Russian shares are cheap again

Russian shares are cheap again
Eastern Europe has witnessed momentous changes since the fall of the Berlin Wall 20 years ago.

By Elena Shaftan
Published: 5:54AM GMT 05 Nov 2009

In the two decades since this historic event, the lives of people in the former Communist Bloc have changed beyond recognition – changes that have increasingly attracted the attention of investors since stock exchanges started to open up in the region in the early to mid 1990s.

During this time, investors' focus has largely been on the opportunities presented by the convergence of Eastern European economies with those in the West.

Commodity shares to rise However, 20 years on from the symbolic collapse of the Wall and notwithstanding some setbacks, a lot of the "easy gains" have arguably been made from this story.

Having been through some difficult adjustments in the 1990s, most former Communist states are now members of the EU and share a common legal and regulatory framework with the West.

Living standards in the region have improved across the board as wages have risen and consumers have begun to discover credit. However, labour costs in many economies remain about a quarter of those in the West and taxes are a third lower than in Germany, ensuring the region remains an attractive destination for companies seeking to lower production costs.

Yet the development of these young democracies has hardly been uniform – some very clear winners and losers have emerged and it is worth casting a fresh eye over the new opportunities ahead of us.

Followers of the region will be all too aware that some of the smaller countries in the Baltics and Balkans got carried away with borrowing their way to growth, resulting in much publicised economic imbalances. However, the situation in economies such as Poland, Turkey, Russia and the Czech Republic couldn't be more different and this is where I believe the greatest prospects now lie.

These countries are benefiting from an improving economic outlook. They have substantial and still under-developed domestic markets and, with consumer debt levels of only 10pc to 30pc of gross domestic product (GDP) - versus 100pc for the UK - offer superior growth prospects than their less-fortunate neighbours.

In Poland for example, economic growth was 1.1pc in the second quarter, having remained positive even during the depths of the financial and economic crisis. Poland has benefited from relatively low exposure to exports but its solid performance has also been underpinned by structural factors.

While many other emerging economies thrived in 2001-2002, Poland struggled as unemployment and interest rates hit 20pc. Now they are just 11pc and 3.5pc respectively and the economy is benefiting from the unleashing of substantial pent-up demand.

This, together with a far smaller debt burden than in many other European countries, has allowed consumers to continue spending and support the economy.

Poland and the Czech Republic are also net beneficiaries of EU funding that aims to improve infrastructure. In Poland for example these transfers are worth around 3pc of GDP per annum for the next four years and are set to boost investment and construction.

Turkey offers further opportunities. While the Turkish economy suffered a sharp contraction last winter, it rebounded rapidly with 12pc quarter on quarter growth between April and July.

A positive side effect of the crisis has been the taming of inflation which has been above 20pc for 25 of the past 30 years, but is now down to a historic low of 5.3pc. This has allowed the central bank to slash interest rates from almost 17pc a year ago to an all time low of 6.75pc.

Lower interest rates should feed through to loan growth and stimulate the economy. Signs of recovery are already emerging with home sales rising 72pc year on year in the second quarter, while seasonally-adjusted automobile sales in September are at record levels.

The Russian economy has also stabilised now that the financing constraints that held back businesses over the winter have eased. After a sharp sell off last year, shares in Russian oil and gas companies now appear cheap compared to historical norms and their international peers.

While the events of 2008 have demonstrated that commodity prices can fluctuate in the short term, the development of China and India provides a structural source of incremental demand that is likely to exert upward pressure on prices over time.

But Russia is not just about oil. It is a country of 140m people – a huge consumer market, with a growing middle class aspiring to raise living standards.

Consumption patterns are changing as a result. Russians still drink on average around eight times more vodka than Britons, yet over the past decade, consumption of beer and fruit juices have leapt from next to nothing to near European levels.


Similar trends are emerging for other goods such as yoghurts, mineral water, vitamins, computers, broadband and banking services. These trends are likely to develop over time, benefiting the strongest local companies.

There are other reasons why we like these markets. First, their stock markets are large and liquid compared to others in the region, making them a more attractive destination for international investors, even though they carry more risk and experience greater volatility than Western counterparts.

Second, they often have very different dynamics, so investors can diversify while making the most of any economic and financial recovery.

Russia, for example, is the world's largest oil exporter, while Turkey imports most of the oil that it consumes. Investing in both means fund managers can take advantage of not only rising but also falling energy prices.

The Polish economy is driven primarily by domestic demand, which helped it to grow even when the rest of Europe was contracting in the first half of 2009. Czech equity markets, meanwhile, contain several solid defensive stocks that tend to be less susceptible to difficult economic conditions.

While stocks listed in the 'big four' markets of eastern Europe are most important for us at present, our ability to invest in the broader region means we can discover some hidden gems in smaller regional markets from time to time.

The ability to invest in a wide range of markets - including for example Israel and Croatia, and former Soviet republics such as Kazakhstan and Georgia - has given us the flexibility to adapt to different market conditions.

We are also exploring opportunities among West European companies with successful operations in Eastern Europe, further broadening the investment horizon.

The Eastern Europe of today is a very different place to that of 20 years ago. There have been economic winners and sadly, some losers. However, the opportunities for investors to profit from the region's success stories are clearer than ever.

Elena Shaftan is the fund manager of Jupiter Emerging European Opportunities Fund

http://www.telegraph.co.uk/finance/personalfinance/investing/6501437/Russian-shares-are-cheap-again.html