Russia Feels Wall Street's Reach

The Russian stock market registered its worst performance for last week Monday, when a 2.9 percent drop followed a plunge on the Wall Street market. The following day it saw gains of 2.2 percent -- the same day better-than-expected U.S. inflation data fueled a surge in U.S. and European markets.

Causes or coincidences?

With global investment funds having boosted their exposure to Russia sharply since the start of the year, local prices are increasingly buffeted, for good or ill, by activity on trading floors thousands of miles away.

"That's actually a sign of acceptance of Russia by the wider, more traditional investment community," said Tom Reed of Bank Menatep's investment department. "In some ways it's good -- the flows are a lot bigger. In some ways it's more dangerous because Russia is much more subject to the flows."

Over the last several weeks, a number of Moscow investment houses have reported trading in sync with swings on foreign markets, though often a day behind because of time differences. A chart of daily percentage changes in the Dow Jones Industrial Average and the Moscow Times Index also shows a rough, if imprecise, linkage.

Always driven by foreign money, the Russian market is even more so now with its recent inclusion in the International Finance Corporation and Morgan Stanley emerging-market indices.

These investment guides increase by hundreds of millions of dollars the amount that major institutional investors will allocate to the market, and that makes local brokers extra-sensitive to swings abroad that sap money managers' time or appetite for Russian risk.

"If the Dow starts plunging, the first thing that happens is the phone doesn't ring," Reed said. "The second thing that happens is the market goes down."

But not all market-watchers are convinced of the strength of the trend.

"It happens that they are correlating, but I'm not so sure that there's anything that drives them to correlate," said Peter Halloran, director of equities at Credit Suisse First Boston. The Russian market's link with the Dow Jones average "may be a short-term reality, but I don't think long-term it's going to have any huge impact."

The reason for the short-term blip is higher U.S. interest rates, which make fixed-income instruments comparatively more attractive than stocks and cloud the outlook for corporate profits. A U.S. rate hike March 25 and expectations of another next month have sent gyrations through world markets and triggered fears that a six-and-a-half year bull run for U.S. stocks may be due for a major correction.

On any given day, it's clear why investors in Russia may sell in line with a falling Dow.

"People don't feel as up for taking a risk when they're taking a beating in other areas of the market," said Coast Sullenger of Pioneer Securities.

Whereas before, much of the foreign money directed here came from hedge funds and dedicated country funds, now hundreds of millions of dollars come through bigger institutional clients such as pension funds that must do more to protect their overall balance sheets.

"If the Dow does extremely badly, then Russia will do badly also," said Danielle Downing, emerging markets strategist at Salomon Brothers in London. "If the Dow just sort of corrects, then Russia won't be as hard-hit."

Alexander Bubnovski, head of sales at Alfa Capital, said some of his international clients will take profits on their Russian portfolio to cushion losses when the Dow has a bad day.

Over a longer period of time, however, equities here would be likely to benefit from a stock slump in the U.S. and Europe, Halloran and Downing said, since global investors would seek higher returns in more exotic markets.

Nor is a link between Russian and Western markets an entirely new phenomenon. Russian equities were hard-hit by the Mexican peso crisis at the end of 1994, which soured investors on emerging markets in general.

Analysts say that over the longer term Russia's market will become more insulated from foreign factors as domestic players such as banks build up bigger equities holdings.

But it's a safe bet that all Russian market eyes will be on the U.S. Federal Reserve and its chairman, Alan Greenspan, at the end of May when it next decides whether to raise interest rates.

For Russian blue chips, Reed argues, "you'd have more of a vision of what's going to happen by looking at Greenspan than [President Boris] Yeltsin."