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Weekend Edition 5-6 March 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as risk assets wind their way lower with Russia upping the ferocity of its invasion of Ukraine.

In brief (TL:DR)

  • U.S. stocks sank on Friday with the Dow Jones Industrial Average (-0.53%), S&P 500 (-0.79%) and the Nasdaq Composite (-1.66%) all down as fear continued to grip investors with conditions in Ukraine worsening.

  • Asian stocks sank Friday as reports that a major nuclear power plant caught fire in Ukraine after shelling by Russian troops continues to shake investor sentiment.

  • Benchmark U.S. 10-year Treasury yields continued to slide on demand for safe haven assets in increasing uncertain circumstances with yields tumbling to 1.732% (yields fall when bond prices rise).

  • The dollar held gains.

  • Oil continued its ascent with April 2022 contracts for WTI Crude Oil (Nymex) (+7.44%) at US$115.68 as Europe and the U.S. demonstrate strengthening resolve to cut Russian oil from global markets.

  • Gold continued to gain with April 2022 contracts for Gold (Comex) (+1.59%) at US$1,966.60 on demand for haven assets.

  • Bitcoin (-3.50%) fell to US$39,174 over the weekend as sinking risk appetite continued to put downwards pressure on the benchmark cryptocurrency.

In today's issue...

  1. How do you invest in the middle of an invasion?

  2. Blood on the Streets as Retail and Professional Investors Swap Seats

  3. Even Bitcoin Isn't Immune to a Nuclear Threat

Market Overview

Fears that the White House will ban Russian crude imports to the U.S. and send energy prices spiraling have coalesced with concerns that the violence in Ukraine is becoming indiscriminate, creating a toxic cocktail that has sent risk appetite flagging.

Russian shells landed near Europe's biggest nuclear power plant in Ukraine on Friday, setting an administrative building on fire, but the situation has since come under control with no signs of radiation spreading and all safety structures continuing to be operational.

Nonetheless, concerns that violence is escalating in a part of the world which has one of the highest concentrations of vulnerable nuclear infrastructure has seen investors lose appetite for risk assets, sending stocks lower.

Asian markets closed lower on Friday with Tokyo's Nikkei 225 (-2.23%), Hong Kong's Hang Seng Index (-2.50%), Seoul's Kospi Index (-1.22%) and Sydney’s ASX 200 (-0.57%) all down.

1. How do you invest in the middle of an invasion?

  • Investors may be better off to ignore the intraday volatility and focus on the long-term trends to build robust portfolios

  • Thematic sectors like defense, clean energy and mining and oil and services are likely to continue doing well regardless of how the Russian invasion of Ukraine resolves itself

Investors may understandably want to sit out this round as Russia’s pounding of Ukrainian cities sees markets more volatile and investment decisions trickier as the war rages on.

But conflict can also be a major opportunity for the plucky investor, provided of course that they fall on the right side of history.

While most Western observers saw Russia’s annexation of Crimea as an event on a par with Russia, the invasion of Ukraine is different and makes real years of doing deals with the devil – relying on resource-rich autocrats who regard the West as the enemy, paying for their armies in exchange for their mineral wealth.

Making astute investment decisions as Russian shells fly into Ukrainian apartment buildings isn’t for the faint-of-heart and the question that investors must ask is how much fear dominates.

An investor who bought Russian ruble-denominated stocks after the market’s astonishing 54% drop in the first two hours of the invasion would have suffered whiplash but been richly rewarded when those same stocks rebounded 42% in the next half hour.

But had these investors not sold, they would worry if they could ever see their money again as the Russian stock market remains closed and Western economic sanctions have essentially isolated Russia from the global financial system.

Yet even for the less adventurous, the tech-heavy Nasdaq 100 fell hard when Russian tanks rolled into Ukraine, only to have its best day since March last year by the day’s close.

But as tempting as the intraday swings are for the profligate gambler, investors who are looking to long term trends will probably want to pay more attention to the prospect of higher inflation and slower growth and approach their portfolios thematically.

Years of underinvestment in mining and extraction, thanks in no small part to stricter environmental regulations and a refocus on managing balance sheets to generate returns, mining companies and other extraction companies should do well.

Even before the Russian invasion of Ukraine, some of the world’s biggest extraction companies had shunned the ruinous and heavily levered blockbuster mining projects to focus on profitability and cleaning up their balance sheets – they’re in the best position for a rally as the Russian invasion has only served to exacerbate underlying trends.

Pax Americana had also led to a complacency that saw military spending as a share of the global economy reach its lowest level in 2018, according to the Stockholm International Peace Research Institute.

Military spending is almost certain to go up, and with many of the best U.S. defense stocks trading at an average of just 15 times predicted earnings, are a lot cheaper than the average for S&P 500 component companies of 22.

Finally, less globalization is almost a given when the dust eventually settles and countries will be looking to re-anchor production locally, a trend under way since 2008 and which will awaken the urgency to derive new, clean energy sources, which will be a feather in the cap for clean energy stocks.

