Sberbank and the Russian Mentality Seen Behind Enemy Lines
February 1, 2015
Sberbank: You take out a mortgage with these cats, and they give you the tabby they just picked up off street. For luck. Seriously. This is just a variation on a theme. Banks have been giving out toasters, beach blankets, other assorted junk to customers since my old man took out a mortgage. I guess it’s a warm and fuzzy way to make people feel better about a giant load of debt that will shape their lives in all kinds of ways. That’s marketing for you. It also speaks to the broader truth that all things broadly in common have a different local color to them.
It just so happens that I am long Sberbank and accumulating. It is an almost perfect position trade: the bank is essential to the Russian financial system, the Russian state owns 50% of it, oligarchs and Putin’s capos depend on it, and it is at very low historical valuations. But what a deeply oversold dog it is. That is to say: What a bone-head I have been in timing this joint.
The investment thesis seemed simple:
There seemed a clear valuation appeal based on assets.Forget fuzzy, hard to believe stuff like book value.If energy prices rebound, cashflow will rebound.Done.
Even if Russia is little more than Europe’s gas station in economic terms, even a gas station has value add—sodas, snacks, and such.So the returns from a viable enterprise would be a derivative of oil prices when they rebound.Optionality.
Putin may be nothing more than a little chucky doll, but even a monster has to de-escalate the military invasion of Ukraine in the face of absolute economic disaster.Popular discontent would demand it.
Here’s what went wrong.
One, I expected 30-40% volatility in oil, which is notable but not rare in the Brent market. My DXY model showed a 80% inverse correlation between oil and USD. These two datum informed my entry point for Sberbank. Oil was $55/barrel.
Instead God played His jokes at the expense of my schemes. Brent imploded 50%. Oil is hovering around $50/barrel killed my valuation model. Putin has dropped the charade about a popular uprising in the “Donetsk People’s Republic” and now is clearly signaling his crematory ambitions in Ukraine. What an ugly and amazing world in which we live and breathe.
It gets even worse. The ruble has collapsed along with oil. A 50%+ currency collapse is no laughing matter. It destroys income, and this destroys the ability to service the liabilities on family and corporate balance sheets. It also turns out that apparently many up-and-coming Russians have FX loans because the interest rate was cheaper. This is absolutely deadly to a balance sheet. Putin will find it hard to finance a war this way.
Two, Sberbank is way beyond hope for a mean reversion argument to hold—too many moving parts to parameterize it. Emblematic of all economic troubles in the Cyrillic writing world, that bank is now groping about in free-fall. Instead of a mean reversion argument, you have money trying to process the new reality of an imperial Russia.
That said, there’s some reason for hope in this groping in the darkness. We have actually seen THE fundamental umbilical cord of the Russian economy break down. Russian stocks held even as oil prices continued to drop. See the relationship of Russian stocks (left hand scale) to Brent (right-hand scale).
Three, I’ve never been a huge believer in cultural differences. I take human nature as constant in the face of incentives: an informed guy in Kinshasa will take advantage of an opportunity in front of him as much as a guy in Chicago. But one of the biggest x-factors here is the Russian willingness to endure and follow a corrupt leader who has no problems sending their sons into the meat grinder and then cremate his corpse rather than ship it back home. I chalk this up to institutions—structures of power—that have coercive inertia and are tremendously hard to reform and dismantle.
The Russian mentality is a puzzle. Why would they support bald aggression even as it causes them great short-term pain and even greater long-term trouble. Why would they accept becoming an isolated pariah state in spite of having chosen to interconnect and become indebted to the global economy? It reads like a tragedy from antiquity.
There is a pattern here. Russia hyper-inflated in 1998, it defaulted on its local currency debt anyway, it suffered hyper-deflationary collapse under the weight of its former imperial self. The Mongols literally ravaged them rotten. The Great Khan literally destroyed them merely so that “his name would live forever in the wake of this desolation.” Even before this, the Vikings gave them the name “slavs”—“slaves” (there is some debate about this). The pattern is clear. Russians over and over again see the rest of the world unfolding in relative tranquility while Russians fall deeper and deeper into the dust. Must have put a Siberia-sized chip on the collective shoulder.
The person who understands the Russian mind more than any other European is the general Hermann Balck. Balck spent his life fighting Russians, behind enemy lines in WWI then a field command through WWII. He offers some hard, non-PC things, which have tremendous content if you think deeply on them. Here goes:
“The Russians, like the Chinese, are very hard to understand. In small matters I was able to predict pretty soon what the Russians were likely to do. But in major events I was never able to understand or predict what the Russians were likely to do. Nor do I think that anyone else has ever been able to do.
“They are a kind of herd animal, and if you can once create panic in some portion of the herd it spreads very quickly and leads to a major collapse. But the things that can create panic are unknowable. In other things the Russians are hard to predict, too. You may find that for a long time they are mistreating prisoners in an abominable way, and the suddenly they turn around and treat them like angels. The Russians clean out the prisons, form companies and battalions, stick a few rifles in the hands of prisoners and march them off to the attack. They take unbelievable losses. Maybe they achieve something, maybe they don’t. In either case, the Russians will say to themselves ‘Well at least we are rid of our criminals’
“The Russian is passive and slow-moving, terribly slow-moving. You have to get inside the Russian psychology. Then you come to very different conclusions, including tactical ones. You have to attack him instantly and throw him out of his position. He is no match for that.
“Some people think that that Russians are likely to collapse when surprised but that has little to do with it. You can’t get inside the Russian mentality.”
The lesson here is simple. Drop your vanilla Russian models when you position trade and build in some history as a discount factor, some local color. Human societies have differences, and a huge number of common features.
You see, in a complex adaptive system, pain always leads to work-arounds that lessen the pain. If everything depends in oil prices, and prices imply a trip to the meat locker, people find a new engine for the economy. It may take considerable time, but it will happen. If money is tight, people tighten their belts and eat less. Everyone is adaptive and it’s murder on your entry points, stop losses and trading systems. Human life remarkably reinvents itself, in spite of pain and loss. This is the glory of man, the consolation for all the rough jokes God plays on His handiwork.