Beware the Russian bear
Price action in the stock market would indicate that global investors believe both sides are bluffing. Putin is simply playing a game of chicken, pundits contend, betting Europe and the U.S. will blink first. They seem unperturbed that the hardware being deployed by the Russians on the Ukrainian front could roll back all the hard-won gains of the Ukrainian government over the past few weeks in a matter of hours.
As for Putin's economic trump card---an embargo of energy exports to Europe this winter-no one believes it will happen. And here's where financial people, especially free market types like those who reside on Wall Street, sometimes get it wrong. They believe that no one would shoot themselves in the economic foot simply for political gain.
Russia makes $1 billion/day from its natural gas and oil exports to the EU. The Russian economy is on the brink of recession after 15 years of strong growth driven by higher commodity prices. GDP is slowing from 0.9% in the first quarter to a forecasted 0.5% in the second. Inflation is rising, now 7%, and so is unemployment. Given the economy's weakened state, the sanctions imposed by the West are having a negative effect.
Its common knowledge that Europe depends upon Russia for a full third of its energy needs. It is also true that Russia's economic growth depends upon its energy exports, which accounts for over 50% of all exports. An embargo would hurt Russia far more than it would hurt Europe.
So, from a financial perspective, it would make no sense at all for Russia to shut off Europe's supply of energy this winter. The problem with that logic is that Putin, backed by a cadre of hard-liners, does not necessarily believe that economic concerns should be their number one priority. Recent history proves this fact.
Back in the winter of 2006, during Russia's on-going energy squabble with the Kiev government, they shut off gas supplies. Putin ordered another Ukrainian energy embargo in January, 2009. That one severely curtailed energy supplies throughout eighteen European countries. Some nations reported major drops or a complete cut-off of energy supplies at the time. The EU's distress was simply collateral damage from the Russian's point of view in its dispute with the Ukraine.
As for the argument that Putin would not dare to push too hard, give the state of his economy, investors have an extremely short memory. In the summer of 2008, the Russian economy was weakening as well, but it didn't stop Russian troops and tanks from over-running Georgia. Putin simply blamed the resulting economic weakness on the American financial crisis.
Today, things are different. The majority of Russians approve Putin's actions. During this crisis, unlike the 2009 gas embargo, the EU is not only supporting Ukraine, but also levying sanctions on Russia as well. Annexing the rest of the Ukraine, after getting away with swallowing up the Crimea, would be a logical next step from Putin's perspective.
Given all of the above, I am far less confident than the majority of investors that this conflict will go the way we expect.
Bill Schmick is registered as an investment advisor representative and portfolio manager with Berkshire Money Management.
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