What the Invasion Means to the Market

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This is a tragic event of epic proportion. Comparisons are being drawn well past Crimea in 2014, back to the 1930s and Nazi Germany. There are many geopolitical experts weighing in on these historic events. You can find them pretty much everywhere you look. My goal is to outline what’s happened, why it matters and what to expect going forward, squarely from a Market standpoint. This month marks 20 years for me at this company. I’ve witnessed, navigated, traded, and chronicled a lot in those 2 decades. There haven’t been many weeks that compare to this one. Here goes.

Stocks were for sale immediately on Tuesday and declined most of the week, after Russia sent troops into Ukraine. This was perhaps the most telegraphed invasion in memory. It’s been building for weeks, years really. Tensions between Russia and Ukraine are not new. Russia has had forces in the Donbas region for 8 years, since it annexed Crimea. This escalation, and invasion, is new. Where it goes from here is unknown. But the Market is just not as affected by it, as long as it’s contained. Containment is the challenge. It’s a complete unknown where this goes.

What is known is the fact that American companies have significantly moved away from Russia throughout the Putin regime. Banks discontinued financing in Russia in 2014, after Crimea was taken. Today, the percentage of sales to Russia from Corporate America is 0.1%, effectively zero. That said, the European Union is Russia’s biggest trading partner.

Economically, Russia and Ukraine are not global powers. However, both nations are large producers of commodities. Prices have been extremely volatile, rising during this invasion. Ukraine and Russia, account for a third of the World’s wheat exports, a fifth of its corn trade and nearly 80% of sunflower oil production. Wheat prices have already risen by more than 20% since the start of the year, while corn costs have climbed 15%. This, after the substantial price increases last year. These countries export a high percentage of fertilizer too. As you know, Russia is one of the largest Oil & Gas producers in the World. That’s the biggest issue right now. Oil is still the prize. Despite all the advances in technology and renewable energy, the World still runs on Crude.

Vladimir Putin plays the long game. But this game is not open-ended. Importantly, two-thirds of Russia’s exports and over half of its revenues come from Oil & Gas. Demand for both around the globe still outstrips supply, by a pretty wide margin. That’s been an issue since Covid. Putin saw an opportunity. But he runs the risk of accelerating the global diversification away from Russian energy. Russia is still basically a 20th-century economy in the 21st century. Ukraine is trying to embrace modern ways. That’s a threat to Russia. Europe has already been trying to expand its renewable energy sources in order to reduce its dependence on Russian fossil fuel. But Putin knows there isn’t enough supply of reliable renewable supplies. He’s acting aggressively while he can because the Russian economy is not geared for the Digital Age.

The price of Oil jumped as Germany shut down the development of the Nord Stream 2 pipeline. This 760-mile gas pipeline, stretching below the Baltic Sea, was designed to double the amount of gas flowing from Russia to Germany. It’s offline. It’s actually never even made it online. Keep in mind, Russia already supplies roughly 40% of Europe’s natural gas supplies. Most of that gas travels through Ukraine. Europe pays the highest prices for Natural Gas, currently over $20 per British Thermal Unit (BTU). This compares to roughly $5 in America. Europeans are facing some serious inflationary pressures that are soaking up their discretionary spending. That will no doubt be felt in the European economy at a time when a reopening is taking shape.

Prolonged tensions could risk significant shipments from ports in the Black Sea. It would stall future production and transportation within the countries. That will keep prices elevated. Rising commodity prices are inflationary. The World already had an inflation problem. It’s gotten worse. The conflict disrupts the cost of raw materials and food. Consumers will continue to face elevated prices. That will clearly influence the Fed and its interest rate hike campaign, which is what the Market cares about the most. More on that below.

Back to the Market: At the open of trading on Thursday, the Dow gapped down 800 points. The S&P fell 2.5%. The Tech-heavy NASDAQ was down 3.5%. Well over 90% of the volume were decliners. It was very extreme. The NAS hit Bear Market levels, officially falling 20% from its all-time highs. It was just a brutal start. Then came a reversal. Thursday was one of those days I will never forget. As a Market professional, you learn early that contrarian calls can work when the herd gets ahead of itself. There was so much selling that by Thursday morning, the tide turned.

