What Financial Markets Are Telling Us: Unpredictability Now Rules
Geopolitical foundations have eroded and the markets will now suffer along with people across Europe. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. There are several negative factors across global asset classes. Gold is trading as a risk-off asset. Oil is pointing to stagflationary conditions. The action in currencies signifies $US strength. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to fall over the next few days.
The bulls were set to take this market higher as hedges had declined and volatility had risen moderately (i.e., the VIX < 30) while bond market volatility had accompanied lower inflation expectations, all suggesting a reversal. But the market and writers like myself have operated on the incorrect assumption that Putin behaves by incentives. In the past 24 hours Putin has broken through the incentives and is now unpredictable, making the geopolitical foundation for markets unpredictable.
Biden’s prediction of an invasion was either based on tremendous intelligence and analysis or a political move to box Putin in and force his hand, the consequence being that Russia will suffer in the long-run and Ukraine will suffer now. The existing sanctions will reduce confidence in Russia as Putin is going out on a limb, but to really influence Putin requires the two big sanction options: SWIFT and technology blocks.
Even if Biden could lead international sanctions on SWIFT and semiconductors they would have huge drawbacks: SWIFT sanctions causes inflation in Europe and possible shortages which would reverse expectations and cause recession unless fiscal taps and energy reserves were tapped even more, a high price for changing Russia. Semiconductor sanctions on the scale of an entire country could lead to shortages of key components for semi production, so highly uncertain. So the market doesn’t expect any more ratcheting from the US and consequently this morning’s decline is actually less than such a historic geopolitical event would merit, meaning the market actually thinks after the initial downturn there will likely be a rally that catches the shorts offside. Importantly, China could restrain Putin since the reaction as given in the Global Times implicitly criticizes Putin.
The Chinese reaction is critical but for the time being I believe the unpredictability of Putin changes everything. The problem is Putin hasn’t followed incentives so far and is willfully damaging his credibility, most flamboyantly in couching his invasion as denazification, which is easily derogated since Ukraine’s leader is Jewish and democratically elected in a people’s vote to bring in an untainted outsider to clean up the nation’s corruption. It is also possible Biden will ratchet things up by mooting the idea of a blockade of Kalinigrad or Turkey closing the Bosphorus to Russia.
Yesterday I again took an additional small position in the market via the levered ETF UPRO. and my current positions still include a sizable cash position, as well as Amgen (AMGN), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.