How Worried Should Investors Be About Their Exposure to Russian Stocks?

In this podcast, Motley Fool analyst Bill Mann talks about:

• Russia's stock market.
• The potential for Russia to default on its debt.
• The one thing every U.S. investor should do if they have exposure to Russian stocks.
• Chinese stocks suddenly rebounding on comments from the government.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 17, 2022.

Chris Hill: We've got a recommended course of action for anyone with exposure to the Russian stock market, and we've got a few thoughts on the latest turn of investing-related events in China. Motley Fool Money starts now. [MUSIC]. I'm Chris Hill, joined by Motley Fool Senior Analyst, Bill Mann. Happy St. Patrick's Day.

Bill Mann: Thank you, Chris. Can I just say from the outset that rage against the machine was not specific about the type of machine they were so angry at? But I'm pretty sure it was a printer. That's what my day has been.

Chris Hill: I know I can identify with that and I think some of the dozens of listeners can identify with raging against.

Bill Mann: I was trying to print one page and I ended up printing 64 without noticing. I need to finance my new set of ink. In the great scheme of things not that big of a deal, but it's my cross to bear at the moment.

Chris Hill: Well, let's get to a much bigger deal and talk about Russia's economy. We'll start with the stock market because Russia stock market was supposed to open this week and best I can tell did not. We will get to the overall economy and the potential for Russia defaulting on instead in a little bit, but let's talk stocks first. What happened with the stock market and then where are we now?

Bill Mann: The Russian Central Bank close their stock market once Western sanctions were placed on Russia. You don't want to give them too much credit. It was probably the right thing to do. Then on Saturday, they decided, we're not going to open up the market just yet. They decided to keep the market closed for another week. Now, it's important to note that this wasn't an exchange decision. This was made by the Central Bank, which is not really the type of meddling that you would see in the US, for example. The Federal Reserve does not have much power to tell the New York Stock Exchange or the Nasdaq, "Hey, hit the showers, take a day off, we'll see you tomorrow." Those types of things are done on much more independent basis. But Russia is, in a lot of ways, a centrally managed economy.

Chris Hill: I don't own any Russian stocks directly, I'm guessing a good number of people listening don't either. Although it is possible, probably more possible that people might own through global funds that they own or ETFs. How worried should investors be about their exposure to Russian stocks right now?

Bill Mann: I think at this point there's no real reason to worry because the damage has been done. Why worry now? It's finished. I actually have the pleasure said in air-quotes of owning two Russian stocks individually and that's not been a whole lot of fun. I think that what ultimately will happen, there's a lot of talk about having the Russian stocks removed from the emerging and developing market indices. That'll be painful because these indices and the funds that track them will do that all at once. Now, as a veteran value investor, I love the thought of going in and finding companies in areas that everybody else is selling. I don't think this is one of those situations. I think that Russia is in for a world of hurt for a very long time. It will be a long time before Russia is treated as a country in the normal sense as far as the financial markets go. This is not an area to wade into. Eventually the Russian stock market will open back up, and I'm seeing now a lot of funds do something called fair valuing. For companies like Yandex, which last traded 18 bucks in the US, it's being fair valued at somewhere about eight dollars by these funds. That feels about right to me.

Chris Hill: There's a lot of talk now of the potential for Russian assets being frozen.

Bill Mann: All of them? What's left?

Chris Hill: What is the ripple effect from that? Because we've been talking about the Russian stock market, and look, if you're an investor in Russia, the world of hurt that you referred to is hitting your investment account in very real ways that could last for a long time. In terms of ripple effects for other countries, what, if any exist in terms of Russian assets being frozen?

Bill Mann: Well, I think that obviously, when you talk about Russian assets being frozen, they are frozen somewhere. For example, the United Kingdom has been a prime repository for assets that have left Russia. The UK banking system has a huge amount of Russian assets. You also look at countries like China. If you look back over the last couple of weeks, one thing that has happened is that raw material and commodity prices have spiked. Not just oil and gas, but also things like nickel, but also the US dollar has spiked against almost every other currency in the world. That is really troubling for countries, again, like China that are effectively short those commodities. When you freeze a market like Russia's, you are not only creating pressure on Russia, you're creating pressure on anybody who has exposure to them. We've seen it in the nickel market, we've seen it in the oil and gas market, I think we're going to see it in other places too.

