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The Crimean War
The Charge of the Light Brigade is from the Battle of Balaclava in 1854. Conspicuously missing is any reference from that war was the Ukraine. In fact, Crimea was effectively "gifted" to the Ukraine in 1954 by Nikita Khrushchev. The Soviet Union had a strong policy of attempting to break up or at least dilute strong groups of a single, non-Russian ethnicity.
So the big problem today is that Crimea doesn't look or feel Ukrainian, and it is home to one of Russia's most important naval bases. For many, this has always seemed like a recipe for disaster.
You lease cars, not crucial military bases. Having said that, I will admit to never fully understanding Gitmo, which is where the US leases a naval base (or interrogation center) from Cuba.
So what does this all mean?
The "Best" Case -- Independent Crimea
At this stage, the "best" case seems to be a deal that creates an "independent" Crimea. Russia can do some chest-thumping and the West gives up relatively little that really it hadn't given up before.
I don't see this ending without an independent Crimea. The situation went too far, and there doesn't seem any way to reconcile. There does not appear to be much interest in the Crimea to remain part of Ukraine, and Russia won't stop agitating until it gets what it wants.
The Ukraine can get some gas concessions from Russia to save face.
I see that as the best case. I am not sure it is the most likely case because it is difficult to determine:
1. Will Russia be content to stop there?
2. Will the Ukraine or NATO take steps to provoke Russia?
Let's hope the best case occurs as it shouldn't have a big impact on the lives of most people, even in the Ukraine, and the markets should remain pretty calm.
The Slippery Slope -- Eastern Ukraine
Much of the Eastern part of Ukraine is Russian-speaking. Vitaly Fiks (the F in my firm, TF Market Advisors), was born in Odessa and spoke Russian, not Ukrainian. That is the norm. Much of the heavily industrialized East has strong Russian connections.
The demonstrations have been spreading to cities in this region.
So will Russia be content with the Crimea?
Think about who the players are here:
A former colonel in the KGB (which I assume you don't get to be by being soft and naive) who has managed to come out on top in a country of oligarchs. The 0.01% in Russia do extremely well, are happy to flaunt it, and go to great lengths (legal and occasionally otherwise) to defend it. This is a hard man who is used to getting his way.
A constitutional lawyer who turned into a community organizer who can barely get people to agree not to default on our own debt. He has a great ability to fund-raise, but seems tired of the job.
Then you have a woman who has been able to hold together the EU and shape it to suit her and her country. She has done a great job of balancing internal and external pressure. She is very smart. She understands the mindset of the East having come from East Germany. Frankly, I think she is the best hope, but she has been extremely quiet, and while cobbling together a bunch of central bankers has been difficult enough within the framework of the EU, putting together something, military or otherwise that gives Russia seems very difficult.
So the next biggest risk is a push into Eastern Ukraine, and I think it is quite possible and there is a good lesson from Georgia on this one.
In Georgia, Russia effectively pushed 10 miles further than it had to. Then, as part of the negotiations, it conceded the territory from that last push and pulled back to the borders it had wanted in the first place.
Why not push and see what happens?
This is our base case. Russians will creep into Eastern Ukraine. My firm expects a reasonably quick resolution that again leaves most people unaffected and can leave the markets calm.
Comparison to the Anschluss
This is where it gets a little more troublesome, at least for the markets.
Germany started with Austria in 1938 and then moved into other primarily German regions of other countries. Small areas, where many of the inhabitants seemed to welcome the change with open arms, were allowed to proceed.
Belarus? Belarus was one of the first to form part of the Soviet Union. I have never heard a single Westerner suggest a visit to Minsk. It is heavily Russian-speaking, heavily industrialized, and struggling. Is that next?
While Estonia and Lithuania seem to have re-emerged with strong nationalistic pride, the same can not be said of Latvia. Is that another area where you could see the ethnic Russians try and create a situation that would be more to their liking? It seems less likely than the Belarus scenario, but, we have moved from "likely scenarios" to where this could lead.
I don't think the markets would respond well to Russia, which is resource-rich, flexing its muscle in this format. We don't think this scenario will play out, but if Russia is allowed to encroach into Eastern Ukraine, expect growing fears of a Russian Anschluss to weigh on markets.
When the Cat Is Away, Syria Will Play
Syria has not yet delivered all of its chemical weapons to the authorities. From what I can tell, we are in a lull and there has been no real resolution.
With all eyes on Russia, it could create an opportunity for Syria to cause serious problems. How could the US go into Syria, but leave Russia alone? Why wouldn't the Russians volunteer to help Syria?
This could happen in parallel with the events in the Ukraine, and we don't think the markets would be comfortable with this. I think it is likely that we see some noise out of Syria and that will be negative.
The Enemy of My Enemy -- Chinese Silence
China seems to be very quiet on the subject of Ukraine and territorial rights. Maybe that is because China has no interest in the outcome? Maybe it is because China isn't aware of what is going on? Neither is true.
Maybe China is watching the developments and deciding whether now is a good time to resolve its own territorial disputes. It seems that China has been getting more aggressive in and around the islands over which it has an ongoing dispute with Japan.
I doubt China does anything, but if it does, markets will be hit hard as that will put a question into global trade like we haven't seen in years. It doesn't seem to be in Chinese interests to do anything, but then again, maybe the country thinks there won't be repercussions?
We view this as unlikely, but will keep an eye out.
Other "Hot Spots"?
Are there other places, off our radar map, that might see this as an opportunity to be more aggressive?
We remain bearish risk assets due to our view that they are overvalued.
At this stage we see very little from Ukraine priced into the market, and with our best case that makes sense and even our base case (encroachment into Eastern Ukraine that is quickly and peacefully) resolved, the impact should be minimal. Probably creates a little downside to the market, but that is it.
As some of the other scenarios potentially come into play, whether in reality or perception, the risk to further downside in the market is significant.
Since we are already recommending being short based on the economy and the misperception of the Fed's next steps, you effectively pick up the conflict for free.
With VIX (INDEXCBOE:VIX)
being so low, picking up some downside protection makes a lot of sense here.