The sword of Damocles is hanging over the Russian stock market after the Central Bank of Russia (CBR) decided to close the market immediately after the Russian attack on Ukraine on February 24. 

(To see this article complete with all the dynamic charts, please view it on the intellinews.com webiste here.)

Trading was suspended with the RTS index at 937, down over 40% since the start of the year and down by a whopping 50% from the peak of just over 1,900 set at the end of October 2021. 

Where will the market go once it is finally re-opened? Down is the obvious answer. Below bne IntelliNews takes a deep dive into the two previous big stock market crashes and compares them with this one. In an ominous sign when trading resumed in the Global Depository Receipts (GDRs) in the leading blue chips in London after the war started – a proxy share that is listed on foreign exchanges that is not under the control of the CBR – the share price in both the state-owned banking giant Sber and gas behemoth Gazprom collapsed by over 95%, making them almost worthless. 

Extrapolating these collapses to the rest of the market, then the RTS index would fall to a mere 22 – worse even than the collapse in 1998. Will that happen? If it does then it could also represent a golden buying opportunity to make a fortune from the rebound. That is what many Russian retail investors think. But with so many moving parts those investors could also end up stuck in a stock that trades sideways for the next decade.  

1998 crisis 

The RTS was launched on September 1, 1995, and the index was set to an arbitrary 100. After initially dropping to a low of 69.9 on March 11, 1996, the next year the index began to climb steadily over the next two years and investors started to make some serious money.

The index reached a peak of 570.9 – a five-fold increase – on October 7, 1997. Moscow had become a party town and the market was the best performing in the world. Slick investment bankers moved in and the local brokerages like Renaissance Capital, UFG and Troika Dialog became the new hip thing in the world of emerging markets.

But it wasn’t to last long. A currency crisis hit in Asia and was getting underway in July 1997. Within a few months, it began to infect the Russian market. Starting in Thailand, the crisis threatened to tip the world into a global recession that would hurt commodities in particular and so undermine the Russian market. Russian equity investors began to sell.

Driving the market down faster was the steady fall in oil prices, the key contributor to the budget. Oil prices slid by 23% during the course of 1997 to end the year at $15.86 per barrel. At the time, the Russian budget needed at least $14 per barrel to break even, so the tumbling price of Brent ratcheted up the pressure on the budget.

And oil revenue was not enough to fund Russia Inc. The government was relying on the Russian Ministry of Finance ruble-denominated GKO treasury bills to raise money, the precursor to the OFZ in use today. Foreign investors held some $40bn of these instruments and were receiving sky-high double-digit returns to tempt them into the market. 

Desperate for cash, the Ministry of Finance was issuing short-term GKOs that matured in as little as three months, in a valiant effort to keep the economy afloat. However, as 1997 wore on, the ministry was slowly issuing longer and longer maturities and interest rates were falling slowly to finally reach single-digits at the market’s peak as the economic outlook began to improve. 

The Asian crisis unravelled all that progress. Yields on the GKO began to spike back into double digits, as investors became more and more nervous until finally on August 17, 1998, the whole house of cards came down and the government defaulted on its debt and the ruble collapsed, losing some three-quarters of its value overnight.

The stock market was already in free fall but took two another two months to hit bottom. On August 17 the RTS index stood at 111, just above its launch value, but wasn't until October 6 that it hit its all-time low of a mere 38 – 50 days after the default and devaluation.

The market traded sideways for the better part of the next year as investors and Russian companies tried to pick up the pieces. It took until May 24, 1999 – 280 days after the default – for the index to get back to just the 100 it started life with, but from there on it began to grow steadily.

At the end of 1999 Boris Yeltsin stepped down and Russian President Vladimir Putin took over. At the same time, oil prices started their inexorable rise from a low of $14 in 1999 before reaching their all-time high of $147 set in June 2008.

And the RTS followed the oil prices up as it became increasingly clear that Russia in the noughties was starting to boom. The RTS hit 200 in January 2000, 300 in March 2002 and then 400 a few months later that year in May 2002. After that, there was another year of waiting but in June of 2003, the RTS passed 500 and 600 that October.

