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There are times when it is easier to make money investing and times when it is harder; this is a time when it is harder. Investors (savers) need to simultaneously navigate a) less Fed money printing and b) a potential war—while not losing sight of the big picture, which is a transformative wave of innovation.
These forces can work in opposite directions. For instance:
a) Removing liquidity (tightening) hurts bonds, prices down, yields up (which is what has happened this year).
b) Invasions fuel uncertainty, which drives bond prices up in places like the US.
c) Simultaneously removing liquidity and an invasion is bad for stocks (which are negative year-to-date).
d) Tech innovation is good for stocks, particularly the companies doing the innovating—but a tech revolution is a longer-term trend that can be swamped by the short-term.
e) Green investing aims to cut fossil fuel investment, war with a major energy supplier (Russia) encourages increasing non-Russia fossil fuel investment.
To make money, an investor needs to balance these forces just right, which is delicate work. I am sharing how I am navigating this, for you to take or leave. THIS LETTER IS NOT INVESTMENT ADVICE.1
Ukraine
Ukraine is really complicated. You could argue forever about what its borders should be, based on competing claims from Ukraine, Poland, Russia and others. Given that, claiming the current border isn’t a true border, which in essence is what Russia is claiming, creates utter chaos. There are potential border disputes all over the world. If you open up one border dispute, you risk opening up many, including, by the way, ones between Russia and the Kremlin’s ally, China.
Culturally, there is a nationalist resurgence afoot in Ukraine. When I was a reporter in Russia in the early 1990s, I went by bus from Russia to Ukraine. Almost everyone spoke Russian. Now Ukraine is linguistically split, more like a Canada (English, French) or Switzerland (French, Swiss-German, Italian). But in Ukraine the split has happened relatively quickly; it accelerated following Russia’s 2014 Crimea invasion. Ukraine is more western the more west you go and more eastern the more east you go, which leaves it vulnerable to civil war.
Economically and politically, Ukraine has not been successful. It is one of the few countries that is poorer than it was before the Soviet Union fell apart. The culprit seems to be a combination of uncompetitive legacy Soviet industry and corrupt leadership. Corruption is a plague in many countries, including the US. But Ukraine is really corrupt, roughly as bad as Russia.
Competing Perspectives
The perspectives of the main players look almost irreconcilable. The bottom line is Russia has vastly superior military force and can seize Ukraine at will and the US is trying to convince Putin he will pay a high price for doing so. It is very risky.
Russia’s Perspective: NATO is an aggressor and the CIA is fomenting opposition to the Kremlin in the historical bedrock of the Orthodox world, Kiev. The Biden Administration is weak, exhausted by war and, as evident in Afghanistan, won’t stick by allies. Ukraine’s leadership is hostile and weak. It’s time to seize Ukraine before it slips into the hands of the West.
Ukraine’s Perspective – We have rapacious neighbors (including Germany) and a bloody history, including an administered famine under Stalin. The latest of many invasions began in 2014. Russian forces have killed thousands and the KGB successor tried to murder a Ukrainian President. Give us anti-tank and anti-aircraft missiles and we will defend ourselves. Our institutions are weak but under the leadership of Zelensky improving. We gave up our nukes in 1994 under the guarantee our borders would not shift.2
US Perspective – Where exactly is Ukraine? Our critical problems are inflation and COVID. Putin is a thug who we would have liked to ignore, but we can’t if Russia is invading a country. NATO is a defensive force,3 that was dying until Putin’s behavior resuscitated it. Given that we won’t put soldiers on the ground or use our Air Force, we can’t stop an invasion.
Europe (Germany) Perspective – We like Russian energy but don’t want impoverished Ukrainian refugees pouring into Poland. The best thing to do is negotiate with Russia. This will take time, but all of the European Union is just one big negotiation. Russia isn’t part of any significant European institutions and should be.
Charts
The charts below illustrate the above. (Rose Technology, an incredible data-visualization start-up, makes them). Russia exports oil, Germany uses that to build machinery. Ukraine exports more agricultural goods and oil products. For the US, trade is simply less important.
Ukraine is poor and corrupt, only slightly less corrupt than Russia4.
Russia has massive foreign exchange reserves, a huge trade surplus (thanks to high oil prices) and low debt. The US is the opposite. This makes Russia harder to sanction.
How to Invest?
I am a) holding less stocks (particularly in Europe) b) a lot less bonds and c) more commodities or commodity linked stocks. Here is my logic:
· Stocks. While earnings are going to be strong, price to earnings ratios (the price you pay for those earnings) are high, particularly in the US, and equities globally are quite correlated. Tightening isn’t good for PEs, invasions are worse. Implication: lower equity exposure, particularly in Europe.
· Commodities. In the event of an invasion, aggressive sanctions are possible, including on raw material exports. Oil could go well past $100. Implication: own more commodities and commodity producing companies.
· Bonds. Commodities are inflation. If we get a squeeze, inflation risks get worse, the Fed needs to tighten even more. Implication: hold less bonds, particularly short-term bonds.
· Russian Assets. Dirt cheap IF they don’t invade, un-investible if they do. The price to earnings ratio on Russian stocks is … 6! The price to earnings on US stocks is…23. If Putin invades and sanctions are applied not clear you can get your money back. Implication: avoid Russian assets. Tragically, disruptive foreign policy is starving Russian innovation of needed cheap capital.5
· Tech – Less an investment implication than a dynamic: a conflict can be cyber as well as physical. Tech also creates transparency where before there wasn’t, like Twitter shots of Russian troop movements.
What might make this go away? Maybe deterrence plus throwing Russia a bone, like agreements over military exercises? War seems more likely. Any troop pull-back results in a massive rally in Russian assets.
OTHER:
Next Podcast: Next week, we release Season #4 of our podcast. Our first guest is Jonathan Yorke, author of Into the Woods and a genius on story, both their immutable structure and why they exist. I think you are going to love this podcast, which Still Press Producer Dave Manahan is putting the finishing touches on now. Here is an out take.
Ask Me Anything: Today at 2 PM Eastern. Subscribers should have all the details already.
Parting Images: As I researched Ukraine this week, I reflected on my own early experience with Russian tanks. I was 25, living in Moscow and witnessed enormous tanks fire on civilians. Terrifying. My friend (and podcast guest!) Paul Fetters took this picture after the hostilities ended.
I thought about this week’s post while walking along the beach shown below, snow mixed with sand. It is single digits in Connecticut. Russian gas heats Europe.
Investing is risky. You can and will lose money. A reader asked me about my background. In addition to the information cited above, I started as a reporter in Russia in the 1990s. During my 20+years on Wall Street, part of the time I focussed on Russia.
Budapest memorandum, 1994. https://en.wikipedia.org/wiki/Budapest_Memorandum_on_Security_Assurances
NATO moved troops to the Baltics after Russia invaded Crimea.
We inverted the rankings from Transparency International, higher is worse.
I wrote about this in The Cost of Invading and The Talent Skedaddle.