Half a league, half a league

Last week was not a week to write a blog.

Although the Russian invasion of Crimea was the major event and had the expected and inevitable effect on the markets, it was so overwhelming event that it drowned out any thoughtful discussion. Best to let things settle down a bit first.

As entertaining as all the sturm und drange about the invasion has been, it is actually pretty pointless. Western Nations are not going to do anything dramatic, and token visa sanctions stopping oligarchs and friends of Putin visiting their London mansions just mean they will spend more time on their yachts.

Bloomberg has gone so far as to post “Russia’s Ukraine problem in six stark lines”. All good stuff, but Putin doesn’t care. He’s rich enough and protected enough; he measures his “success” in different ways.

The UK journalist, Jeremy Paxman, recently described how he felt modern society would never support a rerun of World War 1; we are too self obsessed and hedonistic. The days of sending in a gunboat are even the Light Brigade are long gone. That is NOT necessarily a bad thing, but it does make effective sanctions harder. I am sure Paxman is right, and no doubt President Putin feels the same.

What matters to Putin is rebuilding the image of a strong Russia and reversing the humiliations, as he sees them, of Russia since the fall of Communism. If the Western Powers are so pissed off with him that they are holding emergency meetings, discussing sanctions, or moving military hardware strategically, that means he has a result.

I cannot begin to fathom where this particular story will end, and frankly I don’t think anyone else does. Of all the talking heads out there, someone will be right, but we won’t know until the end who that it is.

Russian stocks are cheap. They were cheap before this invasion, and they will remain cheap for a very long time. I would venture to say they will remain cheap until Putin is clearly on the way out (Whether the ensuing rally will be a false dawn or not only time will tell, but it will make for a fun ride). There will still be opportunities there, although many will be “rentals” for a while. I am looking for real businesses that don’t depend on Government connections and that Putin won’t find a “strategic” need to get involved in.

In the mean time, Europe has a serious problem; it is too dependent on Russian gas.

It is particularly vulnerable to further escalation in the Ukraine, but ultimately it is vulnerable to the whims of Russia. Most people would probably say that Russia has too much to lose by cutting off supplies to Europe entirely, and I would agree, but so much can go wrong in a heavy winter; a few production problems in Siberia, a faulty valve in a pumping station, new monitoring equipment not working as planned…

So I can certainly see Germany quietly restarting its nuclear electricity program to give itself more energy choices. Realpolitik will mean that any announcement will try to avoid any linkage, but I would expect confirmation over the summer that the Government has been “running tests” as it slows down the decommissioning process.

Western Oil companies will pour into the Ukraine to exploit their shale gas, Europe’s 3^rd largest reserves. Ukraine needs the money desperately and the West needs the gas; it’s a marriage made in heaven

Chevron and Shell have both signed deals already, but with the ancien regime. I’m sure, given her history, Yulia Tymoshenko will be easily persuaded to allow such contracts to stand and will encourage the newly elected president to take the same approach. Other former Soviet Satellites, such a Lithuania and Poland, will also accelerate development of their shale reserves.

Elsewhere, the most exciting thing to happen was a bond default in China, that some people are calling China’s Bear Sterns moment. Bear Sterns was famously “saved” by JP Morgan, and markets continued to rise for several more months, thinking that the credit crisis had been averted. The bankruptcy of Lehman Brothers a year later showed the folly of that over-confidence. I think the comparison is a little misplaced myself.

As I have mentioned before, China needs bond defaults so that investors start to price risk correctly and they can start to control the runaway credit in the shadow banking system. Allowing such defaults, especially in an environment where they go against vested interests, is always painful. The trick is going to be allowing sufficient defaults to take place to allow the credit cycle to work but without so many happening that a complete credit freeze occurs leading to a complete rout.

The process becomes more complicated in China where a default can very quickly be seen as a punishment of someone who did not have the right connection, reinforcing the graft and influence peddling that the Government is trying so hard to reign in.

Although this default was widely flagged ahead of time, it has set the Rumour Mill into high gear, and the market is now awash with stories of banks calling in large numbers of private loans, steel mills being forced to shut down….

Complicating the picture are some pretty awful Chinese February export numbers, down 18.1% year on year when expectations were for a gain of 7.5%. It is highly likely that these awful numbers are a product of the usual distortions that occur around Chinese New Year, as the numbers for the first two months of the year only show a decline of 1.6%. Given that the Chinese authorities are also working very hard to squeeze out the rampant over and under invoicing that plagues Chinese trade data, that is probably an OK number.

All in all, I’m starting to get encouraged that an awful lot of very bad news is in the market. We haven’t seen one of the big blow offs that usually mark a turning point, and that makes me nervous, but several of the most vulnerable markets have actually rallied in recent weeks. Barring a plague of Frogs, it is hard to imagine what isn’t being discounted at current levels.