Chris Hill: It's a great point because I think that for a lot of people watching the military situation play out in Ukraine. It is natural to want that to end as peacefully and as quickly as possible. I understand the thinking behind we need to punish Russia, let's issue some sanctions, let's do what we can. But at some point, it's not just punishing Russian billionaires, it hits on the business level that as you said, there are raw materials coming out of Russia, there are a lot of businesses, including businesses in the United States of America that they rely on.

Bill Mann: Yeah, exactly. Obviously, there's been a lot of pressure that's put on the Russian oligarchs. It's a very attractive way to go after the power structure of Russia. I don't know how effective that actually is because of the way that Vladimir Putin has allowed them to retain their wealth by specifically staying out of the political game. At some point, and I know this isn't an attractive thing to say, an off-ramp might be something that is going to help the situation for everyone going down the road, as opposed to some form of mutually assured financial destruction.

Chris Hill: The last time Russia defaulted on their debt, I believe was 1998. While it did not cause worldwide financial panic, it did send some ripples through other markets. If I'm reading stuff correctly and I like to think that I am, there is a 30-day grace period that kicks in. If they can't make the payment on their debt, they have till mid April to make good on that. Assuming that is the case and the grace period kicks in, then I guess the clock starts ticking until maybe April 15th. But I guess my question is, as an investor, how worried are you about Russia defaulting on their debt?

Bill Mann: Actually, a better allegory to think about Russian debt default in this case, is actually 1917 and 1998.

Chris Hill: I wasn't around in 1917.

Bill Mann: Nor was I, so let's just all put a pin in the fact that this is received wisdom. In 1998, Russia defaulted on its domestic, it's ruble denominated debt. In this case, we're talking about a $150 billion and I think 117 million in dollar denominated debt. That's what they have to pay and they have to pay it with an absolutely defenestrated ruble at this point. The question is not just can they pay, but what are they going to pay with? Because they can't pay in rubles, they are supposed to pay in dollars. That's the big question. Now about 80 percent of this debt is also held by Russians, so once again, there's your pain threshold. But 20 percent of it is held by pension funds, it's held by banks, it's held as collateral, it's held on their balance sheet. There are banks in Austria, for example, and banks in the UK that have some are really uncomfortable exposure, and are really hoping to see those payments come through because nobody wants to see that clock start ticking.

Chris Hill: Realistically, and to the extent that there is a relatively simple explanation for this. What needs to happen between now and mid-April for the ruble to rebound, for Russia to be able to finance this debt in a way that makes, maybe, not everybody happy, but satisfied enough.

Bill Mann: Well, since we're talking about debt instruments, the people who own the debt have to be made happy. This isn't a compromised situation. You have either satisfied your debt or you are in breach. It is as simple as that. A lot of your question now is a little bit above our pay grades because I don't know what's going to happen from here. But essentially, these debts have to be paid in full, under the terms under which the debt was underwritten. Or Russia and a bunch of Russian companies are going to be in default, and as they say, those will be interesting times.

Chris Hill: Before we move on, what are you watching now? Other than an end to the conflict in Ukraine, from an economic standpoint, what are you watching to give you a sense of where the story goes next?

Bill Mann: You know what? I think it's really it. How is the conflict going? Because when you're talking about, where does the pressure on Vladimir Putin come from? It's from the conflict because the other power or center in Russia is the military. They, if the news is to be believed, are having their heads handed to them. Ultimately, it comes down to that. It comes down to the negotiations which we see pop up from time-to-time, but ultimately that's it. How's it going there? Because that's the big pressure. That's the big gamble that he has taken. That's going to be the ultimate arbiter of how quickly and under what conditions the world moves onto its next phase.

Chris Hill: Before I let you go I want to circle back to the conversation we had on Tuesday because we talked about Chinese stocks in the US, Alibaba, Tencent, JD.com, Baidu, which at that point were all down 25 percent at least in the matter of just a few days, for a very valid reasons. The SEC was threatening to delist some stocks. Wall Street firms were downgrading pretty much every Chinese stock out there. You'd made the comment at the time that, the Chinese government was basically OK with this because they prefer their companies to list in Shanghai and Hong Kong. I'm wondering if regulators in the United States and China were actually listening to our episode on Tuesday because in the last 36 hours those stocks have bounced back up on the news reports that the US and Chinese regulators are working on a plan to cooperate. China says it will support Chinese companies having IPOs abroad. We've seen the stocks that I mentioned before bounce back up. I'm wondering what you make of, in particular, the comments that have been made public from, I think, it's the Vice Premier in China.

