Putin on a Brave Face

The investment thesis I have proposed to guide readers this year is playing out in spades. The economy will do better than the market as volatility expands and liquidity ebbs. With stock markets now being held hostage to the triple threat of rising interest rates, a growth slow-down, and a geopolitical shit-storm, you can understand my view. When the Fed shifts gears abruptly, elevated volatility, both realized and implied, comes with the territory.

And speaking of territory, the eastern portion of Ukraine is now Russian controlled, as Mr. Putin probes for the breaking point of international tolerance to his hegemony. Despite this, an eerie calm has fallen over markets this morning. Short of live fire between Ukrainian and Russian troops, it seems that market participants have already 'priced in' this news - at least for now.

At the risk of wildly veering out of my lane, let me attempt to parse the geopolitical implications. I assume partial annexation of Donetsk and Luhansk should be enough for the time being. Putin has blunted the hopes of a quick invitation for Ukraine to join NATO, and that accomplishes his mission. A stand-off phase should ensue. The proportionate response from the Western Allies, revealed this morning, shouldn't derail the global growth story, especially in Asia or the U.S.

Oil prices should come down, as flows from Russia to the global energy market will continue, just as they did during the Crimean crisis. The flight to safety in bonds, that has flattened the curve temporarily, should reverse as the headlines refocus on the Fed and the economy. Risk appetite should slowly return and the upcoming March Fed rate move will be less hawkish now that the Russian gambit has chilled the growth story somewhat. This will allow the bulls an opening to start a rally, absent any further unexpected Russian moves on Ukraine.

Lots of 'shoulds' here but that's our new reality now that one hard to predict guy is driving the news flow. The various implications cannot be easily gamed, but I have to at least try. That's why I get paid the big ... oh wait a minute, I almost forgot this is a free site.

Sharply rising oil and labour prices have created a double-barrelled threat, as the inflation expectation and profit margin implications are quickly being recalibrated. But these stagnating effects lead to a potentially slower path to higher rates, affording the Fed room to breathe. In risk markets, positioning has been pared back and risk premia have expanded, allowing for a mean-reverting trade to take shape.

Don't forget that consumer confidence and PMI readings are in retreat as the exaggerated 'post-Covid' restart effects work through the system. These readings will take time to regain upward momentum as we 'lap the comps' that will get tougher. Although the economy will grow this year, elevated expectations, and therefore the fear of excessive rate hikes, have gotten ahead of reality in the short term - mostly due to headline inflation surprises. The pessimistic among us may believe in a more dire outcome - but that's what makes a market. Steering the middle ground between euphoria and panic, taking measured, contrarian bets along the way looks like a prudent course of action this year.

Buy and hold will work too, as the choppy transition phase to a fully re-opened economy and improved sentiment will be more noise than signal. Riding out the 'vol storm', while hard to stomach, is the best course of action for the risk-averse amongst us. Banks and other low beta stocks have held up well here.

Speculators are now getting their day. Day Trading is back with a vengeance, given the binary event risks that abound. But be sure to only bet what you can afford to lose here - remember "there are old traders and bold traders, but there are no old, bold traders".

I'm still mostly sidelined this morning as I await a 'fat pitch'. I expect that to come in the form of a post-Ukraine sell-off in oil that could come at any moment. In an homage to the Iraq invasion in 1991, I'm calling the Ukraine crisis: "Tanks at the Border 2.0".

For what they're worth, those are my Putin takes.

Risk Model: 1/5 - Risk Off

You have to respect the model here, especially as volatility measures remain elevated. The 'duress' rally in gold is hardly comforting, but at the same time, copper remains surprisingly resilient in the face of all the negatives. AAII sentiment is bombed-out as the Boomer crowd frets about retirement fund declines. The Robinhood crowd must be apoplectic after Bitcoin underperformed gold so dramatically. So much for the 'store-of-value' argument there. A "test of the lows" is the most widely quoted reason for waiting to buy stocks this week. It all seems self-fulfilling to me. So far, light volume levels imply a lack of conviction in this latest decline.

A broadening out of the market is likely given the huge shake-out in mega-cap land. Facebook should have renamed itself FacePlant, not Meta. If an equal-weight bull market replaces the narrowness we have experienced recently, I would not be surprised. The trend break that looks likely will be a healthy development, after years of just buying Apple and going golfing.

Equal Weight ETF: Relative Performance to SPY