From Russia with Love?

The big news late last week was German Chancellor Angela Merkel’s and French President Francois Hollande’s emergency trip to Russia for peace talks with President Putin. Obviously, the situation in the Ukraine is heating up again or such Herculean efforts would not be undertaken. This latest escalation was likely caused by a story in the New York Times (NYT) suggesting the United States is about to send a large shipment of lethal weapons to Ukraine to help the beleaguered Ukrainian forces fight the pro-Russian rebels. In past missives I have theorized this was going to happen ever since Ukraine voted to become a non-aligned state. Before that vote Ukraine had been aligned with Russia; and while the non-aligned vote was not a vote to join NATO, it was certainly a step in that direction. To a cornered Vladimir Putin, a NATO-aligned Ukraine is unacceptable for a multiplicity of reasons. In an attempt to gain some insight into the situation, I emailed my friend Bob Hardy, the lynx-eyed captain of the must-have Geostrat organization. My query read something like this, “Hey Bob, if memory serves me, I don’t recall that anything good has ever come about when leaders of the Western world brave Russia’s notoriously severe winter and journey to Moscow. Any thoughts?” Here is Bob’s response:

One thing to note is the U.S. was not included. I hear Putin offered Merkel and Hollande a deal in a phone call last Tuesday. Apparently the French and the Germans are willing to accept a ceasefire and a demarcation line between the two side’s forces that accepts the current situation on the ground. Merkel would never have traveled to Moscow unless she thought a real deal was possible. Last Sunday's NYT report that the U.S. was considering supplying lethal weapons to the Ukraine and the report on Monday proposing $3 billion in American equipment be sent to the Ukraine, sharpened Merkel and Hollande's minds. They know Moscow would invade Ukraine if this happens and the conflict would intensify and widen. Getting into an arms race with Russia in the Ukraine is stupid and dangerous. Kiev is #$@!&, but I think it agreed after the EU promised to send it some money. Notice that Kiev stopped exchanging its currency for dollars and euros. It is broke and faces disaster on the battlefield. We will have to see what develops, but where there is smoke there is fire.

“See what develops” indeed because Russian President Putin is being battered on many fronts. Consider this, Russia needs an end to the destabilizing sanctions imposed for its Ukraine misadventures. As the economic environment in Russia worsens, and the Russian solder death toll continues to rise, more and more Russian citizens will start to realize, as The Wall Street Journal (WSJ) notes:

[The longer the Ukraine crisis goes on] many Russians may come to see that the Ukrainian model of a peaceful and spontaneous rebellion against a corrupt regime can have relevance for them. It was because of the potential power of the Ukrainian example for Russia that Mr. Putin began the war in Ukraine in the first place.

Plainly, corruption is rampant in Russia with 110 people controlling 35% of the country’s wealth, while “50% of adults have household wealth of $871 or lower (WSJ).” Boy, talk about “The 1%!” No wonder Russian capital flight is epic. Moreover, in 2014 food prices surged 15.4% while crude oil prices plunged. Crude oil exports from Russia account for roughly 50% of Russia’s GDP, and the breakeven price for a barrel of oil to balance Russia’s budget is notionally $100. Further, Russian crude oil, for the most part, is priced in U.S. dollars, which is why much of Russia’s debt is also priced in U.S. dollars. Given the dollar’s strength vis-a-vis the ruble, that debt is becoming increasingly difficult to service. For example, if a Russian energy company borrowed $1 million dollars at the beginning of last year when $1 equaled ~33 rubles (33 million rubles), the size of that loan is now 67 million rubles since the exchange rate currently is $1 to ~67 rubles. Accordingly, our hypothetical Russian energy company’s debt has effectively doubled, while its revenues have been cut in half due to the crash in oil prices. To be sure, “Ya got trouble. I say trouble right here in River City. Trouble with a capital ‘T’ and that rhymes with ‘P’ and that stands for Putin!” No wonder Frau Merkel donned her galoshes and trudged off to Moscow.

Speaking to crude oil, I thought the most interesting thing about Friday’s market action was the fact that the U.S. Dollar Index rose (+1.2%) and so did the price of oil (+2.4%). For a very long time oil has gone down as the dollar’s value has increased. What happened on Friday was a change in that relationship and only further bolsters my belief that crude oil has bottomed. Recall, it was three weeks ago today on CNBC I stated, “I think the price of crude oil bottomed last week.” I still feel that way and would tilt portfolios that way. In the conference call I did with Troy Shaver, CEO/Senior Portfolio Manager (PM) of Dividend Asset Capital and outside PM of the Goldman Sachs Rising Dividend Growth Fund (GSRAX/$21.45), we discussed various energy themes and stocks. Three of the energy stocks Troy currently likes, and that are favorably rated by our fundamental energy analysts, include: Enterprise Products Partners (EPD/$35.29/Strong Buy), EOG Resources (EOG/$95.79/ Outperform) and Plains All American Pipeline (PAA/$51.69/Outperform).

Speaking to the equity markets, as stated in Friday’s verbal strategy comments, “What a difference a week makes for it was a mere week ago last Friday when the S&P 500 (SPX/2055.47) was trading at 1990 and threatening to break below a spread triple-bottom. As noted at the time, there was/is a huge amount of internal energy built up on my proprietary indicators making me think that energy was going to be released on the downside.” Silly me, for the news backdrop changed and the SPX surged from last Monday’s intraday low of ~1981 to last Friday’s intraday high of ~2072 before a late fade left it at 2055.47.

The call for this week: I am off to San Francisco to see institutional accounts and speak at various events. Despite last week’s hurrah, all we have done is once again rally from the SPX’s support level (1990 – 2000 to 2060 – 2080). Nevertheless, the last line of Friday’s Morning Tack read, “While I am still not sure about the upside from here, I am pretty certain crude oil has bottomed.” Hereto, I continue to feel that way. Over the weekend, Greece said it would run out of cash in the next few weeks, which is probably why S&P downgraded Greece’s debt. S&P also warned that Greece’s “cash crunch” could force it out of the euro and the EU. As of this writing (5:00 a.m. Monday), there has been little news from the Moscow meeting other than Merkel saying she thinks the Minsk deal will provide a “dividing line” between the “Ukrainian troops and pro-Russia separatists redrawn to take account of recent separatist gains.” There was supposed to be a four-way phone call late Sunday between those leaders, but all that has come from that is another meeting in Belarus slated for Wednesday. Combine that with a defiant Greek Prime Minister on a bailout, and sketchy economic news from China, and you have the preopening S&P futures off some 9 points as I wing my way westward ...

(c) Raymond James

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