We Are Entering A New Phase In The War In Ukraine

By Peter Tchir of Academy Securities

Today we will just highlight a few things:

• Thanks to all my colleagues and everyone who has served, and I want to spend an extra moment to honor those who made the ultimate sacrifice.
• If you missed this month’s Around the World, it is an important read as it outlines Academy’s take on:
  • Israel commencing operations in Rafah.
  • Russian forces advancing on Kharkiv.
  • Xi meets with Putin in China.
  • U.S. force reduction in the Sahel.
• While we cover the Xi and Putin meeting in the Around the World, I think there is also a case to be made that we are entering a new “phase” in the war in Ukraine. One where Russia will attempt to use social media to convince everyone that “peace” should be achieved, and where Russia is able to hold on to much of the land it occupies in Eastern Ukraine. It seems to be more than a coincidence that Putin appears to be publicly amenable to this sort of outcome after the meeting with Xi. It would also not be surprising given the information learned by observing how much social media seems to be able to shape political outcomes in the U.S. (the war in Gaza as a prime example). Could we be at the early stages of where we see the sort of deal we have been expecting for some time?
  • Our base case is that both sides will ultimately get forced into settling for some agreement that satisfies both countries, while not being particularly appealing to either country. Basically, Ukraine will cede some land and receive some of Russia’s frozen dollar reserves as payment, enabling them to pay some debts and embark on the reconstruction of their country.
  • Any such deal will be good for Europe as the rebuilding efforts will create demand for labor and equipment, but it will also be inflationary (at least initially). Globally, there would be some excitement as one of the Geopolitical Risks is taken off the table, but ultimately, not much will change as new global orders have already taken shape and will continue to do so, regardless of the outcome with Russia and Ukraine.
• Overall, Geopolitical Risks remain topical. In our first Geopolitical Risk Perception vs Reality, we discussed the difficulty of incorporating geopolitical risk into “actionable” strategies. We focused on Cyber, Trade War, Commodities, the Middle East, Russia, and “wildcard” risks. We continue to see the markets underestimating the risk on the trade war and commodity front, while other risks seem to be perceived reasonably accurately relative to our view of the actual risk. If anything, Russia may have drifted into the “green” (potential positive surprise) from what we considered a neutral risk.
• On the markets front, a few things seem to pop up again and again in discussions:
  • How are markets so strong with all of the Geopolitical Risks? We have tried to address that in the Risk vs Perception piece, and also in Hedging the Unhedgeable. There is no easy answer to this one, though I think the market has done a reasonable job and I’d look to own commodities and companies that would benefit from reconstruction in Ukraine or an effort to extract AND process more commodities “domestically” (either in the U.S. or with countries that we are very comfortable with politically and geographically – i.e. better control and access to those countries).
  • Last week we suggested that the market was Too Narrowly Focused on inflation and the minutiae of Fed policy. After a week of conversations, I don’t think that is the case. The market participants I speak with all seem to have coalesced around a reasonable view on the Fed:
    • We will get a cut or two this year, and a few more next year. No one seems to care much about whether it is 0, 1, 2, or 3 this year.
    • No one is really worried about the possibility of a hike, and people are consigned to the view that if we get a hike, it will only be because the economy remains incredibly strong, so it won’t be a big deal.
    • No one, in their main analysis and positioning discussions, is watching the tape nervously as economic data comes out.
    • Yet, the markets seem to respond to each headline as meaningful. Since I find it so difficult to identify people who care that much about any given headline, I can only assume that it is the “machines” that care. That algos and quant models are driving the show. Not sure whether that is good or bad, but it goes a long way to explaining the difference in what I see and hear versus what is actually happening in and around economic data. I do have to admit that the Citi Economic Surprise Index bounced last week and is less negative, which helps to explain why the 10-year ended the week near the high end of our range of 4.3% to 4.5%.
  • More and more notes about complacency and low volumes. I saw somewhere that SPY, a large S&P 500 ETF, had its 2nd lowest volume day in a year (only higher than the early close during Thanksgiving and one of the lowest full day volumes in years). VIX dropped back to 12. Anemic volumes may be helping push markets higher, but they are giving little confidence to investors, leading me to wonder how much the “machines” are in charge.
  • AI remains the big story. Having said that, I’m not sure how many people had NVDA up roughly 10% with the Nasdaq 100 down on Thursday. That certainly wasn’t a scenario I thought was plausible, yet It happened. Once again, it makes me wonder about market participation and liquidity.

As we spend time with friends and family at barbeques this weekend, these are the thoughts/questions we are facing as we start the week, and for many, there are no obvious answers. Maybe we continue to grind higher on stocks, setting new records (most barely above the prior record or where we were months ago), or maybe something shakes things up (likely a trade related or geopolitical event, that can be tied directly to the earnings prospects of companies).