Russia, After the Bubble

This is a business obsessed with signs and indicators. Some are free for the taking, such as selling a retailer after it opens a store on Fifth Avenue or selling any firm that buys the naming rights to a sports stadium. Another good one is that any investment idea worthy of an acronym will turn into a bubble and will burst accordingly.

The problem with all investment bubbles, of course, is you should ride each and every one beyond the point of reason, and you should never, ever try to pick the top or bottom. Markets move further and faster than we ever think possible -- consider the course of crude oil prices over the past 16 months -- and campaigning on the side of rampant ignorance is the way to go. Investors made serious money in the dot-com bubble and more recently in the commodity bubble; the trick is getting out after the turn and not worrying about selling the absolute top.

Take the BRIC fantasy, please. This combined both an investing bubble and another one of those telltale signs Zeus is warming up in the bullpen and soon will be ready to come in hurling thunderbolts -- a catchy acronym. The only commonality among Brazil, Russia, India and China was their inclusion in this quartet, but why let that stop you? The total return on the Dow Jones BRIC 50 index between January 2006 and May 2008 was more than 150%; too bad the total return since has been -61%.

From Russia With Love

As is so often the case with things Russian, we have a troika to deal with -- the Russian stock market, the ruble, and the source of so much of the country's export wealth, crude oil. We also have a complicating factor, Russia's economic intimacy with the eurozone to its west. While much of the country's exports are priced in dollars, much of the country's imports come not from dollar-bloc countries but rather from euro-bloc countries.

The Ruble/Dollar Rate and Crude Oil Howard Simons; raw data from Bloomberg

We have to shift back and forth in discussing the ruble between the ruble-dollar rate and the ruble-euro rate. A very strong argument can be made the latter is the more important of the two exchange rates, but we will not delve into that here.

What we can say with great certainty is the ruble-dollar rate started to match the price of Russia's benchmark Urals Blend crude oil exported to the refining centers of northwest Europe after the Federal Reserve's first declaration of war on deflation in May 2003, marked with a green line in the chart; the central bank has since declared war on inflation at least once and on deflation a second time, but that is a topic for another day.

---

Russian Equity Relative Performance Is a Function of Crude Oil Howard Simons; raw data from Bloomberg

What about the connection between this crude oil's price and the relative performance between the MSCI Russia and eurozone indices measured in U.S. dollars? That turns out to be a logarithmic one; as the price of crude oil rose in 1999 and 2000, the relative performance of Russian equities really accelerated; by the time crude oil hit its bubble phase, the relationship turned more linear.

The current data point is at an interesting juncture; it indicates any further downside in crude oil prices will be met with a relative collapse of Russian stocks relative to their eurozone counterparts. The opposite is true as well; a rebound in crude oil prices should lead to Russian stocks outperforming eurozone stocks.

---

Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.