Russia’s reaction to another round of sanctions by the United States and — at long last — the European Unioncould spell trouble for investors in Russian markets, analysts said Tuesday. In a note, Neil Shearing of Capital Economics says Russia’s economy — and markets — are more vulnerable than they’ve appeared. If nothing else, the growing sanctions and rising tensions make the pickup in investment needed to revive Russia’s ailing economy look all the more unlikely. While Russia’s government balance sheet remains strong, its banks and non-financial corporates aren’t in the strongest shape, Shearing notes. Their fragile condition likely to be compounded as it gets tougher to access Western capital markets and as Russia’s central bank raises interest rates in an effort to limit capital outflows, he said. In this context, the falls in Russian financial markets in recent days could be the tip of the iceberg. The stock market edged up by 1% [Tuesday], but is down by nearly 7% this month. At just below 6, the 12-month trailing P/E ratio may be low, but it is low for a reason. Meanwhile, yields on five-year ruble government bonds have risen to over 9.5% – close to the highs seen earlier this year – and the ruble USDRUB has sunk to a two-and-a-half-month low of 35.7 against the dollar. Indeed, the equity market and the ruble are now close to our end-year forecasts, which were looking bearish only a few months ago. Russia’s MICEX index ended Tuesday at 1,369.83, leaving it down 8.9% since the beginning of the year. The index dipped below 1,200 in March as tensions over the Crimea ratcheted up. The largest Russia-focused exchange-traded fund, the Market Vectors Russia ETF RSX , dropped more than 2% Tuesday and is off more than 17% since the beginning of the year. rsx Shearing’s year-end forecast for the stock index remains at 1,375 while the ruble forecast stands at 36 per dollar. “We are not minded to change our forecasts in the current circumstances, but it goes without saying that the risks are skewed in one direction,” he wrote. “If the political situation deteriorates further, things could quickly turn ugly for both the economy and the markets.” Of course, markets around the world have reacted to a summer smorgasbord of geopolitical turmoil with almost eerie calm. U.S. stocks continue to grind out new highs and European bond yields continue to fall (the latter reflecting the hunt for yield as well as deflation fears). Oil prices spiked but then dropped back after a rising Sunni insurgency in Iraq. Russia’s annexation of the Crimea earlier this year and the subsequent downing of a Malaysia Airlines jet have provided only temporary jolts to a stubbornly low-volatility environment. Temporary bouts of haven-seeking by investors have seen momentary flows into gold, the yen and Treasurys quickly unwind. The underlying reason is usually attributed to the world’s major central banks, particularly the Fed, and their liquidity-boosting, ultra-low interest rate policies. So what’s next? Alastair Newton, senior political analyst at Nomura, still has the Russia-Ukraine situation at No. 1 on his midyear list of geopolitical worries that keep him awake at night. He doesn’t expect Putin to change his tune. Putin “appears to remain determined to lock Ukraine firmly into Russia’s sphere of influence, so, any easing of his stance at this stage would likely be essentially tactical.” Newton writes: With Ukraine’s domestic politics in flux and no agreement yet between Kiev and Moscow over gas prices, I believe that new ways for the opportunistic Mr. Putin to pursue his objective will arise, despite military setbacks for the separatists. In the meantime, I expect markets and corporates to continue to look to reduce their exposure to Russia-related risk where feasible, even though I think we are still some way from Iran-type sanctions which would really rattle markets. Source: marketwatch.com