By Michael Every of Rabobank
*You* can't trade geopolitics
We aren't in WW3 yet - despite worries Russia, not bad weather, just took down a Romanian military helicopter and jet - but this crisis is answering a question I have long pondered: how would our 24/7 clickbait, read-no-history, central-bank-liquidity-addled, algo-driven markets have traded WW2? The answer: stupidly. Every other day for six years they would have wondered if it was over yet. While the Battle of Stalingrad raged, they would ponder waterfront condos in the city centre. On D-Day they would have turned the TVs off and gone back to their desks, exactly like the traders I worked with at another bank did in 2003's Iraq War after the statue of Saddam Hussein fell. "No more to see here." "What about insurgency, terrorism, Iran, and regional chaos?" “Shut up and buy assets." Of course, in WW2 markets were largely closed and stockbrokers had to fight too, as in Ukraine now, which changes one’s view of how to trade life.
In a war where one side is led by a former comedian, our less reality-based traders and analysts are inadvertently the funny ones. How about Moody's saying Russia's refusal to allow payments on new FX debts was "a credit risk"(!) and that this decision suggested "a lack of checks and balances" in the Kremlin(!) And how about the attempt to rally on news Russia will talk to Ukraine? Because the Kremlin has never lied: it didn’t claim it would never invade Ukraine; it didn’t just claim it was *Ukraine* which bombed Kharkhiv’s Freedom Square yesterday.
Here's a clue for analysts: don't read what leaders or foreign ministers or ambassadors say abroad in English summarised in Bloomberg bullets. Read what they say at home in their own language. And *read who their leaders read* because that tells you what they are thinking. Last year I told people to read Marx vis-à-vis Common Prosperity; to predict this war one should have read Dugin or Ilyin, a fascist so favoured by Putin that he was personally involved in having his body reburied in Russia and his grave reconsecrated. If you can’t read in the original or are pressed for time, let others do it for you. @y_akopov summarised Russian nationalist intellectual thinking on Twitter yesterday thus:
The war is expected to be over in days, or weeks at most. The main bulk of Ukrainian forces in the East is going to be encircled soon, and the main cities are already under siege. The losses are admitted to be "higher than expected", but it changes nothing. The possibility of resistance after the active phase of war is dismissed, they are confident that after there is a change of power and Ukrainian activists are purged by military police, most people in Ukraine will come to their senses and accept the new reality.
The war is existential in a way that it is supposed to destroy the Ukrainian identity. The desired outcome seems to be not friendly Ukraine with a new government, but at least partial annexation with Ukrainian culture suppressed. There is no talk of a nuclear or further wars yet in these circles. This so far can only be found (albeit quite easily) in 'normie' accounts. Europe arming Ukraine is seen like a futile exercise (too little too late) rather than casus belli.
Sanctions. They are widely considered to be survivable thanks to preparations made since 2014, and the most severe ones are expected to be lifted soon after when Ukraine is defeated. Russian billionaires forced to move to Russia with their money is considered to be great. Autarky is believed to be good. The focus is mostly on tech with explanations how Yandex can provide everything Russia needs. Imports from China are expected to cover all reasonable needs in goods, and domestic manufacturing is expected to boom. Overall, complete dehumanisation of Ukraine, dismissal rather than aggressive challenging of the West (yesterday's hegemon) and the start of a Russian golden era.
Does any of this sound like a regime about to enter into productive peace talks? Meanwhile, Russia just closed its last two semi-independent radio stations and made spreading "fake news" about the war illegal, with a prison sentence of up to 15 years. There are reports that departing airport passengers have to unlock their phones to show their social-media profiles and prove they have not made anti-war statements. Rumours are of mobilisation of men of fighting age and/or an exit ban for those aged 18-60, as in Ukraine: that is where you get an army large enough to occupy a large neighbor from; or more than one neighbor. Or we could see martial law imposed tomorrow. All this suggests a regime doubling down not backing off under pressure. Likewise, for those thinking this is a chance for China to emerge as a good global actor and rebuild bridges to the West by helping broker peace, the US are claiming Beijing knew the invasion was going to happen and asked Putin to delay until after the end of the Olympics.
Of course, Russia is under huge pressure. There are also widespread reports of the Russian military seeing rising troop discontent and self-sabotage: the 40-mile convoy to Kyiv is perhaps a traffic jam, because it isn’t moving into Kyiv proper. There is certainly much more artillery fire to grind out Russian victories across the south of Ukraine. Reportedly, entire residential districts of besieged Mariupol have been leveled; the town of Konotop was told to surrender or be flattened; the key city of Kherson just fell, opening up the roads to the grain port of Odessa; and we already saw the black comedy moment via Belarus’s Lukashenko inadvertently showing the world that Moldova may be next. But if there are to be negotiations, Russia wants to make them with a knee on Ukraine (and Moldova’s?) neck, making any Ukrainian and Western concessions harder to conceive.