It’s impossible to know whether a bottom is in. But the price action was significant, so I share it with you here. There was a big change in leadership. For months, Tech had been for sale. The growthiest of companies have seen their stocks battered. This was a complete 180-degree turn from most of 2020 and 2021, where Tech soared to unprecedented heights. Gravity finally took hold. The high-flyers fell. But they took flight again Thursday. Within the first hour of trading, many Growth stocks that had been left for dead, suddenly came back to life. It kept expanding, with the NASDAQ turning green midday. Small Caps followed suit. Later came the S&P. Financials and Consumer Staples, some of the leaders of 2022, were big laggards Thursday. Energy reversed hard too. That kept the Dow down, before eeking out a 92-point gain by the close. The NASDAQ saw a 6.5% swing from low to close. After hitting the century mark overnight, the price of Oil erased all its gains, settling at $93.

How do you follow up that historic Thursday reversal? How about with the best day on the Dow in 2022. There was some serious follow-through from yesterday’s reversal rally. It sure looked good and felt good on the surface to head into the weekend this way. It started with word that Russia is willing to have formal talks with Ukraine. Ok, but you clearly can’t believe much of anything Putin says. That said, a breather is in everyone’s interest. Looking under the hood of the Market, leadership switched. Friday was much more defensive than Thursday. Banks and Value outperformed while Tech and Growth lagged. This weekend will no doubt have activity, despite the Market being closed. The natural question is, was this a Bear Market rally? It kind of felt like it. There’s a lot more that needs to happen before the all-clear sign shines. That’s what the Market is telling us.

These days it’s hard to get people to agree on much of anything. There are so many divisions, externally and internally. But Russia’s actions have brought the NATO nations closer than they’ve been in decades. They’re still not unified on how to respond. But they’re definitely moving in that direction. France called for sanctions to be “targeted.” Germany and Italy lobbied for energy to be exempted from any sanctions. Putin was clearly acting on these divides. But late Friday afternoon, the United States sanctioned Vladimir Putin personally. You certainly don’t see a head of state from a global power sanctioned very often. This may uncover some insight into the Russian leader’s holdings and net worth, something that has been exceedingly private. Importantly, European leaders led with this action. Europe has far more economic ties to Russia than does the United States. This is no small deal.

It’s not a coincidence that Putin picked the wintertime to launch the invasion. Winter is peak season for Natural Gas consumption to heat homes. Russia has vast quantities of Natural Gas. Europe does not. Europe has been dependent on Russian gas for decades. You know who else has large supplies of Natural Gas? The United States of America. Change is happening. The US now accounts for half of Europe’s gas imports. It seems as though Putin’s calculus did not account for NATO strengthening its resolve.

A pressing, unanswered question is where China stands on all of this. Of significance, China did not call this an invasion. China has been increasing its relationship with Russia, finding common ground in its distrust of America and the West. The joint statement by Presidents Putin and Xi ahead of the Olympics spelled that out. But China finds itself in a tight spot too. China has a balancing act on its hands: Maintaining a united front with Moscow against the United States while avoiding a direct association with Putin’s destabilizing activity. Beijing has indicated that it may not support Putin’s efforts of pursuing a full-scale invasion. It has called for a diplomatic solution while condemning Western sanctions. It seems too late for that. Chinese support is what made this decision much easier for Putin. China has its own ideas about Taiwan and Hong Kong, and is watching the global response very closely.

I was talking with someone today who is really smart on all things China. He pointed out that even though China refused to condemn the invasion, don’t lose sight of the fact that China also refused to recognize the 2 separatist regions that Putin declared. China is fully integrated in the global economy and doesn’t plan to complicate its self-interests. It was reported that China stopped buying Russian commodities today. That’s an interesting development. Keep in mind, Russia is a rounding error in China’s economy. With China, it seems like it’s more about what they don’t do than what they do. We are tracking that closely.

The events around Ukraine are dangerous and concerning, no matter how you slice it. It has certainly had an impact on the Market. Inflation is the biggest issue in focus. Concerns are growing over a Fed rate hike next month, given the global risks created by the conflict in Ukraine. It’s a kind of Catch-22 situation, where aggressively raising rates could exacerbate disruptions to growth, while doing little could worsen inflation and pose a big threat to the Economy. The Fed will need to tread carefully in the coming months and year, and the risk of a policy mistake has never been higher. We have not seen inflation like this in decades. The Fed is going to have some very difficult choices. The meeting is March 16. There’s a lot of space still from now to then. The Market will stay volatile in anticipation of the moves. Prices are sky-high. Interest rates are the price of money. They’re about to go higher. The price of money is what it cares about most.

These are indeed challenging times on planet Earth. We are being tested. We are prepared. We continue to navigate through it. Hang on tight.

Have a nice weekend. We’ll be back, dark and early on Monday.

Mike

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