Why Ukraine Matters To The Markets

The headlines this past week were focused on the Russian invasion of Ukraine, so let’s step back and look at the big picture and see how that may impact the markets.

After years of conflict, Ukraine fought for and obtained its independence from the Soviet Union on Aug. 24, 1991. It began rebuilding its society in a Democratic version of the West (United States). There are approximately 43 million Ukrainian citizens that pride themselves on creating a productive society that enjoys a mostly carefree way of life; much like we enjoy here in the U.S. It is hard for most Americans to fathom what it’s like to experience war in our hometowns. Our thoughts are with Ukrainians who are suffering through this.

But Vladimir Putin sees the world quite differently. There are many reasons why he wants to take over Ukraine, the least of which are that he wants to see the Soviet Union look like the country that existed prior to the 1990s. He has been preparing for the current confrontation for quite some time, divesting Russia of all its holdings and stocking up on .

Putin also wants to keep the “Democratic” West way of life far away from his citizens and mitigate the influence that may have on Russian society.

The one thing that does not seem to be discussed in much length is the abundance of natural resources that Ukraine produces. Possessing these would be a huge boost to the Russian economy and its control of strategic assets.

Absorbing a country with abundant natural resources is critically important to Putin as current day Russia has multiple issues. It has aging demographics, a stagnating economy whose is less than the state of Texas with 5x the population, and corruption that is considered the highest in the world as 85% of its wealth is controlled by less than 10% of its population. Its is sitting at 2008 prices…worst in the world, which is not surprising with a stagnating economy. In fact, Russian GDP is less than what it was in 2008.

And the most compelling reason he wants Ukraine is so that he can easily control the critical flow of energy (the lifeblood of any economy) to much of western Europe.

Here is a list of the critical commodities that Ukraine possesses:

  • 1st in Europe in proven recoverable reserves of uranium ores
  • 2nd place in Europe and 10th place in the world in terms of titanium ore reserves
  • 2nd largest reserves in the world (30 billion tons)
  • 3rd place in Europe (13th place in the world) in shale gas reserves (22 trillion cubic meters)
  • 4th in the world by the total value of natural resources
  • 7th place in the world in coal reserves (33.9 billion tons)

Ukraine is also an agricultural country:

  • 1st place in the world in exports of and sunflower oil
  • 2nd place in the world in production and 4th place in barley exports
  • 3rd largest producer and 4th largest exporter of in the world
  • 4th largest producer of potatoes in the world
  • 8th place in the world in exports
  • 9th place in the world in the production of chicken eggs
  • 16th place in the world in cheese exports

Ukraine can meet the food needs of 600 million people.

Ukraine is an industrialized country:

  • Europe’s 4th largest pipeline system in the world
  • 3rd largest iron exporter in the world
  • 4th place in the world in titanium exports
  • 10th largest steel producer in the world (32.4 million tons)

US markets tanked leading up to and during the initial day of the Russian invasion. Reality had set in after weeks of conjecture.

Far worse was the potential disruption to the World economy this conflict could and would impose (especially Europe). The above referenced exports might stop overnight and the prices of , wheat, and other agricultural products that Ukraine produces, shot straight up.

Clearly, this could have a detrimental effect on Europe and exacerbate already sky-high global inflation rates. This should motivate the Federal Reserve to take aggressive action at their upcoming March meeting.

However, the war in Ukraine and additional geopolitical stress might cause the Fed to ease or reverse its hawkish stance, and we could end up with another bad news rally much like what happened after the outbreak of COVID in 2020. See our previous articles about inflation here:

Why did the market rebound these past two days”?

There’s an old adage on Wall Street, “buy the rumor, sell the fact.” This is synonymous with “sell the rumor, buy the fact.” Markets trend based on greedy or fearful expectations, and then reverse when those expectations come true. This is what happened last week.

This pattern has a reliable history when it is based on war. In fact, there is a saying on Wall Street that the market likes a war. The last 5 major wars had significant selling preceding the actual event. Once the invasion occurred, the stock market rallied hard.

