Stock Market Paralyzed Until Putin Diplomacy Begins

Russian President Putin assumed he would be isolated from the world to some degree and was correct in betting that Europe lacked the fortitude to cut off critical energy imports from Russia. However, he was likely surprised by the degree and unanimity of costly sanctions that have been foisted upon their wealth and economy. The Russian Ruble and stock market are mired in the rubble of scared investors flooding the exits. As Russia approaches almost certain default on its international debt, it has shuttered its stock market, writing off Billions as they make long term departures from ever doing business with Russia again. Our own effort to sell a Russian distribution facility solidifies the common perspective to never invest there again, even if detente returns. The short to medium term and possibly permanent damage to Russia has begun with a costly long term effort to replace Russia’s critical exports of energy, high tech minerals and food supplies. While Russia can send its Oil and products elsewhere, they can’t send Oil from the Western half of Russia to the eastern half to redirect supplies to China and the enormous effort to replace Russian exports with new suppliers will keep chipping away at their national income. Poland needs Russia for 55% of its oil and Gas needs, yet they may be able to replace all of it this year through their pipelines they have been working on with Norway. While a total severing of all energy and mineral exports to Europe would be a major blow to Russia immediately, the current sanctions should still deliver a significant punch to Russia’s economy and a major flight of capital and talent from their interior.

 

Russia has long been forecasted to be a country in decline. Without the vitality of a United States’ free market capitalism and immigration boost to population, Russia is condigned to secular decay. The dramatic population fall as birth rates near record lows and death rates reach new record highs, combined with an insular Dictatorship increasingly isolated from world capital markets, paints Mother Russia with a bleak future and as a very dangerous animal with only Nuclear weapons as its future bargaining chip. 

Unfortunately, many cards can still be dealt,such as the lower odds extreme of small tactical nuclear strikes and World War III. Slightly higher odds are that Europe would find its nerve and cut off Russian energy imports entirely (and Russia may threaten energy stoppage as well). Or Russia could punish Poland for being a conduit of major weapons flowing to Ukrainians by cutting off all Polish pipelines and energy exports. Or build up a major military presence on the Polish or other Eastern European borders. Such actions could send Oil to record highs beyond $150 a barrel and panic markets quickly over rising odds of a major Global Recession. Oil and commodity spikes such as 2022 have presaged  previous Recessions. The Russian escalation of indiscriminant bombing that we talked about in past reports has begun this week. While no serious efforts at diplomacy have occurred, we actually interpret the mixed messages by both Ukrainian and Russian leaders as a positive sign that may set the parameters as a preamble to actual negotiations once Russia has gained sufficient ground through its attacks. This week Ukraine said it would not give up an inch of its territory, but separately said it was willing to discuss losing Eastern Ukraine and become an unaligned-neutral country on Russia’s border. On the Russian side, Putin’s spokespeople said they will not consider anything but a total surrender, but separately mentioned that usurping Eastern Ukraine, demilitarizing all of Western Ukriane and ensuring they are unaligned with NATO were critical elements to securing a peace agreement. Finding common ground seems unlikely until at least their Capital falls. Once this occurs with the first serious attempt at diplomacy, even if peace and war become intermittent for months, it will liklely place a floor in stock markets and trigger a strong sustainable rally phase for investors. When this catastrophic war hits the pause button, Oil, Wheat and other Russia based commodities will rapidly collapse 30 to 50% from their recent Q1 peaks.

The past 2 years of Covid have highlighted how the massive fiscal and central bank stimulus created extreme investor euphoria, yet consumer sentiment continued to fall. Government mandates and skyrocketing inflation, exacerbated by Government stimulus, have depressed consumer expectations. Worker wages are rising rapidly and the 11+ million job openings are at record levels. However, inflation adjsuted paychecks are actually contracting. What should give economists pause is the fact that the recent spike in commodities due to Russian aggression and countervailing sanctions have barely begun to be factored into sentiment and consumer spending. Driving and flying will definitely be curtailed during the busy summer season in Q2 and Q3. Should peace negotiations start with Russia over Ukraine, the economic contraction should bottom quickly with falling commodity prices. Until then, global economic contraction fears will grow along with a compression of stock market multiples.

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Our Q1 stock market correction we outlined that expected major lows in late January and mid to late March has arrived on schedule, so far. We continue to ignore normal degree correction metrics that remain oversold while we await signs of a path toward a Ukraine ceasefire before contemplating net equity additions to the portfolio. Our January/February presumption was that Putin would invade the whole country at first and then agree to pull back, settling for the Eastern quarter of the country with guarantees of a demilitarized Western Ukraine unaligned with NATO. This may still be the case, but Putin appears determined to destroy Ukraine’s military capability and grab whatever he thinks he can hold onto. If Russia attacks Ukraine’s Odessa region, it would mark a significant escalation and confirm this war will continue longer than most now assume. Analysts that have declared for weeks that stocks have bottomed are of course guessing that a ceasefire and protracted negotiations will commence within days and that using Nukes or cutting off energy from Russia is permanently off the table. Many money managers assume that investors have over discounted the consequences of sanctions as well as future Fed rate hikes. While we agree that the current sanctions and future Fed rate hikes are already priced into the current stock market, any sustainable uptrend is paralyzed until a ceasefire or war negotiations begin. Additional downside shocks, such as a Russian energy stoppage and Recession fears, are far from being discounted by current stock prices as investors await clarity over the inflationary impact of the war on world consumption and of course geopolitical risk. Should this war escalate into April without peace progress, then Recession rhetoric will rise enough for markets to start pricing in no more rate hikes or monetary tightening due to growing economic and investor despair. For now, the stock and bond market paralysis continues as war and sanctions ratchet higher without signs of Russian diplomacy. Unfortunately, this has been a major setback for some of our exciting investor portfolio sectors in reopening travel related stocks, retail shopping and financials that have joined the technology sector in the penalty box. Revenue and earnings growth are microeconomic factors that carry little importance during a macroeconomic Bear market phase. In this wartime atmosphere we have shifted our concentration to war affected sectors of cyber security, energy, mining, agriculture and military defense. Even Bonds have merit as prices rise and yields fall on growing Recession fears, even while inflation is soaring to 40 year highs during the flight to US safety trade. Our Seasonal pattern has surprised even us with its mapping of stock market action this quarter and while the end of the bottoming window around March 23rd is not a crystal ball forecast for a strong rally, we do feel we are approaching a period where sanctions and war may reach enough of a crescendo to make the markets more vulnerable for a strong 10% rally into an April high. Should recent lows in the SP 500 Index in the 4100’s break down, we continue to focus on the next levels in the lower 3900’s and possibly near 3800 where a strong base can be sustained.

 

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