. The company also lifted its revenue guidance for the year to the range of $95-97 billion from $94.5-96.5 billion expected earlier driven by increased commercial delivery outlook. Just after winning a multibillion-dollar contract to build a new U.S. bomber, Northrop Grumman Corp. (NYSE: NOC ) reported solid third-quarter 2015 results with revenue and earnings beating the Zacks Consensus Estimate by 6% and 2.4%, respectively. The maker of the current B-2 bomber and Global Hawk unmanned planes has also increased its profit outlook for the full year. General Dynamics Corp.’s (NYSE: GD ) third-quarter earnings from continuing operations of $2.28 per share topped the Zacks Consensus Estimate by 8.6% and also increased 11.2% from the year-ago period on the back of higher defense orders and solid demand for its Gulfstream airplanes. Revenues of $7.99 billion surpassed the Zacks Consensus Estimate by 3.1%. The company raised its 2015 profit outlook based on Q3 results, higher deliveries of Gulfstream business jets and surging sales at the submarine-building unit. Earnings are expected to be between $8.90 and $9.00 per share for 2015, up from $8.70 to $8.80 projected earlier. United Technologies Corporation (NYSE: UTX ) reported third-quarter adjusted earnings of $1.67 per share, down 2% year over year. However, the figure surpassed the Zacks Consensus Estimate of $1.54. Total revenue decreased 6.0% year over year to $13,788 million owing to the impact of adverse foreign exchange and a decline in organic sales. Revenues also missed the Zacks Consensus Estimate of $14,593 million. The company reaffirmed its 2015 guidance. ETFs to Play All these major aerospace and defense companies and their ETFs have been experiencing a surge in share prices, since their solid third-quarter earnings results and improved outlook. For investors who want to play the sector in order to capture the impressive trend, there are a few aerospace and defense ETFs available. Below, we have highlighted some of the key points regarding them. iShares U.S. Aerospace & Defense ETF (NYSEARCA: ITA ) The fund, tracking the Dow Jones U.S. Select Aerospace & Defense Index, holds 39 securities in its basket with Boeing, United Technologies, Lockheed Martin, General Dynamics and Northrop Grumman being the top five stocks. All of them account for more than one-third of the fund assets. With an asset base of nearly $523 million, ITA is the largest player in this space. The fund trades in moderate volumes of roughly 42,000 shares a day and charges an annual fee of 43 bps per year. The fund was up 4.9% in the last two weeks and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook. PowerShares Aerospace & Defense Portfolio (NYSEARCA: PPA ) PPA follows the SPADE Defense Index, with 53 companies involved in the development, manufacturing, operations and support of U.S. defense, homeland security and aerospace operations. Lockheed Martin, Boeing, United Technologies, General Dynamic and Northrop Grumman are among the top 10 holdings and together occupy 30% of total fund assets. The product has managed to garner nearly $238 million in assets so far and trades in an average volume of 36,000 shares per day. It charges 66 bps in annual fees and returned 6.8% in the past two weeks. It currently carries a Zacks ETF Rank #3 with a Medium risk outlook. SPDR S&P Aerospace & Defense ETF (NYSEARCA: XAR ) XAR tracks the S&P Aerospace and Defense Select Industry index, holding a basket of 35 stocks. Boeing, United Technologies, Lockheed Martin, General Dynamics and Northrop Grumman score among the top 10 holdings, with a combined share of 18.6%. This product has attracted an AUM of nearly $147 million and exchanges nearly 35,000 shares in hand per day. It charges 35 bps in fees per year and gained 4.6% in the last two weeks. The fund has a Zacks ETF Rank #3 with a Medium risk outlook. Original Post

RSX: August Review

Summary RSX experienced huge volatility in August, but its share price finished the month only 0.88% lower. Russian GDP decline was bigger than expected and the situation in Ukraine started to deteriorate again. The main catalyst that should be able to push RSX price higher is oil price recovery. The Market Vectors Russia ETF (NYSEARCA: RSX ) declined by 0.88% in August. Although the 0.88% loss may indicated that August was a boring month, nothing is further from truth. Chinese economic woes initiated huge selloffs on global financial markets, Russian share market included. The share market panic was further strengthened by collapsing oil price that reached a new multi-year low at $37/barrel. On August 10, Russia announced that its GDP declined by 4.6% in Q2 2015. The decline was worse than estimated by analysts. The investors confidence was shaken also by news coming from Ukraine that indicated that the semi frozen conflict starts to heat up again. As a result, RSX was 15% lower compared to the July closing price at one moment. But as the situation on global financial markets calmed down and global share indices as well as oil price recovered slightly, RSX managed to erase most of its losses. The 4 biggest holdings in the portfolio of RSX are still shares of Magnit, Gazprom ( OTCPK:OGZPY ), Lukoil ( OTCPK:LUKOY ) and Sberbank ( OTCPK:SBRCY ). Weights of Magnit, Gazprom and Lukoil were