US equities closed out a truly chaotic week with a spectacular two-day rally, even as the fight for Kyiv raged and the US moved to join the UK and EU in sanctioning Vladimir Putin and Sergei Lavrov.
The sanctions are meaningless, of course. It’s all about symbolism. Putin and Lavrov are henceforth in the same category as Kim Jong Un, Khamenei and Moscow’s man in Belarus, Alexander Lukashenko. Video evidence verified by The New York Times suggested Russia may be using cluster munitions in civilian areas, a heinous breach. Russian police, meanwhile, arrested anti-war protestors for a second day. Demonstrations in multiple cities led to more than 1,500 arrests.
After a phone call with Beijing during which Xi personally called for negotiations, the Kremlin indicated Moscow was open to talks. But Russia seemed determined to oust what Putin has ludicrously taken to calling a “junta” in Kyiv.
Putin’s “junta” characterization of the Zelenskiy government was indicative of what looked like a rapid descent into some kind of madness at the Kremlin. On Friday, for example, Maria Zakharova alluded to the possibility of Russian military action against Finland and Sweden. Just in case anyone was under the impression she was taken out of context or that something may have been lost in translation, the Foreign Ministry posted the quote, translated, to its official Twitter account.
Meanwhile, the financial media finally got around to acknowledging that the price action seen over the past two sessions on Wall Street wasn’t solely based on human beings changing their minds midday about the outlook for Ukraine. “Fund managers cut positions furiously in January and February, loaded up on options-market insurance and plowed into short sales,” Bloomberg wrote Friday afternoon, adding that those “precautions may be feeding the velocity of the turnaround.”
Yes, they very well “may be.” I’ve been especially keen on that point over the past 48 hours. The same dynamics that drove Thursday’s reversal were doubtlessly in play Friday. The S&P remained some 9% from record highs even after the bounce (figure below).
“[The] US equities rally needs to transition from ‘hedge monetization'” to actual upside buying “on enhanced risk appetite,” Nomura’s Charlie McElligott said, adding that “the issue with impulsive ‘downside monetization’ flows from the options side being the primary catalyst is that the mechanical covering of dealer short hedges does dry up at some point and needs to be handed off” in order for the rally to sustain itself.
Again, what you saw on Thursday and Friday was the product of what I’ve variously called “tinderbox” dynamics. That’s not to suggest it wasn’t “real.” It’s just to say that the majority of market participants (still) aren’t apprised of how modern market structure works.
As for rates, breakevens have moved higher, putting downward pressure on reals, a headache for a Fed that needs to tighten financial conditions (figure below). The slow de-rating in stocks was probably welcome news at the FOMC, right up until the catalyst was war. Now, the inflationary read-through of the conflict is mechanically pressing real rates lower again, an FCI easing impulse officials don’t need.
Liftoff is still coming in March barring some truly disastrous turn on the geopolitical front. Friday’s US econ data suggested the American consumer is still resilient and inflation still very hot.
“While US rates appear to have absorbed the risks associated with Russia invading Ukraine, we suspect that investors are more eager to move beyond the event than the realities on the ground will allow,” BMO’s Ian Lyngen and Ben Jeffery, ever the diplomats in a world woefully short on diplomacy, said Friday.
“The proximity to NATO countries leaves the prospects for an Article 5 trigger relevant, although all indications are that Putin’s ambitions will stop with Ukraine,” they went on to write, in a characteristically eloquent note, before expressing “caution” on the idea that “Russian forces in Kyiv will be the inflection point for financial markets to simply move on and quickly return to trading the fundamentals.”
In his own Friday missive, Rabobank’s Michael Every said what needed to be said. “Kabul and Kyiv: What a geopolitical track record for Western hegemony that would be within 12 months,” he remarked. “The world is already asking ‘Where next?’ — because there will be a ‘next.'”
Unknown if the battle of Kiev will be short or long. Russians have overwhelming force but as we saw in Fallujah, cities favor defenders. Longer and bloodier probably means stronger sanctions. A SWIFT ban is not inconceivable, neither is Xi pressuring Putin to pull back; Putin must be whipping his generals to quickly decapitate Zelensky / Ukr government so he can present a fait accompli.
Near term I think the course of the war and sanctions is the main factor for Euro markets. I realize that sounds infantile, but it is meant as a contrast to US markets, where attention should turn back to the Fed and inflation.
FOMC members seem to be quashing any investor hopes that “geopolitical events” will slow their tightening, with more musing about 50 bps in recent days. Commodity price-driven inflationary pressures are, Capt Obvious, getting worse. My contacts in manufacturing companies tell me supply chain is not getting better – one company (global producer of heavy equipment) has such a pile-up of WIP that cashflow is getting squeezed and a hiring freeze was just ordered despite a years’ revenue in backlog and a serious labor shortage. Housing pressure on inflation is baked in to stay high. Fed knows all of this and can’t like 2Y-10Y. I think musing about active QT sales targeting MBS and longer dated will pick up.