Bill Mann: I want to take a little bit of a step back because I want to put some frame around what we're talking about here. Because yes, that was pretty spectacular timing for us to have that conversation about Russia being a manipulated market and one that was dominated by the interests of the state. For the state interests, only a few hours later for them to say, well yeah, we're going to do more than you thought we were going to do. That still means that the market is manipulated. It was just manipulated in a little bit of a different way. Then it had been over the previous, I don't know, call it 18 months. In the last seven years, the US stock market, as measured by the Nasdaq, is up by a 177 percent. Chris Hill, how much is the Chinese stock market up over the last seven years?

Chris Hill: I am going to take the under.

Bill Mann: Minus 3 percent.

Chris Hill: Well, I was just thinking under 177 percent.

Bill Mann: Minus 3 percent cumulative. You can annualize that, but it comes out to be your money has sat absolutely positively. All you've had is opportunity cost go out the door. I think that those things that keep in mind is that, when they're talking about delisting Chinese stocks in the US market. It doesn't necessarily mean, and it does not mean at all, that they're going to be delisted, and you don't own anything anymore. It just means that they're going to be much more difficult to trade. Certain brokers in the US have access to the Hong Kong market, which is the most likely location they would go. I think that the Chinese government was pretty smart to come out and say, look, it's not going to be as bad as all this. But for Americans who do not have access to a market that trades in Hong Kong, that does not mean that they are not going to end up having some difficulty trading the stocks. The tension that we talked about the other day, the fact that the Chinese law does not allow its auditors to be accountable to outside, to foreign regulators. That hasn't changed. Until that changes, I would say that at best, there is a yellow light over all of the Chinese ADRs that are listed in the United States.

Chris Hill: For people who have either directly in the stock itself or through a mutual fund or ETF, is this one of those situations where you want to contact whichever brokerage you have your money with and say, hey, let me run a scenario bio. Let's just say this happens. What are my options? It seems like one of those good times.

Bill Mann: I absolutely would, and I would say that the brokers that, in my experience, are most prepared to handle this are Fidelity, Schwab, and Interactive Brokers. If it's a mutual fund you're talking about, don't worry at all. The mutual funds have plenty of ability to trade overseas. If you weren't with one of those brokers, it is in fact a worth to call. You're just scenario planning with them. I wish that we could give an omnibus answer here. We can't because every broker has a little bit of a different access, a little bit of different rules. I would say, call them up, ask for the international desk and just ask, what is going to happen if the Chinese ADRs are delisted with my funds in this brokerage and get an answer for them. I think that's good advice, great idea that you came up with.

Chris Hill: You and I were chatting earlier. I mentioned, among other things, I think it's always helpful for and particularly US investors to remember, the speed with which the Chinese government moves is much faster than the speed with which the United States government moves. The SEC regulations that I referred to earlier, that was something that took years to enact into law. That took, I believe, another 18 months of the SEC working with these companies before they finally got to the point where they said, hey, it's official warning time as opposed to the Chinese government. In a single statement says, well OK, we'll just make this work?

Bill Mann: I have a friend who is an old Chinese hand, and has lived in China for four decades now. I asked him one time, what was the thing that he still did not understand about China. He said, it is still completely opaque how decisions get made at almost every level. But here's what's true about China. They go through the process every five years of building a five-year plan, and it's around a central conflict. There is a whole lot of discussion about what that struggle is. But once that struggle is identified, then the decisions that come after it seem to be made very quickly. They are either in support of that central struggle, or they are in a little bit of conflict with the central struggle. Once you've got that position defined, decisions that come after that can be made pretty quickly. It is also, I guess you could say, nice not to have to ask anybody else what their opinion is about the topic. Maybe I'm glorifying an autocratic system a little too much, but it is the case. News flash. Bill Mann hates democracy. No. [LAUGHTER] But certainly, if you don't have to ask the populace what their opinion is, decisions can be made much faster.

Chris Hill: I really appreciate you take us through all this. Thanks for being here.

Bill Mann: Thanks, Chris.

Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.