The Rich Kid on the BRIC Block

03/11/2010 12:01 am EST


John Connor

Founder and Portfolio Manager (retired), Third Millennium Russia Fund

John Connor, manager of the Third Millennium Russia Fund, sees further up side from strong global growth, despite concerns about Kremlin meddling.

Q.  Do you still believe in a cyclical recovery worldwide?

A. I look real close at China, and I don't see a bubble. China is replacing dirty generating plants and steel plants, and that's been good for Russian exports. They're producing 15% to 25% a year more of rolled steel and flat steel for automobiles. They're going to be building more highways than we have in the interstate system. And then, of course, the steel for high rises. So China's really a great market for Russia, and then there's the rest of South and East Asia, and Latin America, for that matter. So, I think it's looking very strong for Russian exports.

Q. How is Russia doing right now and what's the outlook for the economy and the stock market?

A. Let's start with the pluses. The BRIC countries (Brazil, Russia, India, and China—Editor) are half the market capitalization in the emerging world, and among the BRIC countries, Russia has the highest per-capita income. About 25% [of the population] is middle class, and it's moving towards 50% within a reasonable future. So, a lot of my themes are based on a burgeoning middle class and some of my best stocks are consumer stocks. The price of oil has recovered smartly, and at these prices Russia's trade balance is positive, their fiscal [balance] is probably slightly positive, and growth is probably about 4% a year. That's less than the other BRIC countries, but it's more than you're going to see here in the US. The minus is that the Russian economy is not showing the innovation and dynamism that I would like to see. Everybody looks to the top for direction: Russian kids want a good government job—that's their idea of a career plan. So, small and medium enterprises are not developing as rapidly as one would hope.

Q. The Russian economy is virtually stagnant. You have high unemployment, depressed consumer spending, and yet a stock market that's doubled over the last year. Are you concerned that Russia seems to have a lot of developed-country problems but a market that's been performing like an emerging market?

A. Our fund was up 150% over the last 12 months, but it had gone down 70% in August-September of 2008. So, if you're at 100 and you go down 70% to 30, and you go back up to 60 or 80, you're still not back to 100 yet.

Q. And you don't think the Russian economy is stalling?

A. No. It's not growing as fast as it should, but it's not stalling.

Q. Why did Russia suffer more than other markets during the crash?

A. There's not as much domestic support for the stock market as there should be. You just don't see the sort of long-term money that we see in a mature economy, like life insurance, pension funds, mutual funds. So, you get very heavy foreign participation, where the foreigners rush in and the foreigners rush out.

Q. Are you concerned about another rush for the door, if the business climate takes another turn for the worse?

A. The Russians have no sense of PR. When Prime Minister [Vladimir] Putin took a swipe at the head of Mechel Steel (NYSE: MTL) a while back or when the Russian partners in TNK-BP (Moscow: TNBP) did not act in an appropriate manner, foreigners got very nervous. They think, oh my God, it's going to be another Yukos (the Russian oil company seized in a politically motivated tax evasion case in 2004—Editor). But [the Russian oligarchs, including former Yukos chairman Mikhail Khodorkovsky,] were flouting the laws, starting with the tax laws. There's no real desire on the part of the Kremlin to take over companies and go back to the central planning days. In fact, Italy and France have more public ownership than Russia. 

Q. What do you expect from Russian stocks over the next six months or a year?

A. I would expect some nice appreciation. And the [earnings] multiple is still lower than the other BRIC countries—it's 9.4x vs. the BRIC average of 13x, and of course China is much higher than that.

Q. What sectors look good right now?

A. The consumer sector, the fertilizer and steel sectors look good. I'm feeling very good about Novatek (Moscow: NOTK) and the gas sector, and I'm feeling a little better about Gazprom (OTC: OGZPY.PK). They're beginning to look more and more like a real business. I like TNK-BP the best right now. They pay a fantastic dividend, and they've promised to do more for public shareholders. The float is very small, but if they have a [listing] in London, which I think they're going to do, that would be very useful.

Q. Thank you.

Igor Greenwald

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