Geopolitical Developments: Eurasia Contains Multiple Flashpoints That Will Drag This Market Lower, Russia Being Just An Attention-Grabber

While the Russia-Ukraine crisis makes headlines it’s other issues that really dog the market, and make today’s spike higher likely a temporary move. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), but my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes. Gold is trading as a risk-off asset. Oil is pointing to stagflationary conditions. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to fall modestly over the next few days.

Per my earlier blog postings I view the Russian threat of war against the Ukraine extremely improbable and nearly impossible while China hosts the Winter Olympics. This morning a spike in equities reflects the latest headline from Russia and like the others it will be inconsequential to the market’s near-term action. The deeper issues concern potentially huge mistakes from the Fed and the Chinese Communist Party, both of which seem likely given Fed Governor Bullard’s comments and the latest news regarding suffering in Hong Kong. But yet another issue that is brewing of great geopolitical impact is the deteriorating security situation in Pakistan. Should this persist there will be yet another reason for the S&P to test the 4200 region again, but with the prospects of this being just a way-station towards further losses.

The issue in Pakistan is terrorist attacks that seem to come from all angles, and the reflexive reaction of leaders to implicate India, which plays into the hands of the right-wing religious nationalist leader of India, Narendra Modi. These two countries are the only border antagonists that have nuclear weapons directed at one another.

The diplomat notes “The recent attacks underline a surge in terrorist activities that Pakistan has witnessed since the Taliban took control of Kabul, Afghanistan last year. An Islamabad-based think tank, the Pakistan Institute for Peace Studies, recently published a report endorsing the fear that Pakistan has been slowly sliding into chaos and instability for the last couple of years. These terrorist activities were mostly carried out by banned outfits including the Tehrik-i-Taliban Pakistan (TTP) and the Baloch Liberation Army (BLA)... Based on the trends emerging from and tactics employed in recent terrorist attacks, security experts believe that a TTP-BLA-IS nexus is in the making... The Pakistan Army and the government both believe that such attacks are carried out using Afghan soil with the complicity of India, which seeks to sabotage Chinese investments in Pakistan...”

“In another development, National Security Adviser (NSA) Moeed Yusuf visited Kabul to convey Pakistan’s concern regarding sleeper cells of the TTP and other insurgent groups in Afghanistan. He was assured that Afghan soil would not to be used to plan or conduct attacks against Pakistan. However, just a few days after Yusuf’s visit to Kabul, at least two soldiers of the Pakistan Army were killed in gunfire from across the Afghan border…A report sharing similar concerns has also been rolled out by the U.N. Analytical Support and Sanctions Monitoring Team. The report says that between 3,000 and 5,000 fighters of the TTP are still active in Afghanistan, despite the assurances given by the Taliban regime otherwise. It also states that the group closely collaborates with al-Qaeda and Jamaat Ansarullah to plan attacks on Chinese interests in Pakistan.”

The best that can be hoped for here is the terror attacks diminish and some resolution is arrived for Pakistani civilian leader Imran Khan to work together with opponents from the Sharif and Bhutto-Zardari clans. Even the hints of this happening would likely defuse the situation and remove a dark cloud on global equities.

Yesterday I added to my position in 3M (MMM). My other current positions include a sizable cash position, Amgen (AMGN), Goldman Sachs (GS), Johnson & Johnson (JNJ), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.