Hello there,

A wonderful Wednesday to you as stocks wind lower on escalating tensions in Ukraine and tough sanctions being imposed by the Biden administration.

In brief (TL:DR)

• U.S. stocks opened lower Tuesday after the Presidents Day holiday with the Dow Jones Industrial Average (-1.42%), S&P 500 (-1.01%) and the Nasdaq Composite (-1.23%) all down.

• Asian stocks were mixed Wednesday as investors assessed the Western sanctions imposed on Russia to gauge geopolitical risks from the standoff over Ukraine.

• Benchmark U.S. 10-year Treasury yields advanced one basis point to 1.94% (yields rise when bond prices fall).

• The dollar was steady.

• Oil was higher with April 2022 contracts for WTI Crude Oil (Nymex) (+1.41%) at US$92.35.

• Gold was steady as haven demand ebbed with April 2022 contracts for Gold (Comex) (-0.34%) at US$1,900.90.

• Bitcoin (+2.05%)rose to US$38,026 as the unified Western response and condemnation of Russia's aggression in Ukraine provides some semblance of solidarity and certainty that the world will not sit back and allow such action to go without consequence.

In today's issue...

1. U.S. Consumer Confidence Crumbles Complicating Matters for Fed

2. Investors Betting on War Will Need Incredible Amounts of Luck

3. Long Bitcoin, Short U.S. Equities

Market Overview

U.S. President Joe Biden said Russia had started to invade Ukraine and announced steps targeting Russia’s sale of sovereign debt abroad and the country’s elites.

Those efforts, as well as European moves, stopped short of the devastating measures that had been threatened and helped to shore up some risk assets.

Biden said the sanctions could be stepped up if Russia “continues its aggression.”

The geopolitical risks are putting further pressure on markets, which were already stressed by the prospect of tighter U.S. Federal Reserve monetary policy to fight inflation.

Expectations of Fed hikes edged up as investors weighed the implications of higher raw material costs in the wake of the Ukraine tension.

In China, regulators have asked China Huarong Asset Management and its peers to buy property assets from troubled developers and formulate plans for taking over or restructuring smaller lenders, seeking to stabilize the world’s second-largest economy.

Asian markets were mostly higher Wednesday with Tokyo's Nikkei 225 (-1.71%) down, while Seoul's Kospi Index (+0.18%), Hong Kong's Hang Seng Index (+0.60%) and Sydney’s ASX 200 (+0.39%) were up in the morning trading session.

1. U.S. Consumer Confidence Crumbles Complicating Matters for Fed

• Falling consumer confidence and signs that any sudden moves may tank the nascent economic recovery, against a backdrop of rising geopolitical uncertainty, could sway even the most hawkish policymaker to think twice about turning off the liquidity hose.

• Given that up to 70% of the U.S. economy is reliant on consumption, any serious dent in sentiment could drag down the overall economy.

With just weeks to go before U.S. Federal Reserve quantitative easing comes to an end, the world’s foremost central bank is having to consider a variety of issues that makes its job far more complex than would otherwise entail.

On the one hand, tight labor markets and the fastest pace of price increases in four decades is prompting the Fed to lean more heavily hawkish, raise interest rates and perhaps even unload its vast trove (now around US$8.9 trillion) of Treasuries and mortgage-backed securities.

Yet on the other hand, falling consumer confidence and signs that any sudden moves may tank the nascent economic recovery, against a backdrop of rising geopolitical uncertainty, could sway even the most hawkish policymaker to think twice about turning off the liquidity hose.

In February, the Conference Board’s consumer confidence index fell to its lowest since September as expectations for growth and financial prospects softened amid soaring inflation.

Inflation is outpacing wage growth and the Russia-Ukraine crisis which is increasingly looking as if it may devolve into full-scale war, is taking a toll on confidence.

Gasoline prices are rising and concerns are growing that they will continue to rise, even as surging mortgage rates are making housing that much more unaffordable, all of which is conspiring to weigh on consumer sentiment.

Given that up to 70% of the U.S. economy is reliant on consumption, any serious dent in sentiment could drag down the overall economy.

According to the Conference Board, the share of consumers who expect their incomes to rise in the next six months fell to their lowest level since January 2021, when the ill-effects of the pandemic were first being felt.

Significantly, buying plans for automobiles, homes and appliances softened in February and fewer Americans said they were planning to take a vacation in the coming months, even as pandemic restrictions ease.

All of these factors will conspire to make the Fed’s key rate-setting decision that much more complex as March rolls around, with policymakers increasingly leaning towards a more nimble monetary policy that caters for more dynamic conditions.

2. Investor Betting on War Will Need Incredible Amounts of Luck

• Whilst the instinctive trade at the moment would be to go long on the stuff of Russia, because sanctions would effectively remove their supply from global markets, that trade also makes several (dangerous) assumptions.

• Because war is so unpredictable, investors, especially the part-time variety, are probably better off not taking any bets outside of the long-term, unless they believe themselves to be even more lucky than the Rothschilds.

Investors trying to divine how the potential for the largest European conflict since the Second World War will impact their portfolios will find the decision-making matrix almost impossibly complex and the best solution may be to do nothing at all for now.

