Geopolitical Developments: The Triple Threat Of Eurasia Is Tanking Global Equity Markets

There are no financial theories for hedging risk when the risk concerns the potential for mutually assured destruction. Consequently the markets are flailing about across asset classes, and few believe the carnage is over or even in the middle innings. The volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. Gold is projecting $US weakness. But there were also several negative factors across global asset classes. The action in currencies signifies $US strength. The US yield curve is bear steepening. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to fall over the next few days.

The level of aggression coming out of Eurasia feels unprecedented, as 2022 surmounts both 1962 and 1973 for the sheer complexity of crises afflicting the world order. Not only is Russia implicitly threatening NATO while trying to lay waste to its brother nation Ukraine, but China is asserting itself ever more into Asia while North Korea is taking provocation to new levels of outrageousness. The root cause of this burgeoning triple threat is the inability to cut off Russia’s energy exports, which fuel both Putin’s war and his domestic stability. As The Economist notes “But “real-time” measures of Russian economic activity are largely holding up. Total electricity consumption has fallen only a smidge. After a lull in March, Russians seem to be spending fairly freely on cafés, bars and restaurants, according to a spending tracker run by Sberbank, Russia’s largest bank. On April 29th the central bank lowered its key interest rate from 17% to 14%, a sign that a financial panic which began in February has eased slightly. The Russian economy is undoubtedly shrinking (see bottom chart), but some economists’ predictions of a gdp decline of up to 15% this year are starting to look pessimistic.”

For Putin the key is the above reference to cafes, bars and restaurants. Russia is not the Soviet Union, where demoralization was so profound that failures in Afghanistan were all it took to destabilize the soviet bloc. Present day Russia is a hybrid of autocracy and capitalism, corrupt and often backward, but the basic freedoms are still there to carry out daily living with a modicum of enjoyment. This can only change when the energy industry is forced to retrench, as Russia doesn’t appear to have storage capacity for fossil fuels that can’t be exported away.

This is giving Xi Jinping the green light to make whatever headway he can in Asia while the West is preoccupied with arming and helping Ukraine beat back the Russian army. The diplomatic victory in the Solomon Islands is crucial as it pierces America’s military superiority, and importantly it was achieved because America was distracted. As The Atlantic notes “China’s newfound assertiveness may prove to be a bluff, but that’s not how it’s viewed by those who watch the region closely. “Even a small base could be a game changer throughout the South Pacific,” Medcalf noted. The impact on America’s security is indirect, but significant: Every Australian ship or plane that has to be kept Down Under is a military asset unavailable to support U.S. efforts elsewhere.”

Finally there is the bluster coming out of North Korea that puts all of Asia on alert and causes soul-searching consternation in Japan, since that deeply pacifist nation is now forced to resurrect the militarism that destroyed the nation 75 years ago. The SCMP notes “North Korea watchers have long had to decode Pyongyang’s missives to weed out the bluster from actual signs of policy change, given that its eccentric, dynastic leaders – now in their third generation with Kim Jong-un – have been known for their over-the-top threats…Analysts parsing Kim’s speech at a nighttime parade this week say that – beyond the hyperbole – there are serious implications for Asia’s security, as the hermit state’s supreme leader signalled he would use the North’s nuclear force not just for defence, but to assert control…While vowing to develop the country’s arsenal at the “fastest possible speed”, Kim in his speech on Monday threatened to use the North’s nuclear arsenal “against anyone who violates Pyongyang’s interests.”

The bottom line is keeping a large cash position is critical to dealing with risks that have long been thought unthinkable. I continue to see new lows before this bear market ends, likely at 3700 for the S&P 500.

Yesterday I sold my small offsetting position in the inverse levered ETF SPXU, which restores my exposure to the S&P 500 via the levered ETF UPRO. Consequently 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.