A question on some investors’ minds is whether it makes sense to have some exposure to Russian stocks as part of an emerging markets strategy. The thinking is that should Russia pull out of Ukraine and global sanctions are lifted, could the Russian stock market turn around, offering upside potential? Russia’s stocks have fallen as much as 40% since the invasion, and the country has recently reopened a portion of its stock market. Some stocks have even recovered a small portion of their losses.
Russian Stock Prices can be Deceiving
But research from MSCI indicates that, despite the prices you see on the Moscow exchange, Russian stocks may have no value whatsoever. They’re likely worth zero. I don’t care how speculative you are; would it ever make sense to invest in something that is worthless?
While it’s true that many of Russia’s top companies are still operating, generating revenue, and even paying dividends, access to the Russian stock exchange has been limited since it reopened in March. Essentially, there is no liquidity for holders of Russian equities. But, according to MSCI, many of these companies are like “dead men walking” due to the increased probability of default, which has surged to 80% for five of Russia’s largest stocks. That’s up from a pre-invasion level of 20%.
The primary indicator for MSCI is the current pricing in the credit default swaps (CDS) market. A CDS is a financial contract that would protect investors from possible debt losses in the event of a default by the issuer of bonds. There is currently a disconnect between how the derivatives market is pricing Russian stocks and the prices traded on the Moscow exchange. Essentially, Moscow exchange prices are showing that these companies have some value, while the derivatives market is saying they have no value.
One reason for the disconnect is that investors trading in the derivatives market are not able to trade in the stock exchange. Foreign investors are not allowed to trade Russian stocks, and CDSs are available to institutional investors. The other reason is fear of technical default, in which a company that is still operating is unable to pay bond coupons or principal. Investors are skittish over the possibility of failure of the underlying CDS auction mechanism and being stuck with the losses.
The bottom line is that Russian companies that are still operating hold value for the relatively small number of investors who can invest in them. But the global market, which wields all the power, values them at zero.
About That Russia Recovery: Don’t Hold Your Breath
We in the U.S. have rightly believed that “the market always comes back” because it has for over a hundred years. But Russia, in its war-torn and sanctioned state, is not the U.S. Due to sanctions, Russian companies are teetering on zero valuations. If they get worse, the Russian kleptocracy could end up confiscating property and companies to centralize its economy. And the Russian ruble will continue to be very volatile.
On the other hand, it’s possible the war could end soon, sanctions lifted, and the market could recover. But it could take years for the Russian economy to get back to where it was before the invasion, which was not a very good place, to begin with.