Putin Blinked!

By David Nelson, CFA

Geopolitics have kept investors in a defensive posture for most of the year. While the return of U.S. military operations in Iraq will dominate the front page, events in the Ukraine may be of more importance to investors.

Journalists have spent much of the year trying to get inside the head of Russian President Vladimir Putin. Some have tried to predict his next move or attempt to spell out the end game. Getting a read on the Ex – KGB Spymaster has been an exercise in futility. His head fakes rival those of any NFL wide receiver constantly keeping his opponents off-balance.

Friday’s late day rally highlighted the importance of the region. Investors had a lot on their plate that morning. On Thursday evening President Obama announced he was sending U.S. Warplanes into the skies over Iraq hoping to push back the ISIS encroachment on Erbil and provide humanitarian aid to Yazidi families trapped in the Sinjar Mountains. C 117’s and C 130’s in coordination with F-18’s from the USS George H W Bush were all used in the operations.

In reaction, futures Thursday night were down sharply as Wall Street braced for a rough open. Rumors had been swirling for days so perhaps the President’s announcement added some certainty to the coming events. Nevertheless, the sharply down open on Friday never materialized.

For most of the morning markets loitered between the flat line and modestly positive. All that ended at 1:12 PM EST when equity markets exploded higher off an Interfax News report saying Russia had ended its military exercise. Markets had been teetering on the back of news pointing to Russian troops massing along the border. Rumors of an invasion as early as this weekend circulated Wall Street trading desks for most of the week.

Also on Friday, but less widely reported was U.S. Ambassador Samantha Power’s stern warning to the UN Security Council that the United States would view any incursion into the Ukraine, even if for humanitarian reasons as an invasion. This was first reported by ABC and later confirmed by the BBC late Friday.

Putin Blinked

I haven’t been able to determine which of these news items hit first but it hardly makes a difference. In the world of diplomacy very little happens in UN chambers that’s a surprise. I’m certain Mr. Putin was well aware of the U.S. position and at least for this brief moment “HE BLINKED.”

Click Here for my interview with CCTV’s Michelle Molkori on the day’s trading action.

Trade Wars

Geopolitics and military events often cause knee jerk reactions by investors pushing them to dump risk assets and head for the exits. In the end, it’s important to step back and ask yourself what this really means to the bottom line of companies I own. Often we find it is little or nothing.

However, trade wars left unresolved eventually hit earnings and usually damage the economies of both sides. In a tit for tat battle Russia has responded to U.S. and European trade sanctions with those of its own. Russia retaliated with a ban on food and agricultural imports.

Politico reports that Deputy Assistant U.S. Trade Representative Trevor Kincaid said; “The sanctions that the United States has imposed comply with our international obligations. By contrast, Russia’s move to ban agriculture goods from the United States and the EU appears to have no grounding in the WTO rules governing international trade.”

This is where diplomacy really runs off the rails. We never seem to learn this lesson. When it comes to war whether fought with sanctions or bullets, playing by the rules only works if the other side is playing by the same set. To believe that some arbitrary set of regulations can somehow be enforced is an act of naiveté.

For investors a full blown trade war can be a game changer. Regardless of who wins, and there are many who believe that Russia will eventually be forced to capitulate, a trade war has real economic consequences. The Washington Post put some numbers to this. In just poultry, Russia imports over $300 Million or 7% of U.S. exports.

In another example of trade wars potentially hurting an industry, the Wall Street Journal reported Boeing (BA)* and United Technologies (UTX) have begun stockpiling titanium. The Journal points out that just four companies supply 90% of the titanium used in the Aerospace industry. Russia’s VSMPO – Avisma Corp controls 30%. Eventually events like these start to hit the bottom line.

Europe is entering a triple dip recession so a trade war with one of its largest trading partners only adds to the crisis.

Despite what seems like a no-win scenario for Mr. Putin, Russia has a long history of defying logic. It took a complete economic and political collapse of the former Soviet Union to end the cold war, one they simply could no longer afford to fight. With Mr. Putin’s popularity at all-time highs, the country will follow his lead regardless of how destructive the path.

* At the time of this article funds managed by David Nelson were long shares of Boeing (BA)