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With Russia's Market, Rating Agencies Don't Tell the Whole Story

Could Russia be the financial magnet of 2017?

This post first appeared on Russia Insider

Paul Goncharoff is Chairman, Disciplinary Committee, National Association of Corporate Directors, Russia

Buying rumors, selling the facts has been a tried and true guide for traders since ancient times, and usually indicative of deep changes in the bouquet of factors influencing current markets. Factors at play could be purely financial numbers, geopolitical changes, military activity, while usually it is a mix and match to happily enhance anxieties and uncertainties.

Certainty, or perhaps the better term might be “comfort factor” in a perfect world, has traditionally been served (or perhaps underserved) by agencies such as S&P, Fitch’s, Moody’s and others to assure the investing world that they have the bull by the horns and the bear by its short and curlies. In a perfect world these CRA’s should be apolitical, third party, and as objective as the day is long. The reality is that we live in  an imperfect world, thankfully, where cookie cutter one-size fits all standardizations tend to fail spectacularly.

Credit rating agencies are supposed to provide global investors with an informed analysis of the risk associated with debt securities. These securities include government bonds, corporate bonds, certificates of deposit (CDs), municipal bonds, preferred stock, and collateralized securities, such as collateralized debt obligations (CDOs) and mortgage-backed securities. The riskiness of investing in these securities is determined by the likelihood that the debt issuer—be it a corporation, bank-created entity, sovereign nation, or local government—will fail to make timely interest payments on the debt.

Ratings are usually characterized by a letter grade, the highest and for years considered the safest being AAA, with lower grades at double and then single letters (AA or A) and so on down the alphabet. The ratings handed out by each of the Big Three have power to influence views and implications for investors and global markets. Together they control just about 95% of the credit ratings market mostly due to their institutional nature established over time, and their entrenched role in the US Securities and Exchange Commission regulations of 1975.

In the quest for common sense, the use of CRA data in the emerging markets should be used simply as one more tool in an investor’s toolbox, perhaps like an adze and not a hammer or screwdriver. Investors really ought to stop giving these ratings so much weight. As one commentator on this theme said "The reason why the subprime bubble could happen, or the reason why the European sovereign debt crisis can happen is, largely, that very blind investors bought bonds relying on ratings, and didn't do their own homework about what the real risk to credit was.”

Russia at this writing is rated investment grade only by Fitch, but sub in grade by S&P and Moody’s largely due to the effects of anti-Russia sanctions, geopolitical events, strident political accusations, and the volatile variables in the oil market. Investors have poured more cash into Russian equity funds over the past month  than since 2011. Russian stock funds show inflows of more than $450m in the week ending December 16, the most since first quarter of 2011. Mutual funds and exchange-traded funds invested in Russian bonds had their largest cash inflows since February 2015.

Some recent attraction to the Russian market is clearly seen in the following table:

The rise in the oil price since the OPEC agreement to cut supply last month has been a spark for both ETFs and mutual funds with mandates to invest in Russian assets. Some of the largest funds have seen assets rise by as much as 30+% since late November.

Russia flows are at this time insignificantly small when compared with the flows in and out of much bigger equity markets such as the US, however for those that do their homework and look beyond the “thundering herd”, Russian equities and bonds illustrate how rapidly sentiment in the market can turn. As I was told recently by OPKO Russian Market Partners “Russia is one of the best positioned special situation plays on the investing horizon, and has the advantage of being a solid long term opportunity as today it is increasingly less dependent on external political, financial or resources influence”.

At the start of this December, the Moscow Exchange (MOEX) saw:

* November total trading volumes up 28.3 pct. year-on- year to 73.7 trillion rubles ($1.15 trillion)

* November turnover grew across all Moscow Exchange major markets

* November total trading volumes on equity and bond market grew by 29 pct. to 2,398.6 billion rubles

* November money market turnover surged 75.7 pct. year-on- year to 31.8 trillion rubles

* November FX Market turnover advanced by 8.4 pct. to 25.7 trillion rubles

* November derivatives market volumes were up 6.5 pct. and amounted to 9.9 trillion rubles

* November precious metals market trading volumes reached 10.1 billion rubles

While many are waiting to see, just what form of surprise punishment the outgoing president Obama might dream up as his Legacy for Russia and have the markets twitch. After all, he promised to “respond” to alleged Russian interference in swaying the hearts and minds of the American electorate to choose Donald Trump, so he‘ll have to fish or cut bait before inauguration day in January. Hopefully this hissy-fit shall also pass as yet a further line in the sand, after all if we are to act like Americans and our respect our premise of justice - there should be at least the diplomatic pretense of innocence until or unless guilt is proven… which according to WikiLeaks, the FBI and even the NSA, excepting the politically appointed head of the CIA, will probably never happen.

Assuming all goes swimmingly, and president-elect Trump takes office January 2017, some analysts point to potential improvement in relations between the Kremlin and the incoming Trump administration. The markets today with their increased activity clearly support the “Trump factor”, which hopefully and finally might bring some long awaited clarity and common sense to America’s knee-jerk views regarding Russia as a convenient punching bag. Toning down the shrill and frankly silly demonizing of a country that is ready and willing to be a real and valued partner in so many ways is certainly not worthy of us or our foreign policy, such as it is right now.

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