As of the end of last week, markets were in an emphatic “risk-on” phase. After the initial shock of Russia’s invasion of Ukraine, the S&P 500 had regained a stunning 6.6% in two days’ trading. I argued that the market was working on the assumption that Vladimir Putin would get what he wanted, and that the world could live with this. I also added the following:
What Could Possibly Go Wrong?
Following this logic, these are the risks to worry about:
-Europe comes round to sanctions that really do hurt;
-Russia’s armed forces get bogged down and this turns into a long drawn-out conflict;
-Putin overplays his hand and invades a neighboring NATO member;
-Internal opposition brings down Putin and Russia lapses into chaos.
The first two definitely appear to be happening. The third isn’t, for which we can be thankful, but Putin does at present seem to have overplayed his hand — and his invocation of the nuclear threat suggests a risk of his doing so even more. While it would still be wishful thinking to say that the fourth is going to happen, there is far more internal opposition than many had thought possible. So by the criteria I established last week, the gloomy but market-friendly narrative that held sway then now looks seriously flawed. This matters a lot.
Politics is very much the battle of narratives. A few days ago, a story built around NATO overreach in encircling Russia, a weak, non-democratic “State Department client state” Ukraine, and a need to understand the priorities of the strategic genius Putin appeared to have sway — arguably even in the US, where it had a few prominent adherents in the media. Putin would end up getting what he wanted with very little damage along the way; there was nothing anyone could do about it. Stability would return thereafter, and it was all the West’s fault. For an explanation of how that narrative was nurtured and took hold, read this post from Ben Hunt’s Epsilon Theory, which now seems prescient.
This tale stretched to include other baleful notions. Europe is divided, Germany depends on Russian energy, the growing ranks of the world’s autocrats will support Putin, the US is intractably divided with a weak president and a substantial body of support for Putin and what he represents. All of this has some element of truth, of course. The point is how narratives feed on themselves so that all points that don’t fit with them are ignored. They can become self-fulfilling prophecies.
Markets also move on narratives. With the strength of the received wisdom at the time that the invasion started, and the headlines of the first few hours, it was easy for the narrative that fueled the rebound to take hold. As a swiftly victorious Putin who then went back to minding his own business would imply greater global stability, that imagined scenario swiftly became market-positive.
This whole story is now in shreds. The strength and success of the Ukrainian resistance to date, the brutality of the Russian assault, and the support for Ukraine in the rest of the world and even among Russians has seen to that. Now, two narratives are competing for primacy.
One is that this proves to be “The Great Turning Point.” On this analysis, the European Union now gets its act together, the world’s other autocrats decide to toe the line, the mad pro-Russian strain within American conservatism is decisively defeated, giving the US a credible center-right party once more while bringing the president a new lease of life. And maybe, just maybe, this is the moment when Russia turns on Putin. Liberalism at last wins the upper hand on authoritarian populism. Here are some of the talking points in favor:
-Turkey’s Recep Tayyip Erdogan, another authoritarian friendly with Putin and a member of NATO, appears to be ready to block Russian forces from passing through Turkish waters in the Dardanelles;
-China seems to be distancing itself from Putin;
-Putin apologists in the US are desperately trying to change their story;
-The EU is agreeing to much tougher financial sanctions, and acting with startling unity.
The other narrative needs just one word: “Chaos.”
-Putin cannot turn back now. Like many invaders before, he will continue in the attempt to avoid humiliation. Russian military power is such that it cannot be denied (if, that is, Putin sees some point in taking a country he regards as Russian by destroying it.) Russian behavior in Syria provides an idea of what could happen;
-The western financial upheaval, just to enforce Russia’s new pariah status, will be immense and painful; news that BP Plc will take a $25 billion hit to drop its stake in the huge Russian oil producer Rosneft, in a painful strategic blow, shows the scale of what’s ahead;
-Sanctions are creating what looks like an incipient bank run in Russia, as people try to get access to foreign currency when there’s still a chance, while the effects on bonds and the ruble could be profound;
-Transport bans across Europe threaten to reintroduce the kind of problems created by the pandemic;
-Putin’s rationality looks very questionable at this point, and he’s been hinting at the use of nuclear weapons.
Coverage, as far as I can gauge at present, is veering between these two narratives, with a whiff of premature triumphalism mixing with deepening alarm. In the long run, it matters hugely which one wins out; in the short run, the fact that Putin can’t just take Ukraine leaving the West powerless to do anything about it means that the situation is much riskier than it appeared last week.
Many historical analogies are doing the rounds. I think the best might be with “Red Monday,” Aug. 19, 1991, when Mikhail Gorbachev was detained in his dacha and a group of Soviet hardliners declared a coup. The era of glasnost and perestroika was over; the world would have to get used to a Brezhnev-style Soviet Union once more. Markets sold off. Then Boris Yeltsin famously stood on top of a tank, the coup collapsed, and by the Friday, Yeltsin was thrusting a piece of paper in Gorbachev’s face and demanding that he sign a law outlawing the Communist Party.
Within five days, the narrative went from “Back to Brezhnev” to “Russia is no longer communist.” By the end of the year, the Soviet Union was over. Those were frighteningly swift developments, which re-echoed throughout the subsequent decades. They’re having serious ramifications in Ukraine at this moment. The roles of Gorbachev and Yeltsin, both regarded as unambiguous heroes at one point, remain controversial. But the chances that we will come to see an analogy between Volodymyr Zelenskiy and his social media posts with Yeltsin’s speech from a tank look strong. And even if Putin finds himself in the Gorbachev role, which still seems unlikely, there is ample room for things to go right or wrong in the years that come.
This time around, the narrative has spun from “Putin can have what he wants” with equally stunning swiftness. The lesson for investors is to be extremely cautious, and to remember that a short-term market-unfriendly outcome (more uncertainty) is a consummation devoutly to be wished for the long term.
Bloomberg
