“I’ve always acted alone. Americans like that immensely.” – Henry Kissinger
Have you seen Henry Kissinger lately? At 92, he’s as fluent as ever on foreign affairs. It makes you wonder whether, even at this advanced stage of life, he could do a better job managing American foreign policy than our current leaders.
This brings me to Ukraine, Russia, and China. They look like a beautiful mess right now – but within a reasonable period, American foreign policy will gravitate back to a Kissinger dictum: America can only afford one big power adversary at a time.
At this time, the one adversary is clearly China. In short, the whole Ukraine-Crimea-Russia fiasco could’ve and should’ve been avoided.
Unfortunately, Ukraine is a prisoner of geography and history. It’s a bridge between East and West – a classic buffer state. The country will always need to balance closer ties to Europe with good relations with Russia, and this practical consideration should be reflected in American diplomacy. Pushing Russia closer to China is certainly not in American interests.
Lord Palmerston once said, “Nations have no permanent friends or allies – they only have permanent interests.” Thus, the probability is on the side of U.S.-Russia relations improving in the long run. The stakes are simply too large and the logic of some sort of rapprochement too clear and convincing.
In fact, while headlines have created a perception of a crisis in U.S.-Russia relations, the reality is that diplomats on both sides are working hard on “alliance management.” As an emerging bond trader active in Russia put it to me, “A lot of this is elaborate political theatre.”
Russia Is Dirt Cheap and Unloved
I believe that the gap between perception and reality is where fortunes are made, and Russia is the perfect example.
Despite the country’s reputation as being a non-competitive, monopolistic economy, there were over 21,300 foreign capital enterprises operating in Russia by the end of the second quarter. And American companies invested $1.18 billion in Russia in 2014, nearly double the $667.2 million recorded in 2013.
What’s more, Russia’s stock market is trading at astoundingly cheap valuation multiples right now. We know the reasons: economic sanctions imposed by Western democracies, falling energy prices, and, finally, the falling ruble, which is down sharply against the dollar this year.
The stocks in the Market Vectors Russia ETF (RSX) are trading at an 80% discount to the S&P 500 Index and at less than 65% of break-up value.
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Howard Marks of Oaktree Capital puts price and value at the center of his book, The Most Important Thing:
For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price.
And there are few assets so bad that they can’t be a good investment when bought cheap enough.
Plus, we don’t need a miracle to profit from the situation, either. An American hedge fund trader active in Russian markets put it to me this way: “Things don’t have to turn around in Russia for me to make money. They just have to get a little bit better.”
This is the key. If energy prices stabilize or rise, if the situation in Ukraine improves, if the ruble bounces back – any one of these catalysts could spark a sharp rally.
RSX is down 32% over the past year and has pulled back 16% from its recent peak in mid-May. So it’s a good time to get ready to pull the trigger on one of the largest oil and gas companies in the world, Lukoil (LUKOY).
Lukoil exceeds even Exxon Mobil (XOM) in total proven oil reserves. Even more impressive, the company has remained free cash flow positive during the entire past decade. The company also has a very low risk of government intervention, with a professional board and management at the helm.
Despite this, Lukoil is trading at 37% of break-up value and 4.4 times trailing earnings. Right now, I’d nibble on a position and take a more sizable stake when a clear uptrend develops in the stock.
Like Kissinger, don’t fear acting alone. Investing in undervalued – even hated – stocks when they turn is the most consistent way to build substantial wealth.