Stocks and Shares

The best stock market for the next decade

If you had to guess, which of these stock markets would you say were the best and worst performers since December 1998: Argentina, Russia, South Africa, or the USA? This was a question I recently posed to a conference of 200 private investors in South America. The answer may surprise you. More than that, it points us to where the we’re likely to find the best performance in the next decade.

So, without further ado, here’s the ranking:

  1. Russia
  2. South Africa
  3. Argentina (just)
  4. USA

Yes, really. Despite being despised at the current time by practically every international investor the Russian stock market was the clear winner. And despite currently trading at already elevated levels the US market was the loser over that period.

Even Argentina, a perennial economic basket case that had a massive financial and economic crisis that started in late 2001 and currently has price inflation running over 40% a year, has performed slightly better than the USA. South Africa is somewhere in between. Here’s the chart from MSCI to prove it.

MSCI index (Dec ‘98 to Aug ‘14)

MSCI Index

Importantly this comparison uses MSCI country indices, which are all measured in US dollars. That means we’re comparing apples with apples. You have to be careful not to compare indices that are measured in different currencies.

In fact the Russian index went up 10 times over that period, whereas the US index was up only 1.6 times. This means the investor in Russian stocks made 6.3 times as much money from capital gains as the investor in the USA. The gap was probably even larger with reinvested dividends.

How could this be? Aren’t we always told that Russia is a basket case, full of corruption and government interference, whereas the USA is a free market paradise? Shouldn’t US stocks be the better performers?

I have no doubt that there is plenty of corruption and government interference in Russia. But, on the other hand, I also have no doubt that there is a huge amount of corruption and government interference in the USA.

US style corruption may be slightly more subtle than the Russian variety. Political donations, and lobbying for favourable legislation, take the place of periodic asset seizures by the powerful. A constantly revolving door between public office and highly paid private industry jobs amount to the same as direct cash bribes, but dressed up in a smart and respectable suit and tie. But, for practical purposes, the results are more or less the same.

And government interference in US markets is at a high level. Quantitative easing – which is the process whereby the central bank prints money to prop up bond and stock markets, and to fund excessive government spending – is something that would have made Soviet central planners blush. US asset markets are highly manipulated (as they are in the UK, euro zone and Japan).

So let’s ignore the noise about corruption and government interference in Russia. Both exist in most countries.

So let’s ignore the noise about corruption and government interference in Russia. Both exist in most countries.

Instead let’s cast our minds back to December 1998, and what was going on then. The US market was half way through the technology bubble which finally burst in 2000. Russia had just had a massive government debt default and currency devaluation.

Put another way, almost every commentator at the time was recommending that investors buy into the US stock market. The internet revolution was seen as a “new paradigm”. Stock analysts invented a new language for this virtual world. Profits didn’t matter, but rather “eyeballs” and “stickiness”. It was a world of “clicks not bricks”.

The result was that share prices of any company whose name ended in “dot com” were heading to the moon. This was even if they had no earnings and, in many cases, not even a business plan.

Fashions and technologies may change, but human nature does not. From time to time investors get swept up in a frenzy of greed.

Fashions and technologies may change, but human nature does not. From time to time investors get swept up in a frenzy of greed. The dot com boom had echoes of the South Sea Bubble of 1720. That was a previous moment of insane euphoria where one bubble company famously described itself as: “A company for carrying on an undertaking of great advantage, but nobody to know what it is.”

Many of the dot coms were the same. Disappointment was bound to follow. But in December 1998 the euphoria still had over a year to run. More and more people sunk their pension funds into unproven hot stocks, and gave up their well paid day jobs to become online “day traders”. As the profits temporarily rolled in they confused a bubble market with having brains.

But what about Russia? In the late 1990s it was seen as a basket case. Aside from the default and devaluation, price inflation was running at high double digit rates. Stories abounded, many of them true, of murderous oligarchs who were looting the state and bumping off anyone who got in their way.

