Geopolitical Developments: Eurasian Newsflow is Pumping Up Markets But Only Putin’s Arrest Can Restore The Global Order

A classic bear market rally is in the process and likely to persist this week barring a new disaster for the global order. Unfortunately the risk is growing that such a disaster will happen as Putin finds himself losing on all fronts. For now the market is happily myopic and the volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish. Yesterday's cross-asset action brought several positive factors for US stocks. The action in EM currencies indicates the $US is somewhat weak. 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. Oil is pointing to stagflationary conditions. Expect the S&P 500 to rise modestly over the next few days.

News from China has ticked up with the moderation in COVID cases in Shanghai, while information out of Ukraine points to deep losses by the Russian army for minimal gains. On the economic front data has surprised to the upside in the US and Europe and the $US has consequently cooled down, all of which combine to send the bears packing this morning. But one consequence of the good news out of Ukraine is the potential for a humiliated and fearful Vladimir Putin to resort to the nuclear option. Politico notes “While any use of a nuclear weapon is unthinkable to most of the world, under current Russian military doctrine — usually described in shorthand as “escalate to deescalate” — Putin could choose a nuclear “demonstration” as a warning to halt further American military aid to the Ukrainians. In other words, for the Russian leader, detonation of a tactical nuclear weapon by Russia is entirely thinkable. And so the West needs to do some thinking, too.”

The market discounts this heavily on the logic that Putin would be wading blind into unchartered territory and thus out of character. The potential for a NATO response is limited, but what would theoretically chasten Putin is the prospect that his neighbor Kim Jong Un could get into the nuclear act himself, likely by bombing a small island possession of the historical enemy of Korea, Russia and China — Japan. That would wreck the global order and crater the global economy, reducing demand for the fossil fuels that keeps the Russian economy going and keeps Putin in power. But while this logic is sound so was the notion that Putin wouldn’t commit an obvious strategic blunder by invading Ukraine.

Politico breaks down Putin’s options as follows: “Reportedly, the smallest tactical weapon in the Russian nuclear arsenal has a yield of about one-third the size of Hiroshima or Nagasaki bombs, or equivalent to about 5,000 tons of TNT... There are a few ways that such a tactical nuclear weapon could be used to fire the kind of “warning shot” envisioned in Russian military doctrine. These options come with increasing degrees of risk for the U.S., Ukraine and its allies, and for Russia…Least provocative would be Putin’s resumption of above-ground nuclear testing — by detonating a low-yield nuclear warhead high above Novaya Zemlya, the old Soviet test site in the Arctic, for example...A more provocative demonstration would be an ultra-high-altitude explosion of a more powerful weapon over Ukraine itself... A similarly powerful explosion above Kyiv would not only be visually spectacular but would likely plunge the capital into prolonged darkness and silence by shorting out computers, cellphones and other electronics. EMP effects might also extend into NATO member countries. But the extent of damage from the pulse is unpredictable, and Russian communications could also be affected... Most dangerous — and, for that reason, perhaps least likely — would be using a tactical nuclear weapon to achieve a concrete military objective such as disrupting the delivery of weapons to Ukrainians fighting in a city like Mariupol.”

This is not unthinkable, since Politico recalls that others have thought about the same and voiced it publicly. They note “In 1981, with the Cold War again heating up, Secretary of State Alexander Haig — a former NATO supreme allied commander — let slip that “there are contingency plans in the NATO doctrine to fire a nuclear weapon for demonstrative purposes …”

This risk is a key reason I expect the bear market to persist after the current rally fizzles by the end of the week. Food shortages in Africa, conflict and terror in the Middle East and cyber wars everywhere are with us now, but the gravest consequence of all lies dormant until Putin goes and is replaced by a sensible Russian.

Yesterday I bought an incremental position in the levered ETF UPRO, Consequently my current positions include a large but smaller cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO