Russian Invasion – 4 Questions Investors Are Asking

Posted by David Nelson, CFA on March 3, 2014 in Investment Management | Leave a comment

By David Nelson, CFA

I said earlier this year during a CNBC interview “one of the things that keeps me up at night are the events I can’t quantify. Among those are military conflict and political unrest.” Well, we certainly got that as we headed into the close Friday with reports coming out of the Ukraine that Russian troops had invaded Crimea. The New York Times is reporting that a senior Obama administration official said Russian troops now have “complete operational control of the Crimean Peninsula, with some 6,000 airborne and naval forces there.” What was particularly interesting is that initial phase of the invasion showed troops obviously well trained and equipped with Russian weapons but bore no insignias.

This will dominate the news cycle for weeks and certainly was the focus of every media outlet throughout the weekend. As usual during times of political uncertainty the knee jerk reaction will be to sell stocks, buy gold and drive energy prices higher. Let’s discuss four questions investors are asking.

1. Why Did it Happen?

It’s been obvious for some time Mr. Putin is looking to advance Russia’s prominence on the world stage. He is confident that the U.S. may threaten economic and political sanctions but will do little from a military perspective. Secretary of State John Kerry said in an interview on Meet the Press that “the last thing anybody wants is a military option in this kind of situation.”

This will play well to Putin’s base in Russia. Over the weekend I participated in a Merrill Lynch conference call with economic and political experts from the region that believe Putin will likely get a bump in the polls at home. For now, he seems willing to sacrifice the Russian markets which are down significantly this morning.

2. What’s the End Game for Russia in the Ukraine?

I believe that Putin will stop short of moving beyond Crimea. As pointed out by the press and media, Crimea is a strategic asset for Russia with a predominantly ethnic Russian population. In addition, Russia has military assets in the region and will likely defend at all cost. The Russian military has set an ultimatum demanding Ukrainian army and navy units to surrender and leave bases in the Crimean peninsula. It would seem that a full occupation or annexation is the end game.

I believe the Russian invasion will be limited to the Crimean peninsula and that further military escalation won’t materialize.  If however, my calculus is off and Russia moves into the rest of the Ukraine then all bets are off and both Europe and the U.S. may be forced to do more than threaten economic sanctions and expulsion from the G8.

3. What Military Assets Will Russia Use?

While tanks, jets and the ubiquitous AK-74M are formidable assets in any conflict, the most powerful weapon Russia has at the moment is natural gas. According to Bloomberg OAO Gazprom (OGZD) said on Saturday that they would end the current natural gas discounts for the Ukraine if they weren’t paid the $1.55 Billion already owed for fuel. During the Merrill Lynch conference call which included Russian Economist Vladimir Osakovkiy the consensus was that Russia would use price as a weapon and not supply.

4. What Is the Likely Outcome for?

Even under the best of circumstances predictions are fraught with peril but as a strategist and portfolio manager I have to make a decision as to whether I want to remain invested. If you believe that the events unfolding in the Ukraine are going to escalate out of control with U.S. or even NATO troops going toe to toe with the Russian Military you should sell stocks and other risk assets immediately.

I believe Putin saw an opportunity and seized it. If Russia does not move beyond Crimea the end result will be a stalemate and at some point investors will look back and wish they had taken advantage of the opportunity.