Daily Comment (March 8, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Once again, our Comment opens with an update on the Russia-Ukraine War, where Russia appears to be preparing for a major new assault on Ukraine’s capital city, despite its military problems to date.  We next review a number of international and U.S. news items with the potential to affect the financial markets today.  We close with the latest developments related to the coronavirus pandemic.

Russia-Ukraine:  As the Russian military struggles to seize territory from the Ukrainian army, it continues pummeling civilian targets with artillery, missiles, and aerial bombs.  Official and private military analysts believe the Russians are now regrouping and preparing for a new major assault on the capital city of Kyiv within the next day.  At the same time, Russian and Ukrainian officials met again yesterday to discuss a ceasefire and civilian evacuations, but the talks produced only modest agreements to help civilians flee.  There is great skepticism that the Russians will follow through on the deals.  The Russian and Ukrainian foreign ministers are scheduled to meet on Thursday in Turkey, but French President Macron said his many recent talks with Russian President Putin have left him pessimistic that the attack will end any time soon.  For the global economy and financial markets, the principal near-term risk continues to be the possibility of restricted supplies of energy and other commodities from Russia and Ukraine, which will drive up prices and possibly spark a global recession.  The U.S. today is expected to announce that it will ban all imports of Russian crude oil, which could prompt other countries to do the same and set off a scramble for alternate supplies.  The main longer-term risk is that the global economy will continue to deglobalize and fracture into several trading and financial blocs, further boosting costs and shutting off profitable investment opportunities.

  • Meanwhile, the Russian military continues to lose large amounts of equipment and many troops.  The documented equipment losses include literally hundreds of tanks, artillery pieces, armored vehicles, trucks, airplanes, and helicopters.  Those losses include not only equipment destroyed but vehicles and equipment captured and now available for use by the Ukrainian army.  Russia’s personnel losses include at least two generals and two colonels killed in action, as well as many troops taken prisoner.
    • Over the weekend, we noted one Ukrainian estimate that 11,000 Russian troops had already been killed in action, while Ukraine and some Western officials said in the middle of last week that Russia had lost over 5,000 troops killed in action.
    • However, these tallies seem high to us.  As shown by the great military historian John Keegan, the ratio of killed to wounded in the projectile age of warfare is typically 1:3 to 1:4, based on the surface area of the human body that covers vital organs (but not adjusting for the extensive use of body armor in today’s advanced militaries).  If the Russians really have had 11,000 killed, that would imply perhaps 33,000 to 44,000 wounded, not to mention troops taken prisoner.  Total Russian troop losses would therefore be at least 44,000 to 55,000, equal to almost 25% of the forces deployed to the Ukrainian border before the war, and almost 50% of the total that actually entered Ukraine in the first week of the conflict.  Losses of that magnitude seem impossibly high to us, even with the incompetence we’ve seen in the Russian operation to date.
    • We suspect that the Russian troop losses of 5,000 to 11,000 so far may include both killed and wounded.  If so, Russian troops killed in action might “only” total 1,000 to 2,500, or 1% to 2.5% of the troops in Ukraine over the first week of the war.  That’s relatively more limited, but the total killed would still be much worse than the 400 or so Russian troops who died in one month of fighting during the takeover of Crimea in 2014.
  • Perhaps because of the Russian casualty experience to date and the heavy Western sanctions already imposed, Belarusian President Lukashenko said in recent days that his forces would not be joining in the fight, despite reports last week that Belarusian troops were ready to enter Ukraine.
  • Separately, the war and prospects for Western embargoes against Russian oil continue to drive oil and natural gas prices sharply higher.  According to AAA, the average price for a gallon of gasoline in the U.S. has hit a near-record $4.065 per gallon.  The Biden administration is therefore scouring the globe for fresh oil and gasoline production that could ramp up quickly and quash the price spikes sparked by the war.  The administration is even talking with the Venezuelan government on their ability to help, perhaps reflecting skepticism that U.S. production could ramp up quickly or be palatable to anti-fossil fuel progressives here at home.  Separately, the EU today will outline a plan to cut its natural gas imports from Russia by two-thirds over the next year.  To do so, the plan calls for the EU to import more liquefied natural gas, rapidly boost renewable energy generation, push out the end of coal burning, and cut demand with efficiency measures.
    • The enormous jump in energy prices is probably the primary threat to the U.S., European, and other major economies.  As energy prices rise, consumers and businesses worldwide will need to curtail other spending, raising the threat of a recession and stagflation.  The Fed and other major central banks may still start to hike interest rates in the near term, but the resulting economic slowdown makes it even more likely they will curtail their rate hikes well before they otherwise would have.
    • More broadly, the prices for wheat, corn, nickel, and many other commodities continue to surge.  Increased grain costs (except for rice) will likely have an outsized impact on many poorer countries in the coming months, probably prompting political unrest in some countries.
    • Naturally, the hit to confidence and the rise in commodity costs will hit corporate profits and continue to weigh on stock prices in the near term.  With yesterday’s sharp stock price declines, the Dow Jones Industrial Average has now fallen into a correction (down more than 10% from its most recent peak), and the NASDAQ Composite Index has fallen into a bear market (down more than 20% from its most recent high).  As we have noted before, a quick end to the war could allow a sharp rebound in stock prices, although any such rebound could be short-lived if inflation takes too long to come down.

