Last Friday, the U.S., Britain and France fired more than 100 missiles toward at least three Syrian targets that were producing chemical weapons. The attack is considered a counterstrike because Syrian President Bashar al-Assad allegedly used chemical weapons on civilians and rebels in the city of Douma, Syria.
The chemical attack shocked the world as it led to many tragic fatalities, including women and children. I will try to avoid the subject of what is right or wrong, what should happen or who is responsible. Instead, I will focus on the economic implications. As frequent readers know, I (as do many value investors) do not feel safe with the standard 60-40 portfolio or an index fund like the S&P 500 (SPY, Financial).
This conflict brought the possibity of a massive Middle Eastern (or even global) conflict back into focus. Counterintuitively, I believe there is some safety in Russian exposure even though it is a primary ally of President Assad.
I must disclose I already owned some Russian stocks prior to last week's strikes as the valuations are highly compelling.
Why did the conflict increase the Russian opportunity? Well, as the chart below, which shows the price action of the VanEck Vectors Russia exchange-traded fund (RSX, Financial), indicates, the market dropped violently in response.
Because of the geopolitical tension, however, oil prices actually shot up. Prices have been strong year to date, likely because speculative demand is very high.
This is quite a curious disparity because 42% of the Russian ETF portfolio consists of energy stocks:
Data: Morningstar
Valutions were already compelling, but the selloff only made it more so:
Data: Morningstar
It is almost unheard of for a country's stock market to trade below book value; 7.5 times forward earnings and 5.11 times cash flow are extremely attractive fundamental multiples. It is hard to find even a single stock in the U.S. market with such fundamentals, let alone a basket of stocks. The image below displays the full portfolio of the Russian ETF:
Source: Morningstar
Risks include sanctions by the international community, a conflict between Russia and Western countries, government confiscation and a steep drop in energy prices. In my view, these risks are not unique to Russia, with the exception of government confiscation, and would have a large negative effect on other stock markets around the world.
Merely the risk of confiscaton by the government does not seem to justify the valuation disparity. Considering all of the above, the risk-reward of a modest position in Russian equities is attractive.
Disclosure: The author and subscribers of The Black Swan Portfolio may hold a position in funds with exposure to Russia similar to the RSX.