2003 was the year that the oil prices started to rise really fast and very steadily, lifting the RTS with it. The stock market started returning 50% gains every year from then on, until finally reaching its all-time high of 2,488 on May 19, 2008, only a few months before the Lehman’s brother investment bank was declared bankrupt and the RTS collapsed yet again.

2008 crisis 

The noughties were a good time for Russia and a sense of optimism pervaded the country, as it seemed to have finally made it. Transition was over and Russia Inc. was firing on all cylinders. 

Money was pouring in from continuously rising oil prices. The government was awash with money and after inflation contracted to single figures for the first time in a decade and a half in 2007 the Kremlin announced a $1 trillion infrastructure investment programme – four times bigger than the current RUB27 trillion 12 national projects programme intended to revitalise the economy. 

The private sector was doing even better. There was talk of the economy “overheating” as growth ran at between 6% and 8% thanks to the swelling volume of investment. There have been only two years in Russia’s modern history where it had a net inflow of capital as the flight capital started pouring back in. In 2016 and 2017 over $300bn returned home – as much money as had left in the previous five years. Russian entrepreneurs saw more reward from investing at home than the risks that led them to build up nest eggs in offshore havens for the first time. Wages were soaring and the standard of living caught up with the lower end of the EU members. Russia was on course to overtake Germany as the largest economy in Europe. 

Politically it was also the high point of Russian liberalism. Dmitry Medvedev had taken over the reins as president in 2008. At the annual St Petersburg International Economic Forum (SPIEF) in the summer of 2008, he announced the long-stalled privatisation programme was going to be restarted and major state assets were going to be sold off. The economics wunderkind from Moscow’s New Economic School, professor Sergei Guriev (who later went on to become the chief economist at the EBRD), was given carte blanche to draw up an economic reform programme and later told bne IntelliNews: “Medvedev read it out at SPIEF almost word for word; the Kremlin changed almost nothing.” 

And then it all came crashing down. The sub-prime mortgage market debt was a ticking time bomb that finally went off when the “teaser” low-interest rates expired and house buyer after house buyer began to default on their mortgages. The dodgy mortgages had been packaged into CDOs (collateralised debt obligations) and billions of dollars of these obligations sold to investors with little scrutiny. As they blew up one after the other the entire financial sector was exposed to imploding credits. 

The crisis came to a head on September 15, 2008, when investment bank Lehman Brothers went bust and was not bailed out by the US Federal Reserve bank. 

The RTS had been growing strongly in the preceding years as the economy recovered from the 1998 crisis but it wasn't until the oil prices took off after 2003 that the real party started. The market started to return almost 50% a year and carried on doing that for almost five years in a row (with a hiccup in 2004 for a mini-banking crisis). 

Nerves were building throughout 2008 starting in January, when US banks began to get into trouble due to the unravelling mortgage bubble. The Russian market recovered somewhat after the collapse of Northern Rock in the UK in February and US bank Bear Sterns’ near-death experience in March of that year. The $200bn bailout programme implemented by Fannie Mae and Freddie Mac in March reassured investors that the US would avoid a catastrophe. But when the US market started to fall from around May in 2008 and had lost 20% of its value by June, a rout started on the Russian market that gathered pace as the news got worse and worse. 

The RTS had already halved in value by the time Lehman Brothers went bust in September and it continued to tank for another five months before finally hitting bottom on January 26, with the RTS index at 498, off from its peak of 2,478 set on May 19 nine months earlier. The market had given up all its gains of the previous five years and didn't really start growing again for another decade. 

Russia’s economy began to stagnate in 2013 as growth fell to zero as the petro-economic model of growth was exhausted. There was another crisis in 2014 when Russia annexed Crimea, as well as another oil shock the same year. Sanctions kept the RTS range-bound until 2018, when the economy started to revive and everyone had got used to living with the sanctions. But sure enough, just as the market started to boom there was yet another huge crash in 2020 and then 2022. This time it was self-induced. 

