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Is It Time to Flee Russian ETFs?

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On March 16, 2014, Russia finally clinched Crimea’s support as over 96% of the Crimean population voted to be a part of Russia. The referendum was the result of the more than four-month-long unrest between Russia and Ukraine.  

Historically, Crimea was a part of Russia and went to Ukraine only in the 1950s. The region houses Russia's Black Sea fleet and its chief port is on lease to Russia. Putin suspected that the newly established interim government in Ukraine will cancel the Russian Navy's lease leading to the referendum.

However, this win came at the cost of fierce criticism from the western world. Needless to say that the powers that be in the west did not see Russia’s move so nicely. Both the U.S. and Europe have accused Russia of violating international law as well as sovereignty on the Crimea issue, and viewed this referendum as illegal. A sort of cold war has been doing the rounds since then. As soon as Russia won the Crimean vote, the European Union enforced travel bans and asset freezes against 21 officials from Russia.

Heated Geo-Political Scenario

That’s not the end of the story. Making some analysts’ apprehensions come true, the restrictions imposed by the west on Russia are becoming harsher by the day. The Obama government extended prohibitions against Russia on Thursday in an effort to stabilize the Ukraine situation and prevent Russia from further sortie into Ukraine. The latest escalation in sanctions includes the boycott of a bank and the shunning of several prosperous businessmen sharing good terms with the President Vladimir V. Putin.
European leaders also decided to extend the list of Russian officials subject to face EU travel bans and asset freezes but at the current level refrained to take more weighty measures. As per German Chancellor Angela Merkel a question of financial sanctions – referred to as phase three of its response by the EU - would be brought up at the upcoming summit, but no such treaty is expected as yet.

A section of analysts believe that it is unlikely for Moscow to pay heed to half of the western’s world’s annoyance until and unless some solid financials and trade bans are imposed on Russia. Ironically, some say, the current still-unstable financial scenario in Europe is hindering it to impose stricter dictums against Russia (read: How Russia ETFs Have Performed in the Ukraine Crisis).

Actually, Russia is a commodity rich nation with plenty of oil and coal reserves. For that matter, Europe is highly dependent on Russia for energy, importing about 40% of its energy requirement. Thus, at this current economic juncture it is a little difficult for Europe to enforce a commodity export ban on Russia though such a possibility cannot be entirely ruled out.

The EU made it very clear that it will not think twice before implementing ‘phase-three measures’ if the situation keeps deteriorating. In fact, many feared the outbreak of some sort of ‘third world war’ if Russia keeps intervening into Ukraine. The EU has already lent a supportive financial hand to Ukraine to strengthen its economic position and assimilate more closely with core Europe.

European leaders are diligently planning to broaden their horizons of energy supplies, considering more wind and solar power options, shale-gas exploration and imports of liquefied natural gas from the United States and the Middle East.  Britain passed a paper to EU member states prior to the summit proposing that Iraq could be a possible solution for long-term source of oil and gas supplies (read: 3 Energy ETFs to Buy on the Ukraine Crisis).

S&P and Fitch Downgrade

Though the Russian stock market surged immediately after the Crimea win, the lurking fear of a stricter veto against Russia soon pushed down Russian stocks. The Russian stock market has slumped about 10% this month, gushing out billions in market capitalization. Economists have curtailed growth forecasts to as low as zero this year. Investors should note that Russia’s growth fell to 1.3% this year, the slowest pace since a contraction in 2009, as per Bloomberg.

Foreign investors have been withdrawing money from Russian banks. Thanks to the unsavory Crimean win and its consequent backlash, the Standard & Poor's ratings agency on Thursday slashed its outlook on Russia from stable to negative. The S&P attributed “material and unanticipated economic and financial consequences” from such sanctions for this reduced outlook (read: 3 Emerging Market ETFs Off to a Great Start in 2014).

On Friday, Fitch Ratings also cut irs outlook on Russia debt rating to negative from stable.

Market and ETF Impact

The escalation in western prohibitions led the biggest Russian ETF Market Vectors Russia ETF (RSX) to fall more than 3.5% on March 18 and 2.60% the day after.  Another Russian ETF based on small-cap stocks, Market Vectors Russia Small-Cap ETF (RSXJ), slipped 2.12% on March 18. iShares MSCI Russia Capped Index (ERUS) lost 2.74% at the close of March 18.

Bottom Line

We believe that any further foray by Russia into Ukraine will likely instigate more severe western action, which can hurt Russia’s all-important energy sector. As per the Obama government, though these actions might disturb the global economy, it is essential to stop the movement of the Russian military near eastern and southern Ukraine.

Given the mounting geo-political tensions it is prudent to stay away from Russian ETFs. The latest S&P downgrade will likely add to Russian woes in the coming days. As it is, we have a Zacks ETF Rank of #5 (Strong Sell) for all the three above-mentioned funds (read: Are Russia ETFs Signaling More Trouble Ahead?).

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