What Will A Geopolitical Compromise Means For Markets?Henry Clay was a US Senator from Kentucky, the Speaker of the House of Representatives, the US Secretary of State, and a Presidential candidate in the 1800s. His legacy and nickname were “The Great Compromiser” for his involvement with the Missouri Compromise, the Compromise Tariff of 1833, and the Compromise of 1850. As Henry Clay understood, any great compromise means that both sides at the negotiating table must come to an agreement that makes them uncomfortable or incomplete.
The price of an asset is always the correct price
A messy geopolitical landscape
Option one- A Great Compromise- High Odds
Option two- A prolonged conflict
Option three- The unthinkable
In 2022, the geopolitical temperature has risen to the highest level since WW II. On February 4, Chinese President Xi and Russian President Putin met at the opening ceremony of the Beijing Winter Olympics. The leaders signed a $117 billion trade agreement, but the watershed event was the “no-limits” cooperation understanding. Twenty days later, after the end of the Olympics, Russia invaded Ukraine, launching the first major war on European soil in over three-quarters of a century. Many analysts believe the Russian invasion sets the stage for Chinese reunification with Taiwan.
Markets reflect the economic and geopolitical landscapes. Volatility in markets across all asset classes has increased, and uncertainty is the market’s worst enemy. The war, sanctions, retaliation, and a Chinese-Russian alliance threatens the status quo over the previous decades.
The price of an asset is always the correct price
As we learned in early 2020 in nearly all asset classes, bear markets can take prices to levels that defy logic and rational and logical analysis. The same holds on the upside as price spikes can reach unthinkable heights. The moves to the upside or downside compel many market participants to sell what they believe are tops or buy when they think the market cannot go any lower. Picking tops or bottoms is more about ego than making money, as the effort contradicts to prevailing trends.
Picking a top or a bottom is a statement that the current price is too high or too low, which is always a mistake. Market participants can be wrong, but markets are never wrong. The price of any asset is always the right price because it is the level where buyers and sellers agree on a value in a transparent marketplace.
Declaring a market top or bottom is a contrarian statement as it goes against the prevailing trend.
A messy geopolitical landscape
Two years ago, the world faced a common enemy as COVID-19 ignored borders, race, religion, political ideology, and all of the other factors that separate countries and people. In February and March 2022, the world faces new and daunting challenges:
The Chinese and Russian leaders shook hands on a “no-limits” alliance.
Russia invaded Ukraine, starting the first major war in Europe since World War II. Ukraine continues to put up fierce resistance.
The US, NATO allies in Europe and allies worldwide slapped sanctions on Russia.
Russia retaliated with export bans and other measures.
North Korea test-fired ICBM missiles.
Iran fired missiles near the US embassy in Iraq.
Russian missiles came within miles of the Polish border. An attack on Poland triggers article five of NATO’s charter- An attack on one member is an attack on all.
China and Russia stand on opposite sides of the conflict from the US and Europe.
China plans to reunify with Taiwan against their will.
On the US domestic scene, the US remains divided along political lines with mid-term elections in November.
The central bank liquidity and government stimulus that stabilized the economy during the pandemic ignited an inflationary fuse before the geopolitical landscape deteriorated. The war in Ukraine only exacerbates price increases as Russia is a leading world producer of raw materials. Europe’s breadbasket in Ukraine and Russia is now a mine and battlefield at the start of the 2022 crop year. Russia and Ukraine typically supply one-third of the world’s wheat and other crops. They are also leading fertilizer exporters, causing problems in other worldwide growing regions. In 2022, the war will lead to rising prices, falling supplies, and the potential for famine and civil uprisings. Historically, food shortages have caused many revolutions. The 2010 Arab Spring that began as food riots in Tunisia and Egypt caused the sweeping political change in North Africa and the Middle East.
Meanwhile, the Biden administration pledged to address climate change by supporting alternative and renewable fuels and inhibiting the production and consumption of fossil fuels. US production declined in 2021. After decades of working to achieve energy independence from the Middle East, US policy handed the pricing power to the international oil cartel. Since 2016, Russia has had an increasing role in OPEC’s production policy. In 2022, the cartel does not move unless Moscow agrees to cooperate. Oil prices were already rising when Russia invaded Ukraine, and they moved over $100 per barrel after the attack.
Meanwhile, other fossil fuels have moved higher. Coal traded to a new all-time peak. US natural gas rose to a multi-year high, and European and Asia gas prices rose to record levels.
Rising energy prices fueled inflation, and the war has poured fuel on an already burning inflationary fire.
The war in Ukraine is less than one month old, and the human toll is rising. Tensions are at the highest level in decades. Markets are nervous, and the developments on the geopolitical over the coming days and weeks will dictate the direction of markets across all asset classes. I see three potential outcomes.
Option one- A Great Compromise- High Odds
In the current standoff, neither side wants to give an inch. The Russian leader faces disgrace or worse if he loses to an inferior military but impassioned Ukrainian population, many of who would choose death over capitulation. The US and Europe do not want to appease Russia like the UK’s Nevil Chamberlain appeased Hitler in the 1930s. China may support Russia, but the world’s second-leading economy has close economic ties with the US and Europe.
A Henry Clay-inspired great compromiser could emerge and come up with a solution where Russia, China, the US, Europe, and the rest of the world walk away from the negotiating table unhappy but with a workable solution.
I believe, and it is more than a bit of wishful thinking, that this is the high odds result of the current geopolitical mess, and the result will go down in history as the great compromise of 2022.
A great compromise would likely lead to a significant stock market rally and a commodity correction.
Option two- A prolonged conflict
A prolonged conflict where Russians fight a long and bloody war against Ukrainian forces will devastate the world economy and peace. Russia may capture territory, but it is clear President Putin will never capture the souls of the Ukrainian masses. The Russian brutality over the past weeks will never be forgotten.
President Putin did not count on the passionate resistance Russian troops encountered across Ukraine. The longer the battle and the more brutal the weapons, the greater the price for Russians controlling the territory over the coming years. Millions of refugees have left the country, but that leaves over 40 million Ukrainians; most now consider Russians their mortal enemy.
A long battle will weaken the Russian military and the Russian leader abroad. A prolonged conflict will cause sanctions to collapse Russia’s economy, causing domestic problems for President Putin and his government. Moreover, skirmishes are likely to break out worldwide. In the early days of the war in Ukraine, North Korea and Iran flexed their military muscles. With Europe and the US focused on Ukraine, China could use the opportunity to seize Taiwan.
A prolonged conflict would weigh on US stocks and likely lift commodity prices to higher highs.
Option three- The unthinkable
The final option is the nuclear one, which is low odds, but a highly frightening scenario. If Russian aggression spreads across the Ukraine border into Poland or any NATO member country, it will trigger Article five that states an attack on one is an attack on all. The US and Russia have the most nuclear weapons, which increases the potential of MAD or mutually assured destruction. In this scenario, it does not matter how markets react as the world would face a disastrous situation.
I believe that a great compromise is on the horizon, which would cause markets to stabilize. However, the extent of the compromise is critical as it must address the current situation in Ukraine and Taiwan and threats from North Korea and Iran. Anything short of a comprehensive understanding between the world’s powers will cause years of rising tension and threats to the nearly eight billion people that inhabit our planet. Where is Henry Clay when the world needs him? Expect the volatility in markets to continue.
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