Russian Threats and Bond Fears Send Stocks Lower

Adapting a famous phrase from President Teddy Roosevelt, Russia’s economy speaks softly, but its military carries a big stick. With an economy ranking 2 notches under tiny Canada in 11th place, despite almost 4x the population, Russia’s Putin demands an outsized presence on the world stage. With the world’s second most powerful military and the largest nuclear weapons arsenal, this military dictatorship and kleptocracy continues to agitate passive Western democracies. In 2014, Putin feared that the ousting of his secretly appointed leader in Ukraine would disrupt his quiet annexation of Ukraine’s Crimea, thus he staged a rebellion to complete his goal with a proxy army. With no meaningful sanctions or objections from the US and Europe in 2014, Russia has decided to stage a new rebellion to annex another portion of eastern Ukraine. Knowing that the vast majority of Ukraine favors an alliance with the West against Russia, Putin has amassed an invasion force that seems unlikely to lose face by retreating without usurping some real estate. Rhetoric is quite strong by the US and Europe, warning of consequences of any Russian backed forces in Ukraine. It will be interesting to see how long lasting, severe and unified sanctions would be should the widely expected Russian incursion occur. Upon the White House statement of February 11th that an invasion was imminent within days, the fund flow flight to safety trade exploded with a sharp jump in the US Dollar, Bond prices and Oil, while the stock market abruptly went back into its shell. There is no doubt that these reversals will continue, should an actual war break out. The fundamental supply shortfall spurring Oil above $100 was likely even before Russia became a heightened threat to energy supplies in Europe. Now $100+ Oil appears to be a fete accompli, unless there is a surprising withdrawal of Russian troops and military field hospitals from the Ukraine border. Creating dependence upon Russian fossil fuels has been a major goal of Putin and highlights the naivete of the German led European body. With 30 to 40% of Europe’s oil and gas emanating from Russia and 75% in most of the Scandinavian countries, it will be especially difficult to send abundant US supplies that are being curtailed under the current administration here. 

 

In January we were expecting a stock market correction and then one trading day before the low we sent a report stating that “SP 3850 to 4250 is the ideal major zone to expect an initial climax low and robust short term rally for a few weeks. Watch for a brief capitulation wash-out drop in the SP 500 Index under its 10% correction lows into the lower 4200’s during the January 24th – 28th time frame to be a buyer.”  Since the climax low in the lower 4200’s on the 24th and retest on the 28th, stocks did indeed rally from there for the ensuing 2 weeks before the latest Russian scare on the 11th. While our interpretation of Seasonality had favored a low during the final week of January and a trading range rally into mid to late February before another capitulation phase, the geopolitical fear of consequences from a Russian incursion into Ukraine does risk a speedier fall in stocks toward the March bottom we have been targeting. Conversely a military de-esecalation could trigger a short term buying spree back to the top of the recent trading range. 

The February rally off the lows was more than justified with 77% of SP 500 companies beating income estimates along with a 45% growth in earnings for 2021. However, this correction is different than the brief Buy the Dip pullbacks during the past 2 years of Covid. Fiscal stimulus is fading fast, personal savings are back to pre-Covid levels and interest rates are surging as monetary stimulus is morphing into quantitative tightening. While credit defaults remain historically low, Junk Bonds are often an underlying canary in the coal mine to watch. High Yield Junk Bond prices rose continuously throughout this overstimulated Bull Market from March 2020, indicating a steady decline in default risk. However, in November and December when the stock market indices were hitting record highs, Junk Bonds were falling, presaging trouble for stocks. The current acceleration lower in Junk Bond prices as the 10 Year Treasury ticked above the important 2% yield milestone, is a warning shot that stocks are at an increasing risk of falling to new lows in the weeks ahead. Any fireworks in Ukraine would be an obvious trigger.

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