That earlier reluctance to shift to low-carbon or renewable sources as well as the urgent need to replace Russian supply could see drilling for gas and oil in friendlier regions restart in earnest and will be a boon to oil services supply and prospecting companies which had been conservative in their exploration for years.

For investors without the stomach for volatility in the midst of an invasion, there are plenty of opportunities which are far less stomach-churning, and could just leave bellies filled.

2. Blood on the Streets as Retail and Professional Investors Swap Seats

  • Retail investors have been buying the dip as professional investors sit out this round

  • Longer term prospects for U.S. equities looks good nevertheless, against a backdrop of strong economic growth and robust corporate earnings

The benchmark Dow Jones Industrial Average has now fallen for four straight weeks, and the VIX, the “fear index” has reached 32, near the highest it’s been in a year.

With trouble everywhere, getting a grip as to who’s doing what in the stock market is hard, but one overarching trend that took shape over the past week is that professional traders, while keeping a hand in for picking up gems, are taking a broader step back as retail investors kept the money flowing.

According to a report by Goldman Sachs Group’s (-1.06%) prime brokerage, over the past three days of last week, as Russian shells rained down on Ukrainian cities, hedge fund clients unwound risk at the fastest rate in three months in cumulative dollar terms while retail traders “bought the dip” with US$4.1 billion flowing into S&P 500-lined ETFs.

While retail flows have been increasingly significant in U.S. markets ever since the onset of the pandemic, being held to blame for the meme stock frenzy in early 2021, mom-and-pop investors have also provided some cushion for markets that would otherwise have corrected far more sharply.

Views on the market typically diverge even under regularly quiet market conditions, but a slew of contradictory factors are making the “fog of war” difficult to see through with investors having to contend with the continued Russian invasion of Ukraine against the prospect of U.S. Federal Reserve monetary policy tightening.

The conflicting factors are even confusing the world’s smartest computers with UBS Group’s machine learning model predicting that depending on how the Russian invasion of Ukraine resolves itself, the S&P 500 could end anywhere between 3,800 to 4,800 – a whopping 26% range.

At this rate, investors could be better off training a monkey to throw darts at a financial newspaper to determine which stocks to buy or sell.

Making matters worse, central banks are having to deal with high inflation, especially energy prices, slowing growth – raising interest rates too aggressively at this critical juncture could easily throw their economies into recession, and trigger stagflation (slow or negative growth and high inflation), something that no policymaker wants to have on their hands.

Investors wondering what to do next should note that even though stocks may be able to weather geopolitical crises, even war, they aren’t immune to recessions.

For now, the bull case for American equities remains intact – solid economic growth continues to be expected throughout this year and next, even as higher energy costs compress margins, and earnings for corporate America look to be robust.

And while the raging war in Ukraine has dampened appetite for European equities, it’s actually helped to drive demand for U.S. stocks, solidifying the America First trade.

With the volatility sending the average stock in the S&P 500 below its 10-year average price-earnings ratio, falling U.S. Treasury yields, on demand for safe havens, could point to favorable valuations for U.S. equities.

Moreover, history shows that the market impact from military events, while significant in the short run, is typically fleeting.

What’s most crucial is that central bankers don’t make any significant policy missteps that could push the U.S. economy into a recession and investors can keep calm and carry on.

3. Even Bitcoin Isn't Immune to a Nuclear Threat

  • Russian shelling of Europe's largest nuclear power plant in Ukraine sent Bitcoin tumbling below US$40,000

  • Volumes of Bitcoin traded reflect only a fraction of total volume available, meaning that the long term fundamental trends for the cryptocurrency may be strong despite the volatility as short-term traders see the Bitcoin as a risk asset

While Bitcoin has lived up to its potential hedge against geopolitical turmoil, serving as a possible alternative currency for millions of Russians now thrown off the global financial system, even it is not immune to the prospect of a nuclear disaster.

As Russian shells hit and set fire to buildings at the

News that both Russians and Ukrainians were buying cryptocurrencies, especially Bitcoin, at large volumes in the face of the economic situation caused by the war, saw Bitcoin soar to as high as US$44,000 at the onset of this week, before sinking alongside other risk assets by the end of the week.

While the fire at

The start of last week saw cryptocurrencies outperform stocks by large gains, with the imposition of sanctions driving speculation that Russians and Ukrainians would both turn to digital assets as a means to preserve value.

Nonetheless, Bitcoin’s correlation with other risk assets has ebbed somewhat, with the 50-day correlation between the cryptocurrency and the S&P 500 now at 0.5, with 1 representing two assets moving in perfect lockstep, while zero denotes completely unrelated behavior.

While Bitcoin may yet prove its mettle, the volumes being traded right now do not represent the full stock of the cryptocurrency being held, which is why even a little trading can have an outsized influence on price.

Those traders, as opposed to investors, in Bitcoin at the moment would necessarily see it as a risk asset and trade accordingly, as opposed to the long-term holders of the asset class which see it as a store of value and as a hedge against government intervention.

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