2022 crisis 

With the oil price shock and devaluation in 2014 Russia’s economy went into a four-year-long deep recession. But around the start of 2018, the economy began to recover.

Stocks prices began to grow, starting with individual names, the bluest of the blue chips, as company valuations became “too cheap to ignore” and portfolio investors began to buy into the best companies that were growing strongly. Russia’s leading supermarket firm, X5 Retail Group, saw its share price double in that year, whereas its main rival and former investors’ darling Magnit’s share price stagnated. Leading real estate developer PIK also saw its shares double in value as its profits also doubled. 

By 2019 the groundswell of enthusiasm for Russian stocks gained so much momentum that the index started to rise and by the end of the year had finally broken out of the 900-1,300 trading band where it had been stuck for half a decade.

The coronacrisis and yet another oil price shock knocked the market back on its knees in the first quarter of 2020 but surprisingly didn't do that much permanent damage to the economy, so as soon as the vaccines started to appear at the end of 2019 the market bounced back much more strongly than anyone could have expected.

The stock market rally continued throughout the rest of 2020 and all of 2021 up until the end of October that year. Analysts were predicting the RTS would end 2021 at around 2,100 – close to its all-time high set in 2008 – and with banks and companies earning not only record profits but paying record dividends, 2022 was set to be a banner year.

It all went wrong on October 31 when the RTS was at 1,925. That was when the Washington Post reported that the Kremlin was massing troops on Ukraine’s border.

The rest is history. On December 15 the Russian Foreign Ministry issued its eight-point list of demands, including “no Nato” for Ukraine that the Kremlin said was non-negotiable. In January the first round of diplomacy began with a meeting on January 10 between the US and Russia in Geneva. That failed when the US delivered its letter saying it would not concede to the no Nato demand. French President Emmanuel Macron set off the second round of diplomacy when he and German Chancellor Olaf Scholz tried to persuade Ukrainian President Volodymyr Zelenskiy to implement the Minsk II deal, but on Russia’s terms. That failed too when Zelenskiy categorically rejected it in the third week of February. The next day a kindergarten in Ukraine was hit by a rocket and a few days later Russia attacked Ukraine on February 24.

The Russian stock market was immediately closed and has remained so ever since.

 

1998 vs 2008 vs 2022 

Where will the story go from here? The Central Bank of Russia (CBR) will have to open the market again at some point. The listed companies still have value, albeit greatly reduced, but more importantly, as bne IntelliNews has extensively reported, over the last few years there has been a huge influx of Russian retail investors into the Russian stock market after bank deposit rates fell to next to nothing. The Kremlin cannot simply write off hundreds of millions of dollars worth of Russian retail investments for political reasons.

Is this stock price collapse going to be worse than that of 1998? As the chart shows, the trajectory of all three of the last big crashes all followed roughly similar patterns and rates of collapse. 

Counting from peak to trough, markets were trading at 87% of this peak value after 80 days after the sell-off began in all three cases, which means the average gradient of the fall in the value of shares is more or less the same in all three cases. 

The current crisis has been going on for 141 days at the time of writing, when the markets were at 54% of its peak value in 1998, 23% in 2008 and 49% now. By this measure the 2008 crisis was worse than the other two but as the RTS will surely at least halve when trading resumes, it appears that the 2022 crisis will probably be the worst of the three. 

What happens next will depend a lot on how the story develops. In 1998 the top tier of Russia’s economy was more or less destroyed. In 2008 the slide halted earlier as the Russian economy was stronger and as bne IntelliNews has argued, each crisis Russia goes through does progressive less damage. This time the stock market collapse is only half-finished as the CBR closed the market in an effort to limit the damage and apparently will not open it again until things calm down. With a peace deal in the works, it could wait until an agreement is signed and only then open the market again. 

However, it seems likely that collapse this time is going to be a lot worse than that of 1998 and 2008. After the failure of the French diplomacy in February, investors began to dump their Russian equities despite the fact they were getting fire-sale prices. The gradient of the fall became almost vertical after Russia invaded Ukraine when the market was closed. In trading of Sber (formerly known as Sberbank) and Gazprom shares on the London Stock Exchange (LSE) in the week after Russia invaded Ukraine, both companies lost some 98% of their value.

