Market Overview
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What if the war in Ukraine escalates?
It has happened before. In fact, it’s happened more than once. Wars that start in Ukraine have a way of not ending there.
History, they say, doesn’t repeat itself, but sometimes it rhymes. The first stanza of “Let’s Conquer Ukraine Then Go on To Wreak Havoc on a Continental Scale” dates back to the year 602, when the native Indo-European pastoralists were invaded by the nomadic Avars, who went on to take over Bulgaria, Hungary, Moldova and much of the Balkans. Their occupation went on for around 250 years before Avar society just collapsed.
By 860, the Kievan Rus’ state had emerged, the Kiev-based forbearer of both Ukraine and Russia. It immediately started picking fights with the declining Byzantine Empire. In less than 400 years, it fought five wars with the Byzantines, ultimately supplanting this rump of the Roman Empire as the dominant power in eastern Europe. It was at that point that the Mongol invasions put Kievan Rus’ on the defensive for a couple hundred years.
A history of violence
As the Russian Empire emerged over the following centuries, it fought a dozen wars with the Ottoman Empire – Byzantium’s successor state – which didn’t go nearly as well. (We actually talked about one of those wars in this space, albeit in a completely different context.) These conflicts had a way of bringing in German, Austrian, French and British forces.
Of course, it’s nearly impossible for a state centered in present-day Russia to fight a war with another centered in present-day Turkey without shedding blood up and down Ukraine, located right in the middle. Sometimes the Ukrainians acquiesced to their status as a Russian client state, but sometimes they didn’t. From the 1500s through the 1700s, Ukrainian Cossacks fought a series of uprisings mainly against Russia but sometimes against Poland when it was ascendant.
In the middle of all that, by the way, there was a civil war between the armies of Zaporizhia and those of Crimea. That conflict sparked a war between Poland and the Ottoman Empire that almost took Poland off the map for good. And of course, we can’t talk about wars in Eastern Europe without mentioning both of the 20th century’s world wars. Further, Ukraine didn’t join the Soviet Union willingly. A hundred years ago, an all-out war erupted between the Ukrainians and the Soviets and, when the Soviets ultimately won, a series of doomed uprisings followed.
What’s happening today, then, is entirely on-brand for Russia and Ukraine. The only difference is the drones. And the cyberattacks. And the nukes.
Worst case, or just a cursed place?
So, should we be worried that this conflict will jump a border and trigger a NATO response and a wider war? Perhaps, but what would be the effect here in the United States?
Let’s start with the worst-case scenario and discard it: all out nuclear conflagration. The U.S. and Russia each have between 5,000 and 6,000 nuclear warheads, but there’s no way that they’ll all launch. Most of these are stockpiled; still, each side has about 1,600 warheads ready to go. But the scary part is not the 3,200 deployable nukes; after the first 100 