Jupiter: Russian and Greek markets have the potential to turn around in 2015
Colin Croft, manager of the Jupiter Emerging European Opportunities Fund comments on why Russian and Greek markets have the potential to turn around in 2015
What comes down – must go up?
At last, it is over. 2014 was a year to forget for investors in Eastern Europe, home to the two worst-performing global markets: Russia (-41%) and Greece (-36%)1.
The Russian market faced a perfect storm of falling oil prices and conflict in Ukraine, while a revival of political risk overshadowed the nascent economic turnaround in Greece. Relative bright spots in the region, such as Turkey (+27%) and Czech Republic (+4%)2 were only able to soften the blow to some extent, given their relatively smaller weight within the Eastern European equity universe – where the return for the benchmark MSCI EM Europe 10/40 Index return was in the tune of -25%.3
After suffering such a disastrous year, some people might conclude that it is the end of the world – they might feel an urge to simply throw in the towel, regardless of the cost.
But for those who have followed the Russian market for some time, this situation looks reassuringly familiar – and for us, the instinctive reaction is exactly the opposite of despair.
It’s the end of the world…again
Let’s go back to December 2008, the last time that it was “the end of the world”. The oil price had just taken a terrifying plunge from its all-time high of around $145/bbl down to a low of just $34/bbl, bringing the Russian economy – and its stock market – to its knees.
At the time, it felt like the worst possible moment to invest in Russian equities, and if anyone had advised you to do so, you would have thought them to be completely crazy. Yet anyone “crazy” enough to put their money to work in Russia that December would have doubled it in little more than a year, although there is no guarantee that this type of event will happen again.4
This episode itself was an echo of what happened around a decade earlier, when the oil price fell as low as $9/bbl towards the end of 1998, forcing Russia to devalue its currency and default on its sovereign debt. I still remember reading a copy of the Economist at the time whose cover posed the question “$5 oil”? Much as it has today, consensus opinion very quickly began to assume that because the oil price had fallen, it would continue to fall and remain extremely low for a long time, if not indefinitely. Russian equities would once more have looked like toxic waste at the end of that year. Yet in less than twelve months, the price of oil doubled to over $20/bbl, and the “toxic waste” that was the Russian market would have tripled the money of anyone “crazy” enough to invest.5
My view is that oil prices can’t remain at current levels for too long. In the short run, they might overshoot further to the downside, but eventually the invisible hand of the market is likely to work its magic. Already we are seeing high-cost producers cutting investment, and on the demand side, we may well see consumers starting to use more fuel as it becomes less expensive for them to do so. It may take time for these forces to make themselves felt – but as the examples of 1998 and 2008 show, neither excessively high oil prices nor excessively low oil prices last indefinitely.
Of course, there is one important difference between the current situation and previous Russian crises – the deterioration in relations between Russia and the West. Unfortunately, this may well persist for some time, given the divergence of views on the Ukraine crisis. However, this is widely expected, and to a large extent reflected in extremely low valuations, which have fallen to levels last seen at the trough of the global financial crisis. In any case, in my view the economic impact of sanctions appears to be much less significant for Russia than that of the oil price.
Greek myths and Greek realities
In the same way that low oil prices are unlikely to last forever, we shouldn’t assume that the current political uncertainty in Greece will go on indefinitely. Elections are scheduled for the 25th of January and in the run up to this, markets are being spooked by political rhetoric from both sides – not all of which should necessarily be taken at face value.
Whoever wins the election will face the same fiscal reality – a reality in which there simply isn’t a lot of room for manoeuvre in either direction. Greek voters are understandably weary of austerity, but in order to spend more, you need to borrow – and to borrow, you need to find a willing lender – which requires a credible long-term fiscal policy and an agreement with official sector creditors.
Some commentators have raised the possibility of Greece leaving the euro in the event that Syriza are elected. However, opinion polls indicate that the majority of Greeks want to stay in the euro, and at its recent congress, a majority of Syriza’s delegates voted against a proposal to keep the option of returning to the drachma. Leaving the euro could send interest rates soaring and cause far more economic pain for Greeks than the current austerity, so in my view it would hardly make sense for any Greek government to do that.
More realistically, we are likely to see a series of negotiations between the Troika and the new government regarding the Greek sovereign debt – to what extent can it and should it be repaid, how fast, at what interest rate, and with which conditions attached? We already know what each side might like to have in an ideal world – but this process should reveal what they are actually willing to accept.
In this negotiation, both sides will have some cards to play – but they may think twice before using them due to the costs involved. For example, in my view the government would be wise not to act unilaterally on the debt, for fear of triggering a financial crisis that it might struggle to survive. On the other side, creditors may find that an inflexible position causes too much collateral damage and may ultimately prove counter-productive for recovery rates. The negotiations may thus resemble a game of chicken, in which it would be in neither side’s interest to be too stubborn. As in any game of chicken, one cannot exclude the possibility that both sides are “brave” enough to steer straight into a head on collision, but rational self-interest should give both sides a strong incentive to avoid a crash.
During this volatile period we have been running a tactical underweight in Greece, but if and when the dust settles, a significant buying opportunity could emerge. If the uncertainty surrounding Greece’s public finances can be reduced to an acceptable level, then investors may once again turn their attention to a market that is trading on distressed valuations; at the time of writing, some of the Greek banks are trading on less than half book value, with strong cyclical earnings recovery potential.
Changing for the better?
Of course, buying last year’s laggards may not be a fool-proof strategy in itself – circumstances have to change for the better in order for the market direction to turn around.
In 2013, for example, both Turkey and India had a difficult year – but both enjoyed an excellent 2014 as elections reduced political uncertainty in Turkey and provided a new reform-oriented government in India.
Amid the near-universal gloom regarding Russia and Greece it is important to think about the factors that have the potential to improve during 2015, such as the oil price and the politics – and consider how quickly the weather can change – sometimes for the better.