Extrapolating this fall to the RTS index and the value of the index would be currently a mere 22 if the market were to open tomorrow – worse even than the RTS’ previous all-time low of 38 in October 1998.

Gazprom’s valuation after its sell-off on March 2 implied the entire company was worth a mere $250mn, down from the previous valuation of around $50bn only a few days earlier. But with a revenue stream running into the tens of billions of dollars a year, clearly the share price no longer reflects the company's actual value, even if you discount heavily for the sanctions regime.

After the storm comes the stagnation 

The outlook for the stock market after it reopens and crashes is poor, as the economy is expected to contract by between 8% and 15% this year. In 1998 the market fell heavily but within a few years soared as Russia’s economy boomed. In 2008 the market fell less hard but then traded sideways for nearly a decade as Russia’s economy festered and new problems like the sanctions regime appeared. This time the new and even more stringent sanctions regime probably means a repeat of a decade long stagnation of valuations. 

In normal times investors would expect the share prices to gradually recover as the sentiment shock of the crisis wears off and the “opportunity capital” appears. Eventually, investors once again start to see the shares as “too cheap to ignore.” But what has changed is “the sanctions have fundamentally changed the nature of the economy,” CBR governor Elvira Nabiullina said in comments following the monthly monetary policy meeting at the Central Bank of Russia (CBR).

Previously Russia was a market-based economy with a very open current account. However, the severity of these sanctions and the exodus of foreign companies has happened as Russia has become “like eating toxic nuclear waste” to investors again. The economy is no longer open and the CBR has already slapped on various capital controls that will be hard to remove. 

Prior to the war in Ukraine, economists said Russia’s long-term growth potential was a mere 2% as a result of all the resources being used to build Putin’s fiscal fortress, but now with the added drag of the sanctions that growth potential has been cut even further. Russia is now doomed to fall slowly further and further behind the rest of the world, and that has never been good for stock prices.

Against this gloomy outlook are several positive factors that could support Russian stock prices. The first is the state intends to invest 0.8% of GDP, or about $15bn, into buying back shares to support their prices. Several leading companies have also announced buyback programmes to prop up share prices. 

Secondly, and more powerfully, BCS GM polled its retail clients to estimate the market mood before trading resumes on the Moscow Exchange. 

“We received a record-high 1,000 respondents, apparently reflecting strong interest. The results are rather constructive. People look ready to buy Russian stocks first of all (57% of all), but also bonds (41%), with only a few ‘sellers’ in each category. This is likely to be at the expense of US shares and EM bonds, where selling pressure is above the potential buying pressure,” BCS GM said in a note. “We believe that the Russian market’s stronger potential returns is among the key reasons. Another positive thing for us is that 75% of investors are happy to buy for the long term.”

BCS GM predicts that the share of stocks/bonds in savings may rise, as a result of this crisis. Oil & gas and metals & mining names are the brokerage’s top picks

Another factor pulling potential investors into these stocks is the extremely high yields these companies pay out to shareholders. Indeed, the current crisis only improves the profitability of the raw material companies as their costs are in rubles and those have been reduced by a third. At the same time, they earn in dollars and most of the commodities they sell have seen prices soar to new all-time highs. With the average dividend yield of the leading Russian companies already at twice the level of the benchmark MSCI EM average, those dividend yields are already enough to earn an investor as much as is usually expected from the share price appreciation alone over the long term. 

“As for dividends, our respondents see a fair yield of c20% – not very aggressive and at par with our dividend portfolio before the recent events,” BCS GM said. “Investors are looking to buy natural resource companies in both Russia and the US with a massive gap vs the other sectors. Among the least preferred sectors, we note that the Russian financial and real estate sectors are at the top of investors’ concerns… Finally, 42% of investors plan to increase the share of traded instruments in savings vs 19% planning to reduce.”