On Russian, Crimea, And The Markets

Today’s reports of Russian troops storming a Ukrainian base in Crimea are reflecting a Russian act of consolidation. Russian has annexed Crimea. End of story. Non-Russians are to be there only by permission. End of story.

US- and EU-led visa rejection wars have little impact on the short-term outcome. I guess Western politicians need to show they are doing something. Bluster aside, Crimea is already a page in the history books.

A larger issue is or will be the Russian use of force to cross the Ukrainian border in the eastern section of Ukraine. If it happens, the pretext will be to protect Russians. Readers must recall that this sort of pretext has been used throughout history. Hitler said he wanted to protect Germans when he forcefully expanded the Nazi regime beyond his borders. Will Putin follow a like path in the 21st century? Only time will tell, but his track record in Georgia suggests that the border of Crimea is not likely to be the end point of his ambitions.

Responses in Europe vary. In Finland, there is an increase in air force defense maneuvers and training. In Estonia there is some low profile readiness preparation. The same is true of other Central European regimes, who cast a very wary eye toward the Russian bear in the east. They have a lot of history to reflect upon and ample reason for concern.

This Russian expansionist policy under Putin is not just about energy, although that is a large part of it. It is broader. And it is led by a man who is masterful, powerful, and does not adhere to Western standards of political behavior except when doing so serves his purposes. He is a modern, KGB-trained, czar who has consolidated fifteen years of personal power.

So European leaders and the US are caught without adequate preparations and are scrambling. There is little they can reasonably do in response except to try to use sanctions, which are a very long-term approach of questionable value. And they may undertake visa-revocation wars in which neither side wins anything. They may also seek and achieve a stabilizing position with Putin and stop the escalation of tension. That decision will be up to Putin. Witness how Putin successfully upstaged the US in the Syrian chemical weapons discussion.

Markets, so far, have ignored the contagion risk. Markets have been operating on the assumption that Putin’s expansionist plans will be limited. Thus, markets set new highs.

So far that has been the right thing for markets to do. The issue is simple: political bluster and visa revocation do not alter the valuation of assets by very much. Of course, there are marked-down Russian assets and events may reach to other Central European assets, but the impact is really small in the global scheme of valuations. The G-4 central bank’s monetary policy and global trade policy are much more important to asset valuation as long as there is no broadening of war risk.

That assessment changes if we see Russian military moves across borders and an active Russian intention to alter the balance of power in Europe. Then, what began with the annexation of Crimea becomes systemic, a clear attempt, on Putin’s part, to reassert Russian hegemony in Eastern Europe.

Right now Cumberland remains fully invested. Our view has been that Crimea will be ceded to Russia and that major cross-border military operations will not broadly occur. Our view is based on Putin’s operating purely in his own self-interest, based on how we assess that he perceives the Russian sphere of influence. We do not rely, for one second, on anything he says. Only the movements of Russian feet count.

We will change this outlook at once if troops and tanks move across borders. We may also change it if it appears that the risk of cross-border movement is rising to a point where portfolio action is required as a precaution. Right now there is no way to know what the training exercise with a large mass of troops on the Russian side of the border with Eastern Ukraine will lead to. The risk of action in eastern Ukraine is high and rising. The question we ponder is if it will be limited.

BY David R. Kotok