Page 75 - RusRPTFeb22

8.3 Stock market
8.3.1 Equity market dynamics
Russian stocks have declined some 30% since their October peak. The RTS index P/E has fallen to 4.5x, making the market cheap. Sell-offs of an even bigger scale have happened in the past – e.g. 2008, 2014 or 2020 – but unlike those episodes, now we have good visibility of corporate earnings. We believe that a rising risk premium is the only reason for the market collapse, hence its normalisation is the key source of upside. In this note, we demonstrate that the geopolitical component of the risk premium in itself is relatively limited, at around 150bp, while much of the risk premium expansion happened on the level of the ERP, which is bound to revert to mean, in our view.
Rising risk premium. The dynamics of the fixed income market suggests that recent geopolitical woes increased the Russian risk premium by some 150bp. The effect on the equity market was far more severe. The implied cost of equity soared from 14% to above 20%. As a result, the ERP jumped to above 10%, the highest level in observable history.
ERP has built-in mean-reversion mechanism. Elevated ERP incentivises investors to rotate from fixed income instruments into equities. High ERP also prompts companies to launch buybacks. Historic patterns show that 6% is the fair level for the Russian market’s ERP.
Risk premium normalisation is the key source of market upside. We model sensitivity of the RTS index to different levels of risk premium and conclude that the normalisation of ERP per se could bring the RTS index back to 1900 even if the geopolitical premium persists. If we see positive dynamics on the geopolitical front, the index might recover much faster and go as high as 2100.
The Russian equity market sold off heavily in January on the back of spiking geopolitical tensions and the threat of war between Russia and Ukraine. By the middle of January the RTS had given up all its gains of 2021 and was back at pre-recovery levels.
The downtrend started as early as the end of October, but the downturn has accelerated in recent weeks. The stock index RTS has already fallen by about 10% this year and since last October’s all-time record reading it has come down about 25%. The ruble has also weakened slightly against both the dollar and the euro in January, although the price of Urals oil has risen by almost a fifth and is at its highest level in years. In addition, the price of CDS credit risk derivatives based on Russian government bonds has risen sharply in recent weeks.
The share of foreign investors in the trading volume of shares on the Moscow Stock Exchange (MOEX) has increased in recent years and was about half at the end of 2021. According to MOEX, the share of Americans in Russian shares held by foreign funds in particular has increased and was almost 60%
75 RUSSIA Country Report February 2022 www.intellinews.com