What Trump Means For Russia ETFs

Russian stocks jumped almost 1% on Thursday of last week after news broke that the U.S. Treasury Department had tweaked some of the sanctions on the Russian intelligence agency―the Federal Security Service (FSB).

According to a statement released on its website, the Treasury Department now "authorizes certain transactions with the Federal Security Service (aka FSB) that are necessary and ordinarily incident to requesting certain licenses and authorizations for the importation, distribution, or use of certain information technology products in the Russian Federation."

The news was immediately latched on to by some investors, who speculated this could be the Trump administration's first step in easing sanctions on Russia. But experts said that was not the case, and that Trump had nothing to do with it at all.

"Our understanding is that this is not the start of sanctions easing," Ian Bremmer, political scientist and president of consulting firm Eurasia Group, told CNBC. "It's a rule change clearing up a problem with the sanctions regime that prevented U.S. exporters of nonsanctioned electronic devices from complying with both U.S. and Russian law. The problem was identified by the Obama administration, and this appears to be the response to address it."

Sanctions Relief Possible, But Faces Resistance

While last week's "technical fix" (as Sen. John McCain called it) may not have been the start of sanctions easing for Russia, many still expect that President Trump may eventually reduce or completely lift the penalties, which were imposed by his predecessor, President Obama, in response to Russia's annexation of Crimea in 2014.

Trump has consistently expressed his desire for warmer relations with Russia and his admiration for Russian President Vladimir Putin. In response to a question about whether lifting sanctions was on the table, Trump senior adviser Kellyanne Conway told Fox News on Friday that “all of that is under consideration.”

Standing in the way of any potential easing of penalties is Congress, including much of Trump's own party.

“I’m against lifting any sanctions on the Russians. These sanctions were imposed because of their behavior in Crimea, eastern Ukraine and now we know they’ve been messing around in our elections as well,” Senate Majority Leader Mitch McConnell told Politico. “If there’s any country in the world that doesn’t deserve sanctions relief, it’s Russia.”

If Trump attempts to lifts the sanctions―which were put in place by executive order―Congress could reimpose them through legislation. Republicans in Congress say that the sanctions on Russia should only be removed once the country stops meddling in Ukraine.

“The only reason we should ever lift sanctions on Putin is if he meets conditions of sanctions [and] ends violations of Ukraine sovereignty,” tweeted Sen. Marco Rubio.

Potential Bullish Catalyst For ETFs

With so much resistance, it's unlikely that the U.S. president will provide sanctions relief to Russia in the short term. Trump had his first presidential phone call with Putin last weekend, but according to reports, the sanctions weren't brought up in conversation. Indeed, Trump himself said last week that it's "very early to be talking about that."

Nevertheless, sanctions relief is a potential bullish catalyst that investors in Russian stocks and ETFs will keep a close eye on as U.S.-Russia relations evolve under the new administration. According to a Bloomberg poll of economists, there is a 60% chance that the U.S. will begin easing sanctions on Russia in the next 12 months, up from a 10% chance before the November U.S. elections.

Any sign that the economic penalties on Russia could be reduced may light a fire under funds such as the VanEck Vectors Russia ETF (RSX), the largest Russia ETF, with $2.9 billion in assets. The only three other nonleveraged Russia exchange-traded funds on the market―the iShares MSCI Russia Capped ETF (ERUS), the VanEck Vectors Russia Small-Cap ETF (RSXJ) and the SPDR S&P Russia ETF (RBL)―are sure to benefit also.

These ETFs have already rallied substantially in the past year on the back of the rebound in crude oil, a key driver of Russia's economy. A recovery in the Russian ruble and a good year for the broader emerging market equity space have also supported the funds. Returns for the four ETFs ranged from 58% to 143% in the 12 months ending Feb. 6.

1-Year Return For RSX, ERUS, RSXJ, RBL

Growth After Two Years Of Contraction

Sanctions relief would provide a boost for the Russian economy, and, by extension, Russian stocks and ETFs, because it would "free up imports of Western technologies that Russia would need, and it would free up the ability for Russian banks to tap into European and American financial markets," said Kendrick White of Marchmont Capital Partners in an interview with Russia Direct.

"This is critical, because Russia suffers from a lack of global liquidity for its banks and large corporations. Being able to access international financial markets is the single most important thing that Russia needs right now," he added.

Even without sanctions relief, the Russian economy is expected to return to growth this year after two years of contraction. According to the World Bank, GDP fell by 0.6% last year, and by 3.7% in 2015 due to the combination of plunging energy prices and sanctions. This year, the country may register growth of 1.5%.

Plenty Of Challenges For Russia's Economy

But while the outlook for Russia has brightened, with the potential for more upside to come, investors shouldn't necessarily get carried away with enthusiasm. In a recent report, the World Bank cautioned that the Russian economy remains highly sensitive to oil prices.

"All else being equal, a 15% increase [decrease] in oil prices changes our 2017 growth forecast of 1.5% to 2.1 % [0.7%], underscoring the sensitivity of the economy to fluctuations in commodity prices," it said.

"To its credit, over recent years, Russia has accomplished many positive changes across multiple areas of business regulation, helping improve its investment climate. These are necessary, though not sufficient—despite the substantial changes in the role of the state in recent decades, the ownership of productive assets has become even more concentrated, reducing competition and impairing corporate governance. There are also complex socioeconomic issues of an aging society. Addressing such issues is ultimately what will help turn the tide [for the Russian economy]," concluded the report.

At the time of writing, the author did not own any of the securities mentioned. Contact Sumit Roy at [email protected].