The past several weeks have been a disappointment for the Russian equity market, as the RTS Index has fallen 25 percent since the beginning of May – despite heightened focus on Russia with the inauguration of Vladimir Putin and the subsequent naming of his Cabinet.

The RTS Index is down 30 percent from its 2000 high, but nevertheless, only down just a touch in the year to date. Although the Russian macroeconomic and political environment appears to be improving almost every day, in theory boding well for equity prices, the Russian equity market is unlikely to get much of a break until some semblance of stability on the global market front emerges. Once that happens, though, Russian stocks are likely to appreciate strongly and rapidly.

International market conditions have been the key culprit for Russia's recent lackluster performance, as wobbly conditions overseas have punished sentiment on the Russian equity market. The 50 basis point hike in U.S. interest rates by the Federal Open Market Committee on May 16 failed to provide any increased comfort to global investors, as indications have yet to appear that the interest rate tightening cycle is close to its conclusion. Despite the significantly decreased linkage between interest rates and the U.S. economy (thanks in part to the rise of the e-economy), the Fed's aggressiveness finally has impacted investor sentiment. The NASDAQ last week hit new lows for the year (which, to put the losses in perspective, are nevertheless at the levels of November), and is down 20 percent for the year, while the Dow is down 8 percent in 2000.

The Russian market will remain a hostage of poor global market conditions for the time being. Although the Russian market was surprisingly resilient to the initial downturn in NASDAQ in March, the RTS has by now more than made up for its earlier strength. Investors have been distracted by the severe weakness in U.S. markets: Even if they have no holdings in the United States, the global investment environment tone is defined by U.S. markets. The Russian equity market could remain insulated from global jitters for only so long, before succumbing to deteriorating sentiment.

There is clearly no fundamental reason for Russian equity prices to decline as sharply as they have over the past several weeks – defying predictions of equity market strength based on the continuously improving macroeconomic, political and market environment. Sentiment, however, is by definition rational only by coincidence, and what could arguably be called the irrationality that propelled U.S. high-tech shares to the stratosphere, is now impacting Russian shares on the downside.

When a higher level of certainty and stability returns to U.S. markets, in the form of an indication from the Fed that the end of the latest round of interest rate tightening is near, the Russian equity market is likely to respond very positively. Once investors are able to stop focusing on fear of continued decline on NASDAQ, they will be open again to searching for relative value on a global basis. With valuations of the Russian equity market appearing extremely attractive (the ironic consequence of a down market is increasing fundamental value, as prices drop), investors are likely to reassess Russia in a positive light. A spate of good news that at one point was being priced into the market is no longer priced into shares; at present levels, the RTS is below the levels it reached upon the announcement of Boris Yeltsin's resignation.

This suggests that the Russian equity market at present levels does not reflect a number of developments over the past several months, including the increased political stability engendered by a young, healthy president; strong economic growth; burgeoning international reserve levels, and decreasing capital flight; continued strength in the price of oil; and significantly improved prospects for a reformist economic program, to be implemented by members of a reform-oriented Cabinet. On a micro level, a range of Russian securities are extremely cheap on an international basis, even upon factoring in the discount usually assigned to Russian assets – a discount which will over time decrease with the reduction in risk premium, on the back of decreased risk. But for now, investors in Russia will need to continue to wait for signals of improved sentiment in global markets – and act quickly once those signals emerge.

(Kim Iskyan is an analyst at Renaissance Capital in Moscow.)