In early July, when police swooped down on Yukos, Russia's leading oil company, and arrested one of its major shareholders on fraud charges, theories abounded about what was really behind the arrest. But everyone agreed on one thing: The scandal had sent a disastrous signal to foreign investors, and the only question was how far Russian stocks would plummet. And plummet they did. Russia's benchmark Russian Trading System (RTS) index fell from 518 on July 2, the day of the arrest, to 428 by July 17.
But just take a look at the RTS index now. Less than two months later, the Russian equity index has not only recovered from the Yukos affair, reaching 538 on Sept. 10, but it is within striking distance of its record high, 572. That peak dates back to October, 1997, before the financial crisis of 1998. "It's incredible. There's just great enthusiasm for Russian assets at the moment, and people seem very willing to ignore the risks," says Roland Nash, chief strategist at Renaissance Capital in Moscow.
Investors, it seems, just don't believe the bloodcurdling predictions that were commonplace in July. Back then, the big fear was that the Yukos arrest signaled the possible rollback of controversial 1990s privatizations, which could undermine the very foundations of private property in Russia. But now, no one seems to care much about the arrested and imprisoned Yukos shareholder, Platon Lebedev. The investigation turned out not to be "a real threat to private property, which is what people were really scared of," says Mattias Westman, managing director of Prosperity Capital Management Ltd., a major equity investor based in Moscow.
It helped that the Kremlin eventually showed signs it was keen to minimize its interference in Russian business. In August, Russia's antimonopoly commission approved a merger between Yukos and Sibneft, another leading Russian oil company. Share buybacks and dividend payments associated with the deal have totaled $7.75 billion -- a huge boost not just to investor sentiment, but also to the funds available for reinvestment in the market. Little wonder investors seem so willing to forgive and forget. Another issue: Investors earlier this year snapped up bonds so fast that prices soared, forcing yields down. Now the hunt for high returns has shifted to Russian stocks.
But not everyone shares the optimism. Normally bullish local investment analysts seem increasingly baffled by the market's unstoppable upward run. "What's happening at the moment is ridiculous," says James Fenkner, chief strategist at Troika Dialog in Moscow, who has been working in Russian markets since 1995. He calculates that Russian equities are already about 20% overvalued -- yet they continue to shoot upward. He worries that the market is being driven less by company fundamentals and more by a huge and unstable inflow of funds, largely oil company profits invested in the market by local banks.
Other new money is coming from outside oil and gas funds. Their growing interest in Russia is driven largely by negative developments in other oil markets such as Nigeria and Venezuela, which make Russia's recent problems look mild. For global investors, there are solid reasons to invest in Russia. "If you don't have that context, you're missing a very important part of what is happening," says Paul Collison, oil and gas analyst at Brunswick UBS in Moscow.
There are other reasons for revaluing Russian stocks upward. Corporate governance scandals increasingly are becoming a thing of the past. Growth in gross domestic product is heading for 6% this year, helped by reforms and restructuring, as well as high oil prices.
But investors seem to be turning a blind eye to Russia's political risks. The rally coincides with the runup to parliamentary elections in December and presidential elections in March. Elections often spell political uncertainty, so markets typically rally after an election, once the outcome is known, rather than before. Sure, the results of these elections may not be much in doubt -- President Vladimir V. Putin looks like a shoo-in for reelection. But the Yukos case showed how unpredictable Putin can be. Investors are treating the Yukos affair as a dimly remembered bad dream. But it's one that could come back to haunt them.
By Jason Bush in Moscow