Geopolitical Developments: Russia Fosters Stagflation in Europe, But America Keeps On Trucking

While Europe suffers from the twin devils of inflation and rising COVID, the US bull market holds steady due to vastly different fundamentals and geopolitical vulnerabilities. The volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is neutral. There are several negative factors across global asset classes. The US yield curve is rising and in the current context that is bearish. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days.

Worries about inflation in the US are keyed off the experience in Europe. But European inflation is partly built on rigidities in the market which result from statist dirigisme, a chronic condition America has avoided until now. Technology is why America has more productive labor and more choices, both of which keep inflation low. But technology is not Europe’s strong point, rather it’s culture and sadly culture builds up the state rather than counterbalances it. Statism makes collective action smoother but not efficacious, as the ineptitude of Brussels exemplifies. BREXIT was motivated in part by distaste for the bureaucratic policymaking of Brussels and unfortunately for Britain, the exit from EU created new problems such that inflation is an unforced error there, while it’s a tradeoff on the continent.

European ineptitude is on display geopolitically and that ties into inflation. Energy dependence on Russia is both a geopolitical mistake given the malevolent leadership of Putin, and stagflationary. Sadly Europe has no way out of this in the short run, and that redounds to the suffering in the Ukraine. As Ukraine suffers while Europe acts in its own interests, the moral rationale for the EU attenuates, which further dampens the efficacy of bureaucrats in Brussels.

The Atlantic Council notes “On 1 November, Ukrainian officials announced that Russia had stopped thermal coal exports just as stocks were five times lower than the government’s expected volumes at this time of year. The news was overshadowed by reports from Ukraine’s national gas grid operator, GTSOU, that Gazprom had decreased the transit of natural gas to just over half of the contracted capacity for 2021... Many analysts are persuaded that Russia’s intention is to stop deliveries via Ukraine much earlier than the expiry of the current transit contract in 2024, and to redirect gas to Nord Stream 2 as soon as the new pipeline becomes commercially operational... Under average demand conditions, Ukraine may not have a problem meeting consumption from other thermal plants or nuclear generation. However, this winter may prove a real test for the government and for the Ukrainian economy.”

Fortunately the US has broad and relatively free markets which keep inflation low and limit the vulnerability from Russia from an economic standpoint. But statism is in the air, and I believe the rise of statism under Biden will be slow and possibly counterbalanced by a Republican sweep in the midterms. That will help keep interest rates low, though it won’t solve the geopolitical problems which are impacting global trade and economic health elsewhere.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), Apple (AAPL), FedEx (FDX), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a small net short position in S&P 500 (the levered inverse ETF SPXU).