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From Russia, A Little Love for Income Investors

Nothing like a little mayhem and political posturing to generate a bit of value.

I refer to the turmoil stirred up in Russia’s capital markets by that country’s government’s willingness to annex the Ukraine peninsula of Crimea. Russia’s government wants Crimea, and it appears a good many Crimeans want Russia.

According to Crimea’s election chief, nearly 96% of Crimean voters favor jettisoning Ukraine and joining Russia. Russian President Vladimir Putin, wasted no time in exploiting Crimean affections. Immediately following the vote, Putin signed a decree recognizing Crimea as a sovereign state, thus paving the way for it to be absorbed by Russia.

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The referendum, the Russian decree, the U.S. government’s saber-rattling response to both, and general unrest in Ukraine have lead to an investor exodus from Russian stocks. The Dow Jones Russia Total Stock Market Index has lost 18% of its value year to date, with much of the depreciation realized in the past two months.

This is all good news for new income investors. I see value in Russian stocks that I see in few other equity markets.  Russian energy companies, in particular, are now formidable players on the world stage. Events in the past two months have changed nothing.

Nevertheless, most investors are nervous, hence the sell off. I, on the other hand, am curious. My curiosity having been elevated by the lackadaisical reporting on the U.S.-Russia imbroglio. I don’t know if it’s laziness or ineptitude, but rarely do journalists delve into sanction details.

Here’s the abridged version: The U.S. government sanctioned 11 Russian and Ukraine officials.  In short, U.S. companies with a Russia or Ukraine presence are generally prohibited from interacting with businesses that involve or are related to those sanctioned.

I understand that corporatism and political rent seeking run rampant in Russia, so these 11 officials could carry significant influence, but the sanctions are really little more than a wrist slap. A few U.S. companies might be inconvenienced, but there are many European companies willing to pick up the slack.

Of course, it could get worse, and that’s the concern weighing on Russian stocks.  The International Monetary Fund (IMF) is sufficiently nervous – the default position for most bureaucratic institutions – having downgraded Russia’s GDP growth to 1.3% from an already anemic 2%. The IMF stresses that possible ancillary events – expanded U.S. sanctions against Russia – are leading considerations in the downgrade.

I’m not terribly concerned about ancillary events, so I doubt the current situation will worsen. And if it does, not only will Russia suffer, so will U.S. and European equity markets.  Don’t underestimate how interconnected the world is these days. If dominoes fall in Russia, they’ll fall here too.

I try not to underestimate political hubris and stupidity, but even the most dimwitted U.S. political operative must be aware that most Americans frown upon escalating hostilities with Russia. What’s more, our European allies frown even harder. Russia is one of Europe’s top gas suppliers and for some countries, their main source. Russia meets roughly one sixth of Europe’s energy needs.

Therefore, I see little downside and considerable upside to Russian stocks.

To tap the upside potential, income investors should consider Market Vector Russia ETF Trust (NYSE: RSX). The fund invests in the largest Russian companies, including Gazprom, Sberbank, and Lukoil.  It owns 49 of them, many of which are difficult to access for U.S.-domiciled investors.

The RSX is down roughly 19% year to date, which has raised its yield to 3.2%. As the RSX is presently priced, income investors can pick up above-average profit in an investment with above-average price-appreciation potential.

Russia receives little love from the U.S. political class these days, but that doesn’t mean the U.S. investing class shouldn’t give its stock market a little love.

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