The Markets This Week — March 3

Please join us for our periodic conference call at 10 AM Pacific on March 24, 2022 — there will be a lot to discuss, and we welcome your questions.  We’ll discuss ways you can increase your liquidity, flexibility, and optionality as the world moves into a more volatile and unpredictable future.

Register today by clicking here.

Russia and Ukraine — An Analysis

Russia’s invasion of Ukraine has introduced a new source of unpredictable risk into global markets — stock markets, financial markets, currency markets, and commodity markets.

Stepping back from the humanitarian dimension, which of course is tragic, we just try to understand the motivations of the central actors and the courses of action they will view as desirable or acceptable in order to achieve their ends.

Both Russia and the west have, we believe, made serious miscalculations that have contributed to the situation deteriorating to this point.  NATO and the EU encouraged the Ukrainian government to believe that there was an unambiguous path forward for Ukraine to join the military and economic alliances of the liberal west, and leave the illiberal fold of Russia and the Soviet successor states which have remained in its orbit.  In reality, there was no such path, and no clear commitment to help Ukraine move forward on it.  That consensus may be emerging now, but it is in the midst of a war, which is an altogether more fraught situation — the most alarming of the post-Soviet era.

For its part, Russia gambled on a quick victory without the need for destructive attacks on civilian population centers.  That gamble seems not to be paying off, and Russia’s large but untested military has not seen a conflict of this scale since the Second World War.  Ukrainian resistance has been described as “fierce”; anyone with knowledge of Ukraine’s Second World War history understands the determination with which Ukrainian partisans attempted to repel overlords from the east when they had the chance.  It led to some unsavory alliances — hence Putin’s justification for the invasion as a “denazification,” and the darker history of Ukrainian nationalism which led some to question the key actors in the Maidan revolution of 2014 that installed a pro-western government.

Failure to secure a quick victory may well lead Russia to a more aggressive campaign — which would thus be more likely to summon a response from NATO.  In an era of smartphone communications — now enabled by Elon Musk’s Starlink satellites over Ukraine — the voting population of the west will press their leaders to strike back to defend civilians when they see alarming video clips of casualties posted to Twitter and TikTok.  Such escalation could cause a direct confrontation between nuclear-armed powers — and Russia has already made clear the readiness of their arsenal. 

Germany and the U.S. are already providing Stinger missiles to Ukrainian forces, which will certainly be used to shoot down Russian helicopters, and Germany has announced a massive expansion of military spending.  Russia, hoping to take advantage of a slumbering NATO, may just have energized the alliance.

Resolutions and Further Risks

In the end, we believe that whatever background desire Putin’s regime may have to reassemble the Soviet empire, he is aware of his weakness, and his proximate goals are smaller.  In supporting the breakaway “people’s republics” of the Donbass, was it his intention to secure a politically divided Ukraine that would thus be perpetually blocked from NATO and EU accession?  Perhaps.  But Ukraine never implemented the Minsk protocols that would have given those regions autonomy within a federated Ukraine, so Russia seized the opportunity of a weak and divided NATO (led by a distracted and vacillating U.S. administration) to use military force.

Putin may well be satisfied with a ceasefire that results in a permanent Ukrainian commitment never to host NATO troops and military equipment, or some other mechanism that will functionally deny Ukraine any hope of EU accession.  That might be the best outcome that can realistically be hoped for.  If such an outcome does not occur, there would likely be an extended and ugly guerrilla war on European soil — something with severely negative consequences for Europe.

The financial dimension of the conflict is also profound.  Russia’s systemically critical role in energy is of course front and center; unrealistic dreams aside, the world needs Russia’s energy, and at this juncture, western governments can ill afford the additional inflation impulse that would arise from a long-running curtailment of that supply.  The conflict has caused Germany to roll back its whole green energy agenda, cancel the new pipeline that would have deepened its dependence on Russian natural gas, and embrace coal and nuclear power once again.

Further, sanctions cutting Russia off from the global financial system run the risk of the acceleration of a new international financial axis between Russia and China — one to be joined, presumably, by other illiberal regimes.  China has already announced that it will not be joining in sanctions.

The conflict has put crypto in a new light; we note that for the first time, a situation of geopolitical and financial stress has seen crypto and stock markets moving in opposite directions.  Gold and commodities have also benefited.  Sanctions and cyberattacks have underscored the utility of cryptocurrencies to many actors on both sides — with Russia potentially using them to evade sanctions, and Ukraine using them to secure international aid which it has quickly funneled into relief efforts and weapons purchases.

And finally, Russia’s attack on Ukraine, and their resolution, are being closely watched by China, who has its own ambitions to reclaim an even more strategically significant asset that it claims as its own, with historical animus: the island of Taiwan.  U.S. military officials are already voicing the need for the U.S. to be prepared to fight two major wars simultaneously.

To us, this argues for a multi-year tailwind for defense stocks.  Our own general orientation would lead us to concentrate on defense electronics, cybersecurity, and signal intelligence rather than on the companies making bullets and missiles.

More Gyrations To Come…

Russia’s attack on Ukraine illustrates the many potential sources of volatility that are currently at work in global markets.  In short, volatility is back — whether from central bank policy errors, economic convulsions, or geopolitical events.  Spikes and sell-offs, particularly in commodities, should be expected. 

… So Stay Liquid

One thing we would particularly caution investors about is that this is not the time for getting into illiquid investments, unless because of tax necessity (e.g., a 1031 exchange).  The global macro picture is highly fluid — and in response, we would recommend that investors stay liquid.  We continue to recommmend attention to commodities and raw materials for the coming battery-based economic future — including uranium. 

And don’t neglect this overarching and critical reality: inflation is NOT transitory.

Thanks for listening; we welcome your calls and questions.