Geopolitical Developments: The Status Quo Remains Between The West & Eurasia But That Doesn’t Cure The Market’s More Important Problems

Equity markets continue to trend lower toward their January bottoms as domestic socio-economic problems dominate and marry uncomfortably with the prospect of China self-immolating on a pointless zero-COVID policy. 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 neutral. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. Gold is trading as a risk-off asset. Expect the S&P 500 to fall over the next few days.

The US and Europe depend on their central banks to an unhealthy degree since fiscal policies can’t rectify underling social and ecological problems. That makes the West highly vulnerable to monetary policy mistakes and presently the markets are worried that the Fed is on course to make a major error. The flashier headlines come from the crisis in Ukraine but these headlines don’t influence the underlying negative trend that began at the turn of the New Year.

This irrelevance of headlines regarding Russia-Ukraine stem from the media missing the point of Putin’s exercise and Biden’s response: namely that Putin wants to maintain his popularity and divide Europe from the US, while Biden wants to look strong in deterring a supposed war in Ukraine. The likelihood is Putin has overplayed his hand and drawn Northern European nations like Finland and Sweden closer to NATO, while Germany moves to allow more liquified natural gas from the US to replace reliance on Russia. That hurts Russia in the long run but the process will take long enough for Putin to play other games and try modernizing the Russian economy, so geopolitically the status quo will remain. Putin wins modestly inside Russia as his popularity remains the envy of Western leaders.

Forbes notes “The president said he is working diligently with countries that export liquefied natural gas (LNG)— natural gas converted to a liquid by cooling it at -260 degrees Fahrenheit — to supply Europe should Russia invade. Qatar is the most mentioned. Australia is also up there. The United States now provides less than 5% of Europe’s gas, but it is a growing influence. Norway is Europe’s second-biggest supplier, although its pipeline is already operating at capacity. Turkey can supply natural gas to southern Europe…The United States now has markets in the United Kingdom, Spain, and France — markets to which this country is increasing its exports. But Germany could become the most lucrative.”

But Europe can’t open its markets to gas fast enough to dispose of Russia as a supplier without throwing its economy into recession. Forbes further points out:

“Europe is already experiencing a ‘quasi-curtailment’ of Russia gas flows,” says Michael Stoppard, chief strategist, global gas, IHS Markit. “The result is a European gas import picture that is starkly different from a year ago. One where LNG imports have ramped up to fill the gap…IHS warns, however, that if all Russian exports stopped, it would create a “supply deficit” that no amount of increased LNG imports could satisfy. To that end, Russia has been accused of jacking up its natural gas prices to apply pressure on Germany to permit its Nord Stream 2 plant…So far, this is more of a price crisis than a physical supply crisis,” says Shankari Srinivasan, vice president, global gas, IHS Markit. “While gas supply is sufficient to meet most market needs through the end of the winter heating season, high prices are already leading to closures of some industry and furloughing of workers in Europe.”

So the process will play out where Europe slowly opens up its energy sector while Russia tries to make inroads into Central and South Asia and keep its near abroad so tightly linked that NATO is constrained from expanding eastward. There is nothing the West can do about this since it’s mired in futile domestic politics and so can neither unite fully to counter Russia nor summon the courage to take on a high-risk war.

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