Japan:  Surging crude oil and natural gas prices because of the war have naturally prompted renewed interest in maintaining or increasing Europe’s nuclear energy capability, but the same is happening in Japan.  Former Defense Minister and senior ruling party official Itsunori Onodera today said in an interview that speeding up the restart of nuclear reactors halted in the wake of the Fukushima nuclear disaster may be Japan’s “best option” for riding out any oil and gas shortages that result from sanctions imposed on Russia.  The trends continue to look positive for uranium and nuclear companies.

China:  The American Chamber of Commerce in China released the results of a survey showing that less than half its members were optimistic that the Chinese government was committed to opening its market to more foreign investment over the next three years, down from 61% a year earlier.  Over one-third said they would reduce investment in the country because of an uncertain policy environment.

  • Coupled with the rupture between Russia and the Western democracies, the survey underlines the extent to which globalization is in retreat and the global economy is splitting into two or more economic blocs that will have much less interaction than in the past.
  • As we have warned repeatedly, deglobalization and shortened supply chains will serve to hike costs for businesses, feed higher inflation, and weigh on corporate profitability going forward.

Iran:  According to a senior EU diplomat, talks with Iran to revive its 2015 nuclear deal have now progressed to the point where “political decisions” are needed to finalize an agreement.

  • The official said no more formal meetings or expert-level talks are being held, as the fate of the deal is now in the hands of top political leaders in the participating countries.
  • Given the Biden administration’s political vulnerability because of high energy prices, we suspect it will be inclined to accept a deal in hopes that it would quickly ramp up global crude oil supplies and drive prices lower.

U.S. Digital Currency Regulation:  The White House is set to release an executive order this week tasking several federal agencies with conducting a broad review of cryptocurrencies, the cryptocurrency markets, and the possibility of creating a U.S. digital currency.  The agencies will have up to six months to conduct their reviews and prepare recommendations for public review.  While the U.S. government is woefully behind the curve on regulating the booming cryptocurrency trade, we still suspect that new regulations and/or the development of a central bank digital currency in the U.S. are a risk for digital currencies going forward.

U.S. Environmental Regulation:  The Environmental Protection Agency yesterday proposed new standards that would require engine manufacturers to lower nitrogen-oxide emissions from tractor-trailer-size trucks, as well as other delivery trucks, cement mixers, and trash trucks.  The initiative suggests that even with the Russia-Ukraine war raging and inflation remaining at extreme levels, the Biden administration is not backing away from new regulations that could further boost costs and weigh on profits for U.S. businesses.

COVID-19:  Official data show confirmed cases have risen to  448,030,162 worldwide, with 6,008,440 deaths.  In the U.S., confirmed cases rose to 79,339,497, with 960,314 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people considered fully vaccinated now totals 216,204,455, equal to 65.1% of the total population.

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