Even for investors that have a high tolerance of risk for emerging markets, Russia has become too hot to handle.

Under the capricious rule of Vladimir Putin, the country has gone out of its way to alienate global investments and diplomatic communities. What started with forays into Crimea and Ukraine has extended to a hostile economic environment for any companies interested in doing business in Moscow. Economic sanctions have been the West’s primary response, which has mostly been met with shrugs and statements of blustery nationalism from the Kremlin.

#-ad_banner-#Yet with every passing day, Russia’s pariah status is delivering a fresh blow to an already fragile economy. Russia’s Economic Ministry recently lowered the 2014 economic growth rate to just 0.5%, and that forecast was issued before the further declines in oil prices recently.

The odds of a recession in Russia are rising, right at a time when the average Russian citizen is now seeing sticker shock for many goods. That’s because Russia under-invested in domestic production of a wide range of goods, having been contented to use oil earnings to import many goods. Yet a 20% slide in the ruble since the year began, to its lowest levels since the Russian default crisis of 2008, makes imports painfully expensive. Food prices, for example, are now rising at a double-digit annual pace.

Rising import prices threaten to push the inflation rate above the current 8%. That’s led to talk that the Central Bank will need to hike interest rates, which would create just one more headwind for this beleaguered economy. As it stands, Russia’s government budget, which was based on expectations of crude oil selling for $100 a barrel, increasingly looks to head into deficit territory. The next move may be a cutback in government spending on social services and other programs.

Putin’s impact on average citizens doesn’t appear to greatly concern him. In fact, he’s showing just how much he cares about them by siphoning funds from the country’s pension investment fund and channeling the money toward his core political base: Russia’s oligarchs.

Even so, these oligarchs are growing increasingly restive. Not only are they seeing their assets frozen abroad, but the value of their domestic enterprises are also shrinking as the country’s MICEX stock market index plunges. A group of 20 Russian oligarchs that comprise the Bloomberg Billionaires Index have lost a reported $16 billion already this year. And these oligarchs now have an even greater concern: Russian banks and key companies have more than $50 billion in debt that will need to be re-financed over the next three months. Without the ability to access global financial markets, it’s not clear how that issue will be addressed.

As just one example, mining firm Mechal OAO (NYSE: MTL) is at risk of defaulting on its bonds, pushing its shares to around $1 today down from $30 in 2011. How badly have Russian stocks in general been tarnished? As a group, they trade for less than five times projected earnings. That’s the lowest valuation, relative to other emerging markets, in nearly a decade, according to Bloomberg News.

Ready To Blink?
After having boxed the Russian economy into a corner, Putin appears ready to alter course. This past Sunday, October 12, he ordered the withdrawal of more than 15,000 troops from the Ukrainian border. He is set to meet face-to-face with Ukraine’s president, and increasingly understands that the easiest way to ease economic sanctions is to come up with some sort of peace offering. Those Russian-Ukraine talks are taking place as Secretary of State John Kerry renews a dialogue with his Russian counterpart, Sergei Lavrov.

With the prospect of a cool down in tensions, gutsy investors are starting to see Russian stocks in a different light. For example, legendary global investor Jim Rogers, who has been a perma-bear on Russia for a very long time, recently told Bloomberg News that he’s begun buying selective Russian ETFs and stocks.

To be sure, it’s not a risk-free move, but as Rogers and others will tell you, big profits can be made when an asset class falls out of bed. Simply backing off of threats to divide Ukraine could lead to a lifting of economic sanctions. Countries such as Germany, which count on Russia as a key trading partner, would likely push for such a move if Russia blinks. If sanctions are lifted, then a powerful snapback would likely ensue for the Russian stock market and the country’s currency. And a strengthening currency magnifies returns for foreign investors.

With that in mind, here are some ETFs to consider, all of which carry expense ratios of around 0.60%:

Market Vectors Russia ETF (NYSE: RSX)
With nearly $2 billion in assets, this is the largest and most-liquid ETF available to U.S. investors. Roughly 40% of the fund is tied up in energy stocks, which obviously are also coming under pressure from the pullback on energy prices. Miners make up another 17% of the fund, with the remaining stocks in the portfolio more squarely focused on the Russian economy. The top 10 holdings account for around 55% of the fund.

iShares MSCI Russia Capped (Nasdaq: ERUS)
This fund has an even greater emphasis on energy stocks — Gazprom and Lukoil alone account for 30% of the portfolio. It’s also more concentrated, as the top 10 holdings make up 70% of the fund.

Direxion Daily Russia Bull 3X ETF (Nasdaq: RUSL)
Aggressive investors may want to consider this leveraged ETF, which has taken an especially tough pounding in recent months, but would also post a more robust snapback if Russian stocks are poised to reverse course.

Risks to Consider: Can things get worse in Russia? Surely. If Putin doesn’t calm the waters soon, then the country’s currency could weaken further, key companies may need a bailout and the economy could slip into a deep recession.  

Action to Take –> Think of Russia as a micro-cap stock. As an investment, it should never comprise more than a small part of your portfolio. Still, this appears to be the classic set up of a hated asset that has few supporters and many detractors. If and when tensions cool with the West, investors will notice just how cheap Russian stocks have become. They will always trade at a discount to other emerging markets, at least as long as Putin is in power. But merely closing some of that gap could yield rapid upside.

If investing in Russia doesn’t fit your risk tolerance or moral code, check out High-Yield International for some of the best stocks from across the globe. In fact, 79% of the world’s highest yielding investments are located outside the United States. For more information about the most lucrative foreign companies in today’s market, click here.

Photo by The Global Panorama via Flickr