To some degree, the market had become so oversold, the reality that the invasion had happened, sent a relief to counteract the fear and trepidation that had taken over the markets these past few weeks.

The second input was that interest rates backed off their recent climb. This indicated a flight to safety and signaled that there would be less pressure on the Fed to be overly aggressive at their next meeting in March.

Third, sometime midday Friday, it was reported that President Zelenskyy of Ukraine and Putin would sit down to discuss a cease-fire and truce. This may or may not be true, but the market took it as a positive sign and rallied hard into the close on Friday. As we are writing this Saturday morning, that possibility seems remote.

Some pundits believe that the market had confirmed that it was a “correction,” and it was time to buy. Many of the institutional and individual investors who had plowed into Puts on the indices these past few weeks began to close their positions and take a long position. Investors were encouraged to search for bargains and redeploy money that was sitting in cash since early February.

Last, it is the end of the month, and that typically has a bullish bias for investors. Whatever the reason, we rallied hard Thursday and Friday and saw the gain 5% in two days.

What now? Where should we go?

A few of our Risk Gauges have improved, and we may be stepping back in the market on some of our models in the near future (or not). Our rotation into Oil, Commodities, and Agricultural sectors has benefited our clients these past few weeks and enabled us to continually take profits as they’ve moved higher, especially on the big gap up on Thursday.

One thing that remains intact is that the decline in momentum should be a headwind for Equities longer term, driven by inflationary pressures and higher rates.

Other observations from our Big View indicators

  • The 4 US Equity key indices had a sharp reversal from recent lows this past week and are mean reverting, but all may be heading to potential overhead resistance (+)
  • Despite the nearly 8% rally off of the gap from Thursday, Friday’s positive performance was still not enough for DIA to close positive over the past 5 trading days (=)
  • Utilities () led the rally this week, clearing the 200-day moving average and outperforming the (-)
  • Volume Patterns indicate that improved, with 2 accumulation days vs. only 1 distribution day over the past 2 weeks, while the other key indices all continued with weak volume patterns (=)
  • Consumer Discretionary () -2.8% and Retail () -1.6% got hit hard on the week, consumers of all income brackets are keeping their hands in their pockets (-)
  • Energy () and Metal Mining:() were hot this week
  • The market is in mean reversion mode and bouncing off of oversold levels indicated by Up/Down Volume and the Advance/Decline on the SPY (+). Most concerning is that the cumulative Advance/Decline line took out the levels from the lows seen in 2020 (-)
  • Risk Gauges improved to neutral for SPY and IWM, but remain Risk-Off for QQQ (=)
  • Both the SPY and QQQ were frothy on the downside and in the process of mean reverting with further potential upside according to the number of stocks within each index above their 10-day moving average (+)
  • Despite anticipations of multiple rate hikes, this week’s invasion in Ukraine has forced the Fed to reconsider raising rates at least for the immediate future (=)
  • Even though Growth Stocks () are still underperforming Value Stocks (), both appear to be mean reverting. VTV now has both a positive TSI and has reclaimed its 200-day moving average (=)
  • The most interesting theme in Mish’s Modern Family is that Regional Banks () recovered a bullish market phase by the week’s close, a potential indication that the Fed is going to stick to their scheduled rate increases (-)
  • All of the members of the Modern Family bounced from oversold levels this week and are in the process of mean reverting (+)
  • Foreign equities lost ground across the board, backing off from recent leadership over US Equities (+)
  • Agriculture () got extremely overbought and had a potential blow-off top thanks to the invasion of Ukraine (=)
  • Gold () is being watched for potential mean reversion to the downside as well as having put in a possible blow-off top the day of Russia’s invasion (+)
  • Oil () is extremely overbought on the weekly chart and could be hitting resistance at its major 200-week moving average (=)
  • After the initial invasion of Ukraine there was a flight to the dollar (), but it gave up its gains by Friday’s close (+)

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