Cheap and hated markets spell massive opportunity for brave and patient investors.

Russia was hated by investors. It was seen as chaotic and doom mongers predicted a complete collapse. But what they missed was that the market was also exceedingly cheap. Cheap and hated markets spell massive opportunity for brave and patient investors.

Let’s fast forward to today. The US market is not experiencing the same kind of bubble euphoria as the late 1990s. But, as I’ve explained recently, it still has high prices. With a P/E10 at 25.6 it’s right near the top of the historical range since 1881 (see more explanation here). For that reason alone, investors in US stocks will be lucky to make a decent return over the next five to ten years, even if the market doesn’t crash.

(Although history suggests US stocks will fall hard at some point. Since 1871 the average time between US stock market peaks is five and a quarter years. The last one was seven years ago, in 2007.)

At the same time Russia is cheap and hated once again. The Russian stock market has a P/E just above 5 and a dividend yield above 5%. A couple of years ago I saw it as a market with crisis level pricing but no actual crisis. It was a stand-out bargain in a world of overpriced assets.

Then the Ukraine crisis came along earlier this year. It was brought on by a coup d’etat blessed (and maybe even supported) by the US and EU. Russia reacted to protect its interests against what it saw as yet another attempt to put NATO military bases closer to its borders. Economic sanctions and counter sanctions followed.

The Russian currency sold off, as did Russian stocks and bonds. For a time it looked possible that Russia and NATO could end up in a full scale military confrontation.

Whilst the situation hasn’t been fully resolved, and sanctions remain in place, it has at least started to calm down. There’s a ceasefire in Ukraine between the separatists in the East of Ukraine and the new government based in Kiev, to the West. And as winter approaches in Europe, and as European voters again need Russia’s natural gas to heat their homes, Russia is regaining the upper hand at the negotiating table. Finally, let’s not forget that this was a crisis in Ukraine, and not in Russia itself.

So the question is, should we still invest in Russian stocks? I believe the answer is a firm “yes”, given that the low prices take account of a huge amount of risk. We should certainly expect some negative events, and the Russian economy is going through a period of lower growth. And Russian stocks should only be part of a diversified overall investment strategy.

But it pays to remind ourselves of some of the basic fundamentals. Unlike the late 1990s, today the Russian state has extremely strong finances. Government debt is around just 10% of GDP, which is one of the lowest levels in the world. This is because the Russian government usually has a budget surplus, meaning they spend less than they take in taxes. Most developed countries have government debts over 100% of GDP, and some way above that level, because they usually run huge budget deficits.

So, even if Russia has to run a budget deficit for a few years, its debt is currently so low today that it has massive room to borrow without risking a new default. Due to sanctions it may not be able to borrow in Western markets, or in US dollars, for the time being. But I wouldn’t be surprised to see China, which is Russia’s new best friend, supplying financing if needed.

This low level of debt and high level of reserves is a far cry from the situation in the late 1990s. Russian finances are strong.

Russia also has foreign exchange reserves equivalent to US$465 billion, which is the fifth largest level in the world. This low level of debt and high level of reserves is a far cry from the situation in the late 1990s. Russian finances are strong.

It seems likely that we’ll see more bad news and surprises in coming months. After all, this is about geopolitics. But the longer term picture will be one of growing corporate earnings and a P/E ratio that’s likely to rise to a more reasonable level over time (say 10). And patient investors will also be collecting a 5% dividend yield while they wait for the capital gains. That’s not to be sniffed at in a low yield world.

Russian stocks are just as hated today as they were in late 1998, but the fundamentals of the country are much more sound. The Ukraine crisis will pass into memory and sanctions will probably be lifted in due course.

On the other hand, US stocks are once again expensive, if not as extreme as they were in the late 1990s. It’s my bet, fellow OfWealthers, that 5, 10 or 15 years from now investors in Russian stocks will be laughing all the way to the bank. Once again.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.