As Crimea holds its controversial vote on secession, the outlook for Ukraine is more uncertain than ever. Investors usually hate uncertainty yet they seem to have shrugged off the latest geo-political upheavals.
The rout of March 3, which saw Russian shares lose 12 per cent alongside a headlong rush towards the usual havens of gold, US Treasuries and the yen, barely lasted a day. Within days, investors had regained their poise; only Moscow remained seriously under water while shares in New York continued to test new highs.
The political risks in Ukraine remain large, as Citi’s political analyst describe the developments there as the most significant in years. Although the smart money is on a cash injection by the IMF, Citi thinks there is a non-trivial risk of outright break-up and default. If that were to happen, recovery of capital might be well below the assumed average for emerging markets of around 60 per cent.
Why so sanguine?
So why have investors been so sanguine? The answer is that Ukraine and Russia matter less in economic terms than their sizes might suggest. And they probably matter too much in geo-political and strategic terms for either side to do anything really silly.
Neither the US nor Europe would appear to have any appetite at all for any serious challenge to Russian intervention. Sanctions look likely to be limited to travel bans and asset freezes.
According to Credit Suisse, the impact on global growth is likely to be limited. Russia accounts for about 2.9 per cent of global economic output, with Ukraine adding another 0.4 per cent. Russia’s imports from the US amount to $US11 billion with a further 87 billion euros from the eurozone. Those figures represent less than 1 per cent of both economies. By itself, the crisis isn’t going to move the economic dial very far.
Germany is most on the hook, but even here only 3 per cent of exports go to Russia. The impact is more significant in the other direction, because half of Germany’s oil and 40 per cent of its gas comes from Russia and about half of that passes through Ukraine. But here too it is easy to over-estimate the risk because Russia needs the export revenues and inventories are high enough to smooth any temporary disruption.
That means that an initial price spike in crude oil, arguably the biggest threat to global growth, was short-lived. Commodity prices are anyway more influenced by slowing growth in China where, despite Beijing’s insistence that China’s economy will once again expand at 7.5 per cent, marginal demand for resources is declining.
Hardly a worse time
Events in Ukraine could hardly have come at a worse time for emerging-market investors, already suffering as hot US money starts to head home after its recent forays into the world’s riskier markets in search of yield. There are notable exceptions – China, Russia, Turkey and Hungary all trade on single-digit multiples of expected company earnings – but overall there is not much difference in the valuations of emerging and developed markets and that makes shares in the developing world look vulnerable to further weakness.
Russia looks the most obviously cheap emerging market on just five-times earnings and with a 5 per cent yield. Shares are valued at just two-thirds of underlying assets – the same level they reached at the time of the Lehman crisis – but unlike other markets the Russian index has recovered only half its losses since March 3’s dive.
The bullish case for Russia before it started flexing its muscles in Ukraine centred on its more robust current account than other European emerging markets, better earnings forecasts and combination of value and momentum. At its current level, investors are effectively assuming declining earnings in perpetuity.
Safer opportunities
Investors, however, are not yet queuing up for Russian bargains and who can blame them when safer opportunities exist in developed markets?
The bounce since March 4 is a clear signal that investors are more inclined to buy the dips in these markets than they are to sell the rallies. Driven by resurgent interest in technology stocks the parallel with 1998, when western stock markets were temporarily derailed by a Russian default but quickly regained their composure and carried on rising for another two years, is striking.
With healthy earnings growth predicted, cash-rich companies eyeing takeovers and buybacks and sentiment still far from extended, it will take a significant deterioration in Ukraine to unsettle markets.
