Prepping for Putin Panic or Bargain Buying

When a military crisis breaks out and normal correction level indicators are oversold, it’s usually a safe time to become fully invested in your stock portfolio. Perhaps the caveat is that when a military conflict pits a perceived irrational nuclear superpower against the world and it’s still escalating, then the degree of oversold conditions and risk parameters may need to be viewed from a more extreme perspective. Rational Choice Theory assumes most people are rational beings motivated by self interest to maximize gains and minimize losses. Sometimes this impulse pushes the limits of the rational risk parabola, feigning irrational actions to force concessions that maximize their aspirations. In the 1980’s and 90’s, Latin American Countries suffered numerous defaults and successfully demanded shared losses with their creditors with the compromise offer of Brady Bonds to avoid continued debt defaults. Using the threat of sovereign bankruptcies, “too big to fail” became the leverage that the collective of 3rd world countries used to force US Banks to share in the losses.  Kim Jung Un, the supreme supplicant beggar of North Korea, uses his threat of nuclear war incessantly to gain attention and acquire free food shipments to sustain his Hermit Kingdom. Without being a threat to the world order, these examples of extreme irrational threats could be considered a form of non-cooperative game theory exhibiting rational behavior. With “great power comes great responsibility”, thus we expect the world nuclear superpowers of Russia and the US to behave rationally to avoid a misstep that leads to a nuclear winter wiping out humanity. The supreme leader of Russia, Vladimir Putin has singular control of the largest nuclear weapons stash on the planet and is purported to have the most advanced missile delivery system. Like Kim Jung Un, one must weigh the rational game theory actions of Putin against the potential perspective of an irrational megalomaniac who would knowingly risk global isolation that threatens his country’s survival in order to invade a sovereign Ukraine. Rational or not, the projection of irrationality is occurring to maximize gain and minimize loss. Goals and expectations can be debated, but the leverage of being the primary energy supplier to Europe, combined with the open ultimatum of using his nuclear arsenal, raises the stakes to the finality of global existence. Putin likely considered a range of responses to his provocation, from sanctions to a war beyond Ukraine. The united actions of the world against everything Russian has quickly approached maximum pressure, with a moratorium on Russian energy exports being the last economic blow that remains. Putin has no intention of losing all that he has taken, so the question is, what are the possible outcomes and the best manner of utilizing investor capital in response.

(1) In one extreme scenario, Putin could be deposed by his Oligarchs and Generals that are reportedly dismayed by current circumstances and his propensity for risking the survival of Russia and the world. Reports since the invasion indicate that many Russian regulars thought they were on a training or humanitarian mission rather than actual war. Reports of defecting soldiers and sabotaging equipment to stall the advance indicate a lack of motivation or discipline on the front lines. Even if there are “peace talks”, it appears certain to us that Putin will not stop until he has control of Ukraine (and beyond?), thus a revolt by his army and financial power brokers are the signs to watch for. Such an outcome, however unlikely, would be a extremely Bullish for stock investors into mid year.

(2) Another low odds outcome would be the start of a tactical nuclear war, which would crash all financial markets, economies and threaten humanity’s existence. Viewing Putin as irrational makes this unthinkable outcome thinkable when considering how the global sanctions have resulted in multiple unequivocal threats from his public relations head and Putin himself, that using nuclear weapons against NATO and the US is on the table if  bordering nation consider joining NATO’s Western alliance in Europe or even if maximum sanctions continue. He has stated that the West “faces the gravest (nuclear) consequences in history”. His propaganda chief, Kiselyof stated to the world that Russia with “our submarines 500 nuclear warheads…would guarantee the destruction of the USA and all other NATO countries” should they continue to threaten (‘illegitimate sanctions’ ‘) Russia. Currently, the path toward extreme posturing continues on  both sides as Europe has surprisingly responded with not only building up its military along bordering countries, but joining neutral countries in sending serious weapons to combat the Russian army. After Russia gains effective control of Ukrainian cities, it’s conceivable they will build up its forces along its new borders with the West. 