Because wars are unpredictable, making decisions based on at best incomplete information is an exercise in futility.

Whilst the instinctive trade at the moment would be to go long on the stuff of Russia, because sanctions would effectively remove their supply from global markets, including natural gas (24% of global supply), platinum (9%), palladium (35%) and rhodium (7%), that trade also makes several (dangerous) assumptions.

Not so long ago, in a battlefield not so far away, the legendary Rothschilds banking dynasty bet that the French war of aggression against an allied army led by the English would be a long and protracted battle, as it had been for all of Napoleon’s previous wars.

By the time of Napoleon’s initial defeat in 1814, the Rothschild’s learned that the economic disruption caused by war tended to push up the price of gold relative to the British pound because the gold-standard rule that allowed convertibility of pounds into gold at a fixed price would be suspended during periods of hostility.

In the early 19th century, war also tended to drive up both short and long-term interest rates, and so when Napoleon returned to France and reclaimed his imperial throne in March 1815, the Rothschilds assumed that another protracted period of conflict was just beginning and positioned themselves accordingly.

The Rothschilds hoovered up as much gold as they could from their extensive credit network, expecting that the price of gold would soar as the war dragged on.

Instead, the Rothschilds had underestimated the strength of the allied military response which culminated in the defeat of Napoleon and his armies by June 1815, meaning that all the gold accumulated would not be needed to fund armies and would very quickly depreciate relative to the British pound.

Rather than surrender (Rothschilds not Napoleon), Nathan Rothschild took a bold bet to salvage the dire situation, buying British sovereign debt on a massive scale, betting that they would be in demand on the news of peace and selling them when they rallied hard.

With the benefit of hindsight, Napoleon’s final and irrevocable defeat on the plains of Waterloo ushered in a century of comparative peace in Europe, with no major wars involving the great powers until the early 20th century despite numerous smaller conflicts that might have easily escalated into a general war.

The Rothschilds may have been astute businesspeople, but they were also incredibly lucky and sufficiently humble enough to recognize that having made their fortune despite Waterloo, they had every incentive not to lose it again by being caught out in such a scenario.

Because most investors (retail or otherwise) are unlikely to be as savvy or as lucky as the Rothschilds, war is rarely a profitable affair regardless of which side one takes bets on.

In our present context, it’s entirely possible that Russia stops at the eastern regions of Ukraine, determining that a full-scale invasion would be far too costly in terms of blood and treasure and enters a diplomatic settlement with the West on European security.

It’s also entirely possible that prolonged sanctions on Russia (which would cause the prices of the commodities that Russia exports to soar) would force Russia into a situation where it becomes pressured into invasion.

During the Second World War, the Empire of Japan, languishing from sanctions by the United States and the League of Nations after its invasion of Chinese Manchuria and declaration of that puppet state with its own emperor but under effective Japanese control, was essentially forced economically into a wider conflict.

Russia has endured sanctions before, but with each successive round of economic punishments meted out by the economic community, there are only two real possible outcomes, circumvention through other means, or wider conflict since the price has already been paid.

Because war is so unpredictable, investors, especially the part-time variety, are probably better off not taking any bets outside of the long-term, unless they believe themselves to be even more lucky than the Rothschilds.

3. Long Bitcoin, Short U.S. Equities

• The benchmark cryptocurrency has outperformed U.S. equities in a welcome change as geopolitical uncertainty continues to roil markets.

• Correlation between the tech-heavy Nasdaq 100 and Bitcoin was as high as 0.46 in January but has been falling recently to as low as 0.23 over a three-month period.

Despite Bitcoin’s infamous volatility, the benchmark cryptocurrency has outperformed U.S. equities in a welcome change as geopolitical uncertainty continues to roil markets.

Bitcoin rallied on Tuesday when U.S. traders came back from the long weekend, outperforming the Nasdaq 100, which extended losses from last week after trading resumed from the Presidents Day holiday.

Correlation between the tech-heavy Nasdaq 100 and Bitcoin was as high as 0.46 in January but has been falling recently to as low as 0.23 over a three-month period.

Bitcoin recovered over 3% to above US$38,300 even as the Nasdaq 100 slipped 1.2%, demonstrating again how unpredictable the cryptocurrency’s correlation with other asset classes continues to be.

Nevertheless, weekend data for cryptocurrencies always needs to be taken with a pinch of salt because volumes tend to fall off and much of the trading is left to bots (automated trading programs that act on predetermined factors).

Weekend price swings tend to be exacerbated because of lower volumes and corrected on the weekdays when human traders are back at their desks.

The bulk of cryptocurrency trading is still very much manual, executed by human traders as opposed to algorithmic programs, unlike in the traditional equity markets.

Another possible reason for the rebound could also be that Bitcoin was oversold during the weekend and some traders are taking the opportunity to buy the dip, especially given the cryptocurrency’s potential role as a hedge against inflation in increasingly uncertain times.

Although flows into gold and gold investment products has been on the rise on the prospect of a Russian invasion of Ukraine, there continues to be a significant investor base that has taken increased exposure for Bitcoin, as a digital gold alternative.