J.P.Morgan - Russia - Relative attractiveness should not be overlooked

Russia’s outperformance begs the obvious question: will it last? The MSCI Russia Index has doubled in the last three months, beating the main peers (other BRICs and SA) as well as emerging markets in general. This makes a switch trade look appealing. However, we argue that underweighting Russia may backfire.

More comprehensive comps reveal Russia’s relative attractiveness. Those arguing that Russia’s outperformance means inevitable reversion should look at the 12M comparisons where Russia is still a visible laggard. Nor are Russia’s valuations demanding, as the aggregate 2010 PE is still at a 34% discount to that of the MSCI Emerging Markets Index owing to the relative cheapness of the key Oil and Gas sector (some 65% of MSCI Russia).

Strong oil means upside to consensus earnings. Comparisons of oil futures (WTI) and the sell side consensus suggest earnings estimates should move higher, rally or not. We highlight that notwithstanding the heavy taxation of oil companies, earnings’ sensitivity to the oil price is high (>15% ’10 JPMe EPS for 10% higher oil price). Oil, the most widely-traded commodity, provides the sector with a uniquely loud indicator of earnings changes particularly as consensus has been slow to reflect the price increase.

Economy a concern but... with commodity stocks accounting for near three quarters of the MSCI Russia Index capitalization, global factors remain key. We also highlight that stocks have a well-established record of being a leading macro-indicator. All in all, for investors seeking exposure to high beta and commodities (the winning themes in our view) Russia should still look attractive. We believe a correction, not surprising after such a large rally, should be used as an entry point.