(3) The third option would be the most rational. When Putin has reached his minimum goal of defeating the core of the Ukrainian army and installing his puppet leader in Kyiv, he will use that milestone to start his first serious negotiations for a disarmed Ukraine that is forbidden from a Western alliance, along with recognition of a Russian controlled Eastern Ukraine and Crimea. To keep his mad man perception intact, Putin also demands removal of neo-Nazi leaders in Ukraine, despite the Ukranian President being Jewish and losing family members in the Nazi Hollacaust. Our expectation is that within a month or two the massive bombing assault and taking of key cities will be complete and official peace talks will begin. Shortly before any diplomacy, stock markets will stage a significant multi-week breakout rally from the February/March trading range. Commodities like Oil and food crops should deflate as stocks rally. Unfortunately, a sustained Bull move in equities will require significant narrowing of the wide chasm of war demands that currently exist. While some would say an additional option is that Russia will be unable to defeat the Western armed Ukrainian resistance, we feel Putin would risk the irrational vulnerability of depleting his entire military in order to control Ukraine and avoid a humiliating defeat and personal death sentence. Thus, despite the shockingly poor military logisitics of the Russian army and many failures to date, they will eventually prevail militarily with a massive artillery and bombing campaign. It will be difficult for stocks to escape the confines of escalating war uncertainty, which has flooded the flight to safety trade into the US Dollar and Treasury Bonds, despite almost 40 year high inflation rates.

Typically, aggressors continue escalating to a point where diplomatic de-escalation provides them with a win. At some point the the US and Europe will achieve maximum pain with sanctions and in assisting Ukraine to the point where Putin is boxed into a corner. Then he becomes a very dangerous dictator if left with no choice other than admitting total defeat or risking nuclear war. How long before Putin escalates the war risk with NATO and the US? Due to extreme sanctions, Russia’s monetary war chest could be evaporating in weeks instead of months or years as early estimates had calculated. Gold is unable to be converted to currency at scale and the Ruble is trash given their banks locked out of the global system, prevented from converting into any other major currencies. As Russia’s domestic panic worsens and its military weakened after taking control of a Ukraine it can’t pacify, it will then be critical for the West to provide an off ramp for Putin to allow a path of de-escalation with a pyrrhic or partial victory in Putin’s eyes. It will be exceedingly difficult to engineer an acceptable compromise that allows Russia back onto the global financial system controlled by the West without a further rise in credible threats of nuclear attacks or his removal from power.

The Russian currency has collapsed to record lows, down 75% over the past decade and losing a third of its value in the past few weeks. One of the few economic levers left for Europe to play is cutting off energy imports from Russia. The reluctance here highlights the pain that Europe and the world would suffer being unable to replace the enormous Russian energy flows. Europe (Germany) should immediately turn on its Nuclear Power plants and the Western world should adopt an emergency “everything approach” to energy production from all sources. 

The recent run in Oil from $90 a barrel to $116 this week is entirely due to the Russian threat and anticipation of eventual energy sanctions. The world risks Oil prices in the $140 to $200 range in varying parts of the globe should Oil and Gas exports from Russia be cut off and energy sanctions be implemented. US WTI Crude and Natural Gas are best positioned to offer relative bargain pricing for prices for domestic use, but Europe and Asia will feel greater economic pain of disproportionately higher prices as long as sanctions and Russian troops remain in place. Eliminating biofuels will help, but $80 to $150 oil in the US is our expected range in 2022 despite the massive release from the Strategic petroleum reserves from around the world. Releasing emergency reserves is shortsighted and fleeting while the global supply chains are experiencing record delays. Additionally, higher prices are needed to curtail demand and incentivise more forms of supply, thus tapping our reserves looks premature and more of a public relations effort. With Putin in charge, Oil and Wheat will see higher prices this year. Oil has already spiked 85% over the past 14 weeks due to the prospects that sanctions will remove almost 4 million barrels a day of their Oil exports from the global market. In 2020 Russia was the world’s largest exporter of Natural gas. A progression to peace talks after Putin gains a stronger grip over Ukraine will allow a deep energy price correction short term, but dips can be bought until Putin is removed or the world economy hits stall speed as inflation weary consumers slow consumption. The good news is that the Recessionary effect of high prices during a protracted sanctions effort will bring down core inflation and ease the labor restricted supply chains globally. The bad news is  the world will become worried about a Recession and need for falling interest rates later this year if sanctions and a war footing remain.

