Geopolitical Developments: Equities Are Telling The World To Act Now To Limit Future Carnage

Equity markets are starting to crack and reflect the uncertainty of how long the War in Ukraine will last and its impact on food and energy inflation. The prospect of another Arab Spring due to inflation’s impact on poverty is troubling but the thought of it extending to every country that imports food is horrifying. I see Biden’s dithering over how much to help Ukraine backfiring as financial markets tighten and lower confidence, eventually cascading into lower consumer and business spending. 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 saw one key negative factor across global asset classes. 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 and then descend as Russia goes on the offensive in Eastern Ukraine while Zelensky pleads again for Biden to step up for freedom.

One clear fact about the War in Ukraine is the consistent overestimation of Russian capabilities and intelligence in conducting the War. This implies the West should be more aggressive in stopping Putin, but Biden still refuses to head calls from former military officers and political pundits to send all the equipment Ukraine requests. Biden’s calculus includes 3 major risks that he feels can be avoided by holding back arms, namely: 1) Putin launches nuclear armageddon; 2) Putin launches massive cyber attacks; 3) sanctioning Russian oil and gas means Europe crumbles into recession, boosting the far right and effectively sealing the new world order of aggression, revanchism, illiberalism and deglobalization. All serious risks, but as the War drags on not only does inertia and apathy build but also potential disunity, as the spat between Macron and Polish Prime Minister Morawiecki attest. The case for risking catastrophe for Western values could not be clearer.

And there is the possibility each of these risks is overestimated. It’s likely that Putin’s inner circle blanches at nuclear war, given they were clearly unsure of the War at the outset. Many pundits now claim this risk is minor, particularly as the inner circle doubtless knows the history of both countries walking back from the brink in 1962 and 1973. And with Putin’s popularity surging the likelihood grows that the inner circle starts drinking Putin’s kool-aid and backing him as if he occupies the judgment seat. So far from shrinking from this risk, Biden should recognize this risk actually grows the longer Putin stays in power.

The cyber risk is more nuanced. Most analysts are shocked at how little cyber plays in the War, noting that Putin’s tools have been basic (i.e., denial of service attacks) rather than sophisticated. But Foreign Affairs takes a more troubling view: “To the contrary, the magnitude of Moscow’s pre-kinetic destructive cyber-operations was unprecedented. On the day the invasion began, Russian cyber-units successfully deployed more destructive malware—including against conventional military targets such as civilian communications infrastructure and military command and control centers—than the rest of the world’s cyberpowers combined typically use in a given year…The cumulative effects of these attacks were striking. In the hours prior to invasion, Russia hit a range of important targets in Ukraine, rendering the computer systems of multiple government, military, and critical infrastructure sectors inoperable.”

The US likely has equivalent or greater cyber capabilities so this may explain why Putin has achieved so little despite his emphasis on coordinated cyber and terrestial war. And each day Putin remains in power the risk grows that other capable cyber actors like North Korea or Iran act against the West in an effort to complicate the War even further.

Finally there is the prospect of economic recession and whether Europeans would bear this as the price of freedom. Martin Wolf writes in The Irish Times “A survey by Clemens Fuest of the Ifo institute in Munich presented at last weekend’s Ambrosetti economic and finance forum, shows that estimates of the decline in GDP vary between a tiny 0.2 per cent and 6 per cent. As he states, “We don’t really know”. But we do know that if an embargo became necessary, it would be best to do it now: as the paper cited above explains, the justification “is the seasonality of gas demand. A cut-off from Russian gas over the summer months could be substituted from Norwegian and other sources, keeping industrial supply going.” Such an early move would also trigger the substitution and reallocation dynamics that are central to reducing economic costs.”

It’s outrageous for Germans, Italians and French to argue that significant economic sacrifice is unnecessary to secure freedom, given the history of World War II. Conjuring up that epic battle of good vs. evil would not only steel Europeans and Americans for doing what is right but arguably bring Europeans closer to rejecting the modern day vestiges of the ultra right. The political calculus for aggressively challenging Putin is clear, and the more Biden dithers the more likely confidence falters, as can be seen in recent moves down in global equity markets.

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