Crisis in Ukraine. A Russian invasion—again. Panicky headlines, scary video clips, rumors on the Internet.
So, what do investors need to know? What moves should we make in response to protect ourselves, and maybe even profit?
What does this crisis mean for our money? Does it mean anything at all?
There are some bold moves that active traders may want to make, and take their chances. More about those in a moment. But, what does this crisis mean to everyone else? What does this mean for those of us who want a quieter life, but who nonetheless want to make money—and, most importantly, not lose it?
Here are five implications:
1. This is why investors who want to sleep easily at night always hold some long-term Treasury bonds in their portfolio
Long-term Treasuries are portfolio insurance. When everything goes to hell in a handcart, and everything else goes down, they go up. They even went up in 2008. And if this crisis becomes much bigger, it’s a fair bet that investors will rush to move money into U.S. Treasury bonds, sending prices up yet again.
That’s because investors believe that the U.S. government, for all its troubles, remains the world’s lender of last resort. Uncle Sam oversees the world’s largest economy and can pay its bills. The Treasury market is by far the most liquid bond market in the world.
No other U.S. bonds serve this purpose. Even AAA-rated corporate bonds went down in the crisis of 2008.
The Treasury bonds which provide the most crisis insurance for your investment dollar are long-term zero-coupon bonds, often known as “Zeroes.” These basically represent a single fat check that Uncle Sam promises to hand you in about 30 years’ time. In boom times, investors won’t pay much for zeros because they figure they will earn much higher returns over the next thirty years from riskier assets. When a crisis hits, suddenly everyone wants zeros. They basically doubled in the fall of 2008.
2. This is why investors who want to sleep easily also own natural resource stocks in their portfolio
In recent months I’ve been talking to a lot of money managers about the perfect “all-weather” portfolio that I (or anyone) could just hold and forget about. I suggested that one ought to include natural resource stocks, including energy stocks and agriculture stocks, as a specific asset. Several money managers wondered why.
This crisis is the reason.
Ukraine is a major food producer. It has some of the best agricultural land on the planet. It’s the Iowa of Eastern Europe. Russia, meanwhile, is a major producer of oil and natural gas, as well as some other resources such as nickel and platinum.
War and conflict have always disrupted the supply of raw materials. Every war in the modern age has been a boon for cotton producers, farmers, oil and coal companies, and so on.
Someone who allocates some of their money to energy, mining and agricultural stocks through a fund has less to worry about than someone who just trusts to luck.
3. Gold isn’t silly
I’ll confess I have always been in two minds about gold. It’s mostly useless and generates no income. On the other hand, it one of the few currencies in the world that is universally accepted and which is not controlled by any government. Diamonds, gold, bitcoins? (Hmmm).
This is why gold has usually boomed at times of great geopolitical distress. It’s not so much an economic safe haven as a political one. Even in the days of the “gold standard,” when central banks backed their currencies by gold, they usually suspended convertibility during war—as the Bank of England did at the outbreak of the World War I in 1914.
There doesn’t appear to be much that the U.S. or Europe can or will do directly to intervene in this crisis. Partisans can make their own points, but one clear point is that the U.S. no longer enjoys anything like the kind of hegemony that it enjoyed in the 1950s or, briefly, after the collapse of the Warsaw Pact in 1990. America’s share of the global economy is shrinking as other countries, especially China, rise. Within a few years, the U.S. will no longer even have the world’s largest economy, measured in real, purchasing-power terms.
Throughout history, one global hegemon has given way to another—as France did to England 200 years ago, and England did to America just over 100 years ago. Those transitions have usually been accompanied by conflict. And they have usually been good for gold. That may make a case for keeping a small amount of gold in your portfolio.
Many gold bugs like to own gold directly. Right now, shares in the stocks of companies which mine gold are particularly cheap.
4. Emerging markets might be becoming a bargain
Turmoil in Russia. Turmoil in Turkey and Brazil. A disturbing slowdown in China. No wonder money managers have been fleeing emerging markets. A recent survey of top money managers by Bank of America Merrill Lynch found they had the lowest allocation to emerging markets on record.
Time to sell? Nope. Time to think about buying.
Too many investors approach emerging markets in completely the wrong way. They jump on board the bandwagon when it is fashionable, and the stock markets of developing countries are expensive. Then they bail out in panic when the wheels come off.
Emerging markets are volatile. But there are three reasons why investors should have exposure to them. First, they constitute a large and growing share of the global economy. Second, they are often (though not always) a bargain, because so many investors are afraid to own them. And third, they may have a low correlation with other markets, which offers diversification benefits.
The low-tech way of doing this is to set aside a certain percentage of one’s stock portfolio to emerging markets funds, and then to rebalance periodically. Emerging markets have underperformed markedly for the past two years, so anyone doing this consistently will be a net buyer. Those who wish to be opportunistic may pounce if there is a further selloff this week.
5. This may not cause a slump in U.S. stocks
Even though Wall Street looks ominously overvalued by several long-term measures, and sentiment has been dangerously complacent of late, there are reasons why this crisis might not cause a slump in the stock market (unless it gets much worse).
U.S. corporations are using their record profits to buy some of their own stocks hand over fist, and that keeps pushing up stock prices. Meanwhile, if this crisis gets worse, Wall Street may start betting that it will strengthen the hand of the “doves” at the Federal Reserve—those who want to keep purchasing bonds to sustain the economic recovery. Ironically, that may cause investors to bet that stocks will go still higher.
Furthermore, in a crisis investors world-wide tend to want to buy dollars, and once they have done so they may decide they might as well hold U.S. stocks as anything else—which may add further to demand for stocks.
What about active traders?
What moves should investors make in response to the crisis?
If this crisis causes a panic this week, the bold investors might want to take this opportunity to buy what everyone else fears—and that means stocks in Russia, maybe Poland, and maybe Turkey.
Russian stocks are dirt-cheap, factoring in a lot of political risk. The Russian market overall is on just five times forecast per-share earnings, according to FactSet. GazpromOAO, the giant energy company, trades on three times forecast per-share earnings, according to FactSet data.
Three times. To put this in context, world stocks overall trade on 14 times per-share earnings, and the U.S. market is on 17 times.
If Russian stocks fall in panic this week they will become almost a free bet. When you buy stocks this cheap you are being compensated for a lot of political risk.
The Turkish market is also cheap, one less than nine times forecast earnings. The country has been embroiled in some political turmoil recently. But it is just across the Black Sea from the Crimea, and this crisis might cause a further selloff in stocks there.
Russia’s neighbor Poland is more expensive—the market is 15 times forecast earnings—but it contains far less political or economic risk. Poland is increasingly part of western Europe and Vladimir Putin would only threaten Poland if he completely lost his mind, which doesn’t seem likely. Poland is a buy if this crisis causes a mass stampede of investors out of central and Eastern Europe.
As for Ukraine? It is such a small market that there are few ways to play it. And the few Ukrainian investment opportunities available to western investors do not appear to have factored in much, if any, bad news. The Ukraine Opportunity Trust, a closed-end fund focused on the small republic and traded in London, closed on Friday at a record high of 4.50 British pounds (to buy). That means the shares actually cost 17% more than the most recent net asset value.
Credit default swaps on some Ukrainian government bonds—insurance against default—surged late last night, and may have further to run. But anyone trying to bet either way is betting on a poker hand with the cards facedown.