The huge 80% surge in Wheat prices this year and over 50% in the past 5 weeks is entirely due to the world’s number one Wheat exporter (Russia) invading the number 5 exporter (Ukraine). Normally this triggers Commercial producers/users to hedge with large short positions and Money Managers to become heavily net long. Thus far there has been no reaction in either direction to the price rise from expected Wheat shortages, which allows more room for prices to run higher or stay elevated for longer. The window on Ukraine planting crops appears to be closing and sanctions will curtail much of Russia’s Wheat exports. With at least 10% and possibly more than a third of Global Wheat exports being removed from the supply chain, Wheat seems destined to remain above the 13 year highs of $9.50 into the summer growing season with potential of new records above $13, unless Putin is removed from power or the world enters an economic contraction later this year. Peace talks can knock 2 to 3 dollars off of Wheat prices short term, but again, dips can be bought as supply shortages will persist. With a shortage of Ukrainian Potash and elevated Natural Gas prices, crop fertilizer will also keep Corn and Beans elevated into the planting season. The last time Wheat shortages manifested in 2010/2011, civil unrest and the Arab Spring resulted. More of the same and possibly worse this time in Authoritarian countries.

The stock market has already acheived techncial oversold readings that merit increased allocation to portfolios with an emphasis on healthcare and emerging markets in Q2. However, we would rather wait for some geopolitical clarity to seep in during our seasonal bottoming period between March 8th and 23rd. The corrective journey in 2022 has traced out as we illustrated severral times in January and Februray, but short term risk remains for stocks falling to our next support level just above SP 3800 or lower. Given the positive condition of technical indicators in this negative geopolitical period of uncertainty, we are also willing to add equity exposure at modestly higher levels should a breakout above the 4500’s occur, if we have yet to confirm a market bottom. We will maintain our start of the year outlook of a late January low, mid February trading range rally high and a more important low within a week of mid-March before a rally phase into the 2nd half of April. The 2022 outlook is still a broad trading range outlook that will be greatly influenced by the degree and timing of geopolitics.

The Russia – Ukraine crisis we believe will become worse before it has a chance to improve with increased use of more brutal artillery and bombing on the battle front as well as the potential for a tortuous Cuban Missile Crisis type of escalation on the nuclear front as Russia lashes out at the world that is increasingly aligned against him long term. We believe Russia would use Nukes tactically or broadly if they are offered no off-ramp to de-escalate with some sort of symbolic and partial victory. Ultimately their goal is to control Poland and the Baltic states after gaining unfettered deployment and military transit through Ukraine. While preamture, when we include the possibility that the burgeoning hostility of China towards Taiwan may be coordinated with Russia, there may be an eerily sinister potential parallel with WWII Gernamy and Italy. Events can move quickly and investors should not alter their long term investment outlook at this juncture, but the remote chance of a global war on multiple fronts is something that  investors need to monitor. With Russia’s weak economy, rapidly shrinking population and painful isolation from the world, the West can’t afford to maintain a stranglehold on Russia forever without either risking nuclear fallout of a World War III or strategically finding a degree of concession that both sides can live with. For now, this global confrontation in Ukraine will persist beyond just major shortages of Wheat, potash, fossil fuels and neon gas for computer chips. Prices have already spiked, but until official diplomacy begins, it could be difficult to see the light at the end of this tragic conflagration.


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