As such, Russia and Belarus are being further excised from the international community, economy, and markets. Sanctioned or not, nobody wants to touch Russian goods or assets. As someone on Twitter claims, "I work in the aviation sector, and I can tell you that for all intents and purposes Russian aviation has -at best- about three weeks before it’s show over." Likewise, no more Apple products; and no more Microsoft. Even MSCI are to remove “uninvestable” Russia from their benchmark market indices (but the big Western accounting firms and management consultancies are staying put). Meanwhile, Ukraine’s foreign minister has stated that coordinated efforts to prevent evasion of sanctions are needed. That says that we are not just in our Ukraine metacrisis Scenario B (war and biting sanctions), but the risks are we are edging towards Scenario C (war and biting sanctions and secondary sanctions – and a bifurcated global economy).
So now let’s pivot to a cliché getting lots of airing by The Street - "You can’t trade geopolitics". But why not? Is geopolitics inherently different to a natural disaster; or elections with binary outcomes and opinion polls that can be wrong; or economic data which can be six sigma outliers; or central bank policy cycles? It's either all a random walk or nothing is. The key point is not all “geopolitical” developments matter to markets. In fact, very few do. In order to qualify, one needs to involve either large economies and/or a critical mass of economies, and/or critical inputs/outputs. You shouldn’t try to day-trade a brief firefight in the Middle East. However, that’s not the same as using economic history, political science, sociology, psychology, ideology and theology, heterodox economics, defence studies, and the assumption of complex non-linear dynamics to look for triggers for huge market shifts. That’s just hard to do: it’s not that you can’t trade geopolitics, it’s that *you* can’t trade geopolitics.
As an example, and of more inadvertently funny analysis, see the notes from people who didn’t see this war coming arguing how markets trade during wars – using WW2, the Korean War, the Vietnam War, and the Gulf War as one example, and then averaging them; or the Suez Crisis, the Cuban Missile Crisis, the Soviet invasion of Czechoslovakia (but not Hungary for some reason), the Yom Kippur War, the Soviet-Afghan War, the Gulf War, the bombing of the World Trade Centre, 9/11, the Iraq War, and the 2014 Crimea Annexation as another set, and then averaging them. To put a median through these is like plotting median war deaths in every past conflict (WW2 was 85 million; the Soviet Invasion of Afghanistan was 2 million; the Soviet Invasion of Czechoslovakia was just *249*). It is geopolitically and statistically ridiculous in that it misunderstands the very fat tail risks involved in both. To put it another way, it makes as much sense as saying “This is the average hospital bill for every health event over your lifetime” when we all know that, except for some unlucky folk, the bills when we are young (e.g., a broken arm or a minor op, etc.) are usually a fraction of the ones of when we are older (e.g., for a serious/chronic disease, heart attack, or organ transplant, etc.)
Yes, ‘Gavrilo Princip’ moments don't happen every day, and looking for them daily is ridiculous. But not looking for them when we know they can happen is a sillier strategy. Did we not flag back in January and again pre-war that if we were to see this war then:
Energy prices would soar: as nobody now wants to touch Russian oil, the US hints at Russian energy sanctions, Brent touches $115, and European gas leaped 55% and coal 30% on the day.
Agri commodity prices would soar: as wheat hits a 14-year high and other key benchmarks move higher with it.
Bond yields would fall: which they had before partially reversing, and even global bellwether US and UK 2s yo-yo like penny stocks. Despite Powell’s statement yesterday that “the near-term effects on the US economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain”, which Philip Marey covers in more detail here, January’s huge ADP job losses flipping to huge job gains on revision is more on the Fed’s radar than NATO. Indeed, while they may go slower now due the war, the war risk is they will have to do more later on, despite the yield curve already screaming policy error. And when that occurs, recall the Fed’s website shows during WW2 it “supported the war effort in several ways: it helped finance wartime spending, fund our allies, embargo our enemies, stabilize the economy, and plan the return to peacetime activities.”
Equities would fall: which they have when they remain focused on what matters (which is never for long of course).
The Russian ruble would collapse and perhaps see the FX market frozen entirely, which is the case, while the US dollar would outperform as traditional safe haven, especially vs. the Euro. Meanwhile, with Russia disappearing from the economic map, and so Russian petrodollars disappearing from the global rinse cycle just as rising US dollar commodity prices mean global importers need more greenbacks to feed and fuel themselves, ex-Fed Street guru Zoltan Pozsar argues US sanctions are likely to see demand for the dollar to *fall*(!) Yes: once we find an alternative currency with a massive import-based consumer economy, rule of law, liquid financial assets, an open capital account, and a hegemonic military machine. Until then, not so much. That’s a funny market call when trying to trade geopolitics.
As argued many times previously, this would be the kind of political excuse needed to crack down harder on crypto, which is what we also heard from the Fed yesterday.
How hard is that “geopolitics” to trade? If you want to ignore all of the above then ironically let one market drive your view of geopolitics, not vice versa: are US defense stocks dipping yesterday signal or noise? But then again, what is the off-ramp from here? How does one plot out the roll-back of current sanctions? Oh dear – we are back to difficult questions for The Street: time to say “You can’t trade geopolitics” again!