Geopolitical Developments: Dark Trends in Eurasia Can Flip If Modi Can Change The Indian Economy

Investors are relying on economics trumping geopolitical risks as the Russia-Ukraine crisis plays out everywhere except in the major stock and bond markets. Putin has good economic reasons not to invade Ukraine, and this suits the markets better than worrying about a break between US & Europe or the consequences of Europe rejecting Russian gas. 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), while my technical reading of key stocks in the S&P 500 is bullish. 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 was also one negative factor across global asset classes. Oil is pointing to stagflationary conditions. Taken together I expect the S&P 500 to be range-bound over the next few days.

While Putin and Biden and Macron vie for center stage the markets largely ignore the media-driven Russia/Ukraine crisis since in the current context of Russia sanctions and China’s staging of the Winter Olympics, there are simply no good reasons for Putin to actually invade Ukraine. Instead the markets are focused on more likely policy mistakes, such as increasing statism, Fed hawkishness and China’s strict COVID policy, while completely ignoring the real crises concerning the depredations in Myanmar and Afghanistan. Similarly the problems facing Pakistan now that the vicious boomerang of supporting the Taliban has returned to Pakistani territory is of little import. Professional investors are largely governed by a providential perspective, and the vested interests of the world’s powerful help investors rationalize away Russian provocations in Eastern Europe, while the consequences of recent developments in South-Central Asia can be optimistically relegated to future role of India in leading the region. This is because under Modi India has managed to grow much faster than its neighbors and maintain confidence despite the horrible toll of COVID and the poor rollout of vaccines. As S&P notes “Indian banks are set to expand lending and improve their net interest margins in 2022 as they benefit from the nation's economic recovery…Indian banks are ready to shift into a growth phase, just in time to meet rising demand as the country's economy recovers," said Nikita Anand, associate director for credit risk at S&P Global Ratings. "Faster loan growth will be bolstered by improving asset quality and a normalization in credit costs over the next 12-18 months."”

Given high levels of confidence the time is right for Modi to reprioritize his economic and cultural agenda and promote manufacturing and r&d as part of India’s ascent in a competitive world. In contrast with futile policies at improving public education and malevolent policies towards non-Hindus, Modi could reap rewards from simply liberalizing the economy to let manufacturing flourish. The consequences of eliminating land and labor policies and allowing manufacturers to build and hire as they please are not just the usual benefits of manufacturing, namely higher r&d spending and rising productivity, but also sustainably high levels of voter confidence. This is because people feel more confident when manufacturing is a large part of their economy, since it allows the less educated to make more money working in factories. In the case of India there are several other reasons confidence would rise, namely that 1) increasing manufacturing makes the trade mix with China less one-sided, 2) the tendency towards “jugaad” (i.e., quick fixes) declines as manufacturing becomes more sophisticated, and 3) making products that are anonymous (as compared with services) reduce India’s vulnerability to xenophobia in developed markets. High and sustainable levels of confidence would relieve India’s own insecurity regarding its Muslim population, and thus help Indian politicians react rationally and shrewdly towards helping India’s neighbors. Modi’s “Make In India” program is a step in the right direction and investors have some reason to shrug their shoulders at the region’s violence and intone that the future of Asia is sunny even as darkness afflicts the region this winter.

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.