over 7%, weight of Sberbank was slightly below 7%. On the 5th position, Norilsk Nickel ( OTCPK:NILSY ) replaced Novatek. The weight of Yandex (NASDAQ: YNDX ) keeps on declining, as shares of the company don’t perform well. If this trend continues, Yandex will slip out of the top 15 in the coming months. (click to enlarge) Source: own processing, using data of vaneck.com Out of the 15 biggest holdings, only 4 companies experienced share price growth in August. The biggest share price growth was experienced by Uralkali. Shares of the major potash producer were supported by its huge share buyback program. The biggest decline was recorded by shares of Yandex. Shares of the Russian search engine provider peaked at $21 in April. After 5 months of declines their current market price is less than $12. Source: own processing, using data of Bloomberg Although the recent months were hard for RSX, it is still up by almost 15% y-t-d. Among the 15 biggest holdings, Micex quoted shares of Surgutneftegas ( OTCPK:SGTPY ) did very well and they are up by almost 37%. Uralkali experienced a great August and as a result its share price is more than 30% up y-t-d. On the other hand shares of Yandex lost more than 1/3 of their value over the last 8 months. The second worst result was achieved by VTB Bank. VTB Bank share price lost almost 10% y-t-d. Source: own processing, using data of Bloomberg RSX remained to be very strongly correlated to the oil price (represented by The United States Oil ETF (NYSEARCA: USO ) in the chart below). The correlation between RSX and USO was stronger than correlation between RSX and S&P 500 for the better part of August. Given the important role that oil production plays in the Russian economy and given the strong position of energy companies in the RSX portfolio, it is hard to expect any meaningful and lasting change anytime soon. Source: own processing, using data of Yahoo Finance RSX share price went crazy in late August. The major share markets experienced a huge increase of volatility and the Russian share market was no exemption. The volatility measured by 10-day moving coefficient of variation was relatively stable from the middle of June to the middle of August. It was range-bounded in the 1%-3% interval. But in late August it increased rapidly and it crossed the 5% level for the third time over the last 8 months. (click to enlarge) Source: own processing, using data of Yahoo Finance Some of the more interesting news: The Russian companies were reporting H1 2015 and/or Q2 2015 financial results. Most of the important news were related to these reports in August. Gazprom announced its H1 2015 financial results. In H1 2015, Gazprom recorded net income of R568 billion which is 25% more compared to H1 2014. However in dollar terms, the income was only approximately $9 billion which is almost 30% lower compared to H1 2014. Norilsk Nickel surprised positively as its H1 2015 net profit remained almost unchanged compared to H1 2014, despite significantly weaker metals prices (nickel and copper prices were significantly lower compared to H1 2014). Norilsk Nickel recorded revenues of $4.9 billion (-14%), EBITDA of $2.7 billion (+8%), net earnings of $1.5 billion and adjusted earnings of $1.9 billion. Sberbank experienced a huge drop in profitability. It recorded net profit of R85.2 billion which is a 50% decline compared to H1 2014. In dollar terms, the decline is whopping 72%. The decline was caused by net provision charge for loan impairment that increased by R81.5 billion y-o-y. Total operating income before impairments remained almost unchanged. Rosneft signed LNG Supply and Purchase Agreement with state-owned Egyptian Natural Gas Company. According to the agreement, Rosneft will deliver LNG to Egypt. Rosneft has also reported its H1 2015 financial results. The company recorded revenues of $46.2 billion (-42.5%), EBITDA of $10.8 billion (-36.1%) and adjusted net income of $3.5 billion (-40.7%). Uralkali announced its intention to buy own shares and GDRs worth $1.32 billion. The company plans to purchase up to 411,042,224 common shares (1 GDR represents 5 common shares), representing 14% of company’s issued and outstanding shares. The purchase price will be $3.2 per share or $16 per GDR. Magnitogorsk Iron and Steel Works , one of the biggest Russian steelmakers, signed an agreement with Yandex Data Factory, an analytical subsidiary of Yandex, to develop a mathematical model and related software for steel making. The aim of the cooperation is to optimize consumption of ferroalloys and other materials during the steel production. Conclusion August was a wild month for RSX share price and it is probable that September won’t be too much calmer. The developments in China, oil prices and FED’s decision whether to raise or not to raise interest rates will affect RSX significantly in September. It is important not to forget about the political risks. Situation in Ukraine seems to be deteriorating once again and there are also rumours that Russia is about to start a direct intervention in Syria to support the government forces in its war with the Islamic State. It is hard to predict whether RSX will grow or decline in September. The only sure thing is that it will be a volatile ride. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.