Paper Chase: Ukraine
Either way, the events in Ukraine will impact markets across the globe.
February’s employment report showed 175,000 jobs were created which exceeded economists expectations. Unemployment rose to 6.7%, but the past two months jobs numbers have been revised upwards with weather being blamed for the initial forecasts.
Americans are worth more money now than ever. Household assets rose 4% in the last quarter to $80 trillion. This can be attributed to rising real estate values and increases in the stock market.
The Market
When you increase speed from 20 to 25 miles per hour, it feels like your speeding even though you are still going very slowly. That is the most apt description for the current market. While the weather clouded a lot, once it cleared, we could see that we are in a slightly better economy. Median household income decreased from approximately $55,000 in 2000 to $51,000 last year reinforcing the fact that an increase in service sector jobs over that time was ineffectual in mitigating lost wages. Those jobs just don’t pay much. Outside of lower housing starts and retail sales, there are no more weather related excuses for the economy. The jobs numbers and the two point increase in the Chicago PMI last year is further proof that the economy is improving. Housing may take longer and it is in my opinion more related to higher mortgage rates.
What I’m Doing
We are now five years from market lows, and are currently in a market that is priced for perfection. Currently, the market is trading at sixteen times earnings of the S&P 500. Historically, the market trades at thirteen times earnings. While this does not necessarily constitute a bubble, disappointments will lead to market contraction.
Anyone getting into the market now would not be buying at the top, but more at the upper end of it. The entire market is trading at above (p/e) price to earnings ratio, except large cap growth which is still selling at a discount. It will be this way until we see some corporate revenues. Revenue growth was at 2.5% in 2013 and is expected to be at 3.8% for 2014, though that estimate has been revised downward because of the weather.
We have talked about it before on the Paper Chase, but now is the time to really alter your defense. The bond market is 3.5 times larger than the stock market and we already know that the era of ultra easy money is coming to an end due to an improving market. Now is the time to shorten duration in your fixed income investments.
As far as stocks are concerned, I take a bottom up approach. I value names that have been beaten up and/or are currently out of favor. Checkout Centurylink and Fossil Group.
Ukraine
The events in the Ukraine affected the markets for all of about a day. This is not to say that they still won’t have an impact on economy, but that will be determined by whether diplomacy, the military, or global markets resolve the conflict.
Sanctions
Sanctions will only be effective if Europe gets involved. There is limited support for sanctions as most nations are prepared to see the Russians stay in Crimea. There would be more support for sanctions if Russia were to expand their footprint in Ukraine.
European nations have been trying to figure out the best way to combat Moscow for about a century now. They are a lot more reticent for physical confrontation as geographically those nations are a lot closer to Russia than we are. The possible withdrawal of Russian bank deposits could lead to economic vulnerability as well.
Hyperbole
This is not like when Germany invaded Poland in 1938. That type of ambition or ideology is not driving this action. Putin lost orientation of the Ukrainian government when President Yanukovitch was ousted. This move in Crimea was largely to offset that political loss. If anything, this move was aimed more towards domestic Russians as some in Moscow could look at the events in Kiev and interpret Putin as being weak or vulnerable.
This move, unlike Hitler’s, is not a part of a larger design to conquer Europe. There have been Soviet challenges in Hungary(1956), Czechoslovakia(1968), and most recently Georgia(2008). It’s extremely dangerous to apply historical precedents when they really don’t fit.
Geography, Politics and History
The Crimean War of 1853 transformed the region. Because of battles, population exchanges, and nationalist movements incited by the war, the present-day states of Ukraine, Moldova, Bulgaria, Romania, Greece, Turkey, Azerbaijan, Armenia, Georgia, and regions such as Crimea and the Caucasus all underwent some degree of change. The Ukrainian War of Independence (1917-1921) resulted in the establishment and development of a Ukrainian republic which would later become a part of the Soviet Union as the Ukrainian Soviet Socialist Republic. Ukraine became an independent state in 1991, and signed a treaty with Russia in 1997 allowing Russia to keep fleet in the main port of Sevastopol until 2042.
Reality
Russia has always had a place in the Ukraine. It is believed that up to twenty percent of Ukrainians are ethnic Russians. There is hope here though. U.S. policy towards oil and gas has always been seen through the prism of dependence, but with our production levels sky high, we can use energy as a resource, instrument, or tool to curb Russian influence. I suspect that we will try (if we haven’t already) to export natural gas and oil to Ukraine, as well as the technology for them to develop shale deposits.
Russia is no longer a great power. They have little military reach beyond their region. They do have plentiful oil and gas. We can adopt our export policy to tamper the only real power they have left.
Best Case Scenario
Russia leaves Ukraine. This would probably happen through a negotiation where Russia is ensured a role in the economic and political future of the Ukraine, protection for ethnic Russians, and maintenance of strategic access to the Port of Sebastopol. This is a long shot.
Worst Case Scenario
Russia expands control over Ukraine outside of Crimea. This is also a long shot.
Likely
Russia will sit on Crimea to a point where it becomes autonomous or is absorbed in the Russian orbit. This will become the new normal.
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