Three months ago I received a number of emails and even comments on news articles here about how Russia would kick-start a war with Ukraine this summer. It was prescient. Almost too prescient. In the past four weeks, Ukraine president Petro Poroshenko has been warning about Russia amassing military equipment along the eastern border. Whether this is true or not is not the story here. What is worrisome about this is that Europe extended sanctions in March and there is chatter of U.S. sanctions continuing into next year. Reheating a civil war in Donetsk and Luhansk will surely make that come to pass. And there goes Russian equity in 2016.
In fact, since Poroshenko has been coming on television discussion Russian military tactics over the past four weeks, the Market Vectors Russia (RSX) ETF is down 11.1%. It is now underperforming the
Then there's the ruble. Oil price declines haven't helped it. The Russian currency is down 7.67% in the last four weeks since Poroshenko has been beating the war drums. The iPath S&P Crude Oil Index is down 4.5% in the same period.
The ruble is the worst performing BRIC currency in the last four weeks, and while I doubt this is because of Poroshenko or Ukraine, a worsening climate there will sour investor appetite and could push oil down further.
"We do not believe the civil war will heat up even more, despite histrionic reports by the Kyiv government that a Russian-led invasion is imminent," says Vladimir Signorelli, founder of Bretton Woods Research, a top-down investment research firm based in New Jersey.
One way to look at this: Poroshenko and prime minister Arseniy Yatsenyuk may very well decide to raise the specter of the Russian bear in an attempt to plug up the holes in their terrible public approval ratings. The Ukraine economy is in shambles. GDP contracted 17.6% in the first quarter and annualized inflation is nearly 60%, 58.4% as of May. Renewed hostilities may be the easiest path for government officials to cool the heat on themselves, but the rhetoric, if that is what it truly is, will have to be weighed carefully by RSX holders. The chatter is not going to help, nor is the renewed fighting in Donbas. It's been a few months now since Russia was the bad guy in global equity markets. Maybe its time has come again.
Looking at this from the other side, with the sectoral sanctions extended against Russia until Dec. 31, 2015, Russia could feel picked on enough to stir the pot and make mince meat out of the Minsk Accord. This is the absolute worst case scenario.
The base case scenario is that Poroshenko is wagging the dog about a full blown invasion. There remain concerns that civil unrest continues, with pro-Russia forces fighting the Ukrainian army still in cities across eastern Ukraine. Some seem to be cheering for it. Actual fighting and Poroshenko's dire warning of a pending escalation have made the G-7 agenda this week.
Opinion polls show declining faith in both leaders. Almost 60% of Ukrainians disapproved of Poroshenko`s performance in a March survey. Yats has lost even more support than Poroshenko, because the population associates him with the economic crisis, unemployment, low salaries, and inflation, Anton Grushetsky, an analyst with the Kyiv International Institute of Sociology, told the Christian Science Monitor's Fred Weir.
Local elections across Ukraine are scheduled for October. It will be interesting to see just how the locals reward the pro-European politicians under Yats. Or if we go back to more of the same Ukrainian ways. These are all unknowns and I won't pretend to know them. There are plenty of people out there who will pretend to know, even without sources in the the Russian or Ukrainian governments. (That's amazing!)
What we do know is that Russian assets will follow the direction of two things: oil futures and Ukraine's short-term future. Oil will weigh more, so long as Poroshenko is wrong. If Poroshenko is right, and violence intensifies, the Russia ETF will feel the pressure. Oil will probably decline as it has in the past when the Ukraine variable was in red alert.
Meanwhile, Putin has been playing it cool. The Monitor's foreign correspondent Fred Weir noted that the word "Novo Rossiya" (New Russia) has been dropped from the lexicon of top Russian officials these days, an attempt to back people off the belief that the Kremlin is planning on acquiring more Ukrainian real estate.
Russia annexed the Crimean peninsula in the Black Sea in March of last year following a local vote to secede from Ukraine. The U.S. and European Union blasted Russia for annexing Crimea and said the vote broke international law and Ukraine's constitution.
The Minsk Accord does not allow for any more annexations.
Meanwhile, Foreign Minister Sergei Lavrov remains a continued advocate for negotiations between rebels and Kyiv. Secretary of State John Kerry was also in Russia recently to meet with Putin. Clearly the trip was geared to stabilizing the situation, rather than exacerbating it. This is a plus for investors concerned with political risk.
What we know is that the anti-Russian, hawkish elements of the Poroshenko government have lost their shine, Signorelli wrote in a note to clients on Friday. "The easiest path for the West may be to keep calm on Ukraine, rather than inflame the situation with Russia," he says.
