Investors just can’t have nice things. After being traumatized by a global pandemic in 2020, investment accounts then soared in value for nearly two uninterrupted years.
Now, this week investors are handed “the first war in Europe since 1945” headline to process. To be sure, global capital markets were not happy on the morning of the 24th. I took personal satisfaction hearing on Bloomberg the Russian stock market was down 50% the morning of the invasion.
Russia executed a slow-motion invasion of the former Soviet satellite country, Ukraine, exactly as US intelligence agencies predicted they would.
Earlier this week I heard some talking head idiot on a cable channel allege that no Russian/Ukraine invasion would be forthcoming. Instead, the dire warnings were contrived by the Biden administration to draw attention away from Hunter Biden and his Ukraine ties. Solid journalistic analysis right there. I know, why was I even watching?
Russia is a third-world country, topical in normal times only because of their energy assets, their military and their nukes. Their war action, however, will likely create outsized ripples across the global economy.
Putin’s strategic endgame that underpinned the Ukraine invasion is unknown, perhaps even to Putin. Experts are guessing it may have been to secure ownership of major continental energy pipelines crossing Ukraine into Europe; other believe it was a deterrent move to keep Ukraine from joining the NATO European defense alliance, no one knows for sure.
We do know that Putin is now officially an irrational (mad?) dictator, which is scary as hell given Russia’s massive nuclear arsenal.
A consensus has quickly formed that Putin seriously miscalculated by invading Ukraine. Pundits say Ukraine is too big to occupy and the Ukrainians are now ticked off and seem willing to fight for their independence. Finally, the Russia economy is small - the size of Texas - backwards and vulnerable, unable to support itself for too long.
Putin’s leverage over Europe is meaningful in the short run, however. The major Western European countries import almost half of their fossil fuel energy needs – oil and natural gas – from Russia!
How strategically stupid was it to transfer your energy dependence to a dictator? If Putin were to turn off the energy pipelines valves, Europe would face an epic humanitarian crisis.
Economic sanctions immediately levied on Russia after the invasion seem meaningful, but the fact is they will not deter Putin so long as Russian energy exports are not curbed – and they were not curbed.
Russia has been building up a substantial foreign currency reserves over the past few years; now we know why.
Does this gravely serious world event matter to US capital markets? Of course it matters, at least in the short run. Oil and natural gas prices immediately jumped on the news. Which makes sense since, per Wall Street Journal, Russia produces twelve percent of the world’s oil and seventeen percent of its natural gas. They are a major energy player and swing producer.
In the meantime, US oil drillers are displaying uncommon discipline by not ramping up their drilling activity (at least so far). They seem content to make investors happy with rising profits and dividends from their existing well portfolios boosted by robust oil and gas commodity prices.
Longer term, Europe needs to build new liquified natural gas (LNG) terminals to receive natural gas imported from the US (and others) to release Russia’s energy stranglehold.
Perhaps the Russia-Ukraine crisis will serve as a slap-in-the-face to the Biden administration to stop treating the US energy industry as a hostile enemy. Their misguided hostility to US energy producers since taking office had to embolden Putin. It was a stupid, unforced strategic error.
In the meantime, higher energy costs will fuel higher inflation for longer. Moreover, world economies will need time to adjust to the new geopolitical realities, which could eventually lead to economic recessions, both in the US and abroad.
Another caveat is Russia happens to be major wheat and fertilizer exporter, so more food inflation is likely on the horizon.
Yields on longer-dated government bond declined on the invasion news, which signals that bond investors are expecting some adverse economic consequences. And it certainly muddies the Fed Reserve’s plan to start raising short-term interest rates starting next month.
The triple punch of higher inflation, war and rising interest rates could be enough to tip the US economy into a recession. If it happens, the stock market will not be happy, at all.
So what, do you ask? Well, investors should first exhale and measure the potential economic impact on their portfolios from placing Russia in an economic penalty box.
As always, world events create both risk and opportunities.
We’ve been a broken record with respect to our fondness for US pipeline stocks; we’re doubling down on this sector given Europe’s need to wean itself off Russian fossil fuels – fast.
Most commodity prices have been rising rapidly over the past year and will now face more upward pressure with Russia sidelined. Precious metals (gold and silver) are a safe haven investment vehicle and can be quite appealing in turbulent times, we get it.
In our view, diversified managed futures funds can be a good option to invest in commodities and metals in your portfolio. Commodity trading advisors can take both long or short futures positions and thus better manage risk in these notoriously volatile investment classes.
If inflation runs higher longer, then investment grade bonds will continue their pain and suffering in 2022. We expect real asset investments to continue to outperform with an elevated inflation climate, especially after Putin’s folly this week.
Technology stocks have been on sale in 2022, but we’re still waiting for a clearance event to even nibble on this sector. We see more pain for tech stocks that as a group are being held to unrealistic sales and profit projections by Wall Street – and they now can’t deliver on them.
Until next time, be safe and well…Tim