Assuming that this week’s rallies were options-driven, and non-retail discretionary money doesn’t join in next week – looking for institutional money, not just retail BTD / chase – when the calendar flips to March and liftoff is just weeks away, I think the risk is to the downside.
Oh, forgot to mention – from an old school, obsolete, Graham & Dodd, OkBoomer point of view, SP500 looks roughly fairly valued to a rather pessimistic scenario (rF and ERP +100 bp, 2 ppt haircut to N5Y FCF growth, 1 point discount to historical multiples from my chosen reference period) so the valuation spring is compressing. For those who believe in skating to where the puck is now, using today’s rF, ERP, and FCF forecast, index valuation looks attractive. I personally think a moving target has to be led, but recognize that some strategists’ “valuation commentary” should be getting more constructive. When enough Fed shoes have dropped, and assuming they don’t crash through any floorboards, I’m looking forward to spending cash later this year.
I took a break from NFTs to buy some US tech on Thursday morning. I mentioned that in an article when I did it. Comms Services was down ~25% from the highs. I’m sitting on large (in percentage terms, anyway) gains on oil & gas shares I bought during the pandemic, so that was my hedge in January and into this month as well. There’s also an (amusing) argument to be made that crypto has held up remarkably well. Folks will laugh, but think about it: Bitcoin, Ether, Avalanche and Solana are down between 35% and 65% in an environment where the Fed is telegraphing aggressive tightening, the fiscal stimulus spigot is turned off and Russia sparked the biggest security crisis in Europe since World War II. It’s a miracle crypto didn’t implode entirely. Facebook, PayPal, Netflix, the Cathie Wood complex, etc., etc. all suffered the same losses as crypto. That said, I’m becoming very concerned about DeFi. I was enthusiastic at first, but almost every platform and protocol is based on Ponzi dynamics. In most cases, it’s not clear (at all) that the developers even realize it. Anyway, just some thoughts.
I’m very happy you’re seeing this. I wouldn’t want you to heed the sirens of absurdly high interest rates on Monopoly money.
I was reading today that Russia started talking about invading Norway and Switzerland. Hopefully they don’t.
Mr. H, U quoted BMO, “…all indications are Putin’s ambitions will stop with Ukraine”. A week ago the world was whistlin’ Dixie while 200,000 Russian troops had surrounded Ukraine on 3 sides. I was naive along with many in thinking that a full scale invasion of all Ukraine was very unlikely–wishful thinking cognitive bias. Now it’s becoming obvious that Putin’s real goal is to actually test Article 5/the unity of NATO…. when push comes to shove…comes to tanks and a “minor incursion”. Poland appears most clear-eyed and appears to have no delusions about the menace of Russia. The Baltics are tiny in population and size. A “minor incursion” into Latvia or Lithuania, or Estonia….will have Germany gyrating with excuses and diplomatic doublespeak about how the flow of Russian gas into Germany can’t be interrupted under any circumstances. As the 20th century repeatedly demonstrated, the Europeans will then happily volunteer American boys to fight their wars while they sit in their cafes. Because such a descent into madness is ‘unthinkable” is precisely why we refuse to think about it. Its not an accident that Putin has brazenly attacked civilians in multiple cities with cluster munitions–a deliberate strategy to terrorize populations into quick submission. Terror has effectively been used by Genghis Khan and many other tyrants in history. In summary, these events demonstrate that rules-based “globaloney” has been exposed as impotent. Maybe Peace thru Strength isn’t such a bad idea after all.
“As the 20th century repeatedly demonstrated, the Europeans will then happily volunteer American boys to fight their wars while they sit in their cafes. ”
That is one thing the 20th century clearly did NOT demonstrate. Here are the death-only numbers for major country participants in the Great War:
United Kingdom and colonies (953,104; UK- 744,000); France (1,150,000); Italy (460,000), Romania (335,706); Russia (775,369-1,700,000); United States (53,402). Source: Wikipedia
I think you’ll find a similar distribution for WWII.
German statement in favor of “targeted, functional” exclusion of Russia from SWIFT. Germany also seems to be reconsidering its blocking of weapons aid to Ukraine. Canada and Italy have switched from no-ban to yes-ban. Seems only a matter of time before the SWIFT sanction is applied.
If Xi is getting alarmed at Putin’s behavior, he doesn’t need to take action against Russia, just slow walk the support that Putin is counting on. CIPS might have technical difficulties, Chinese banks might need extra time to review LOCs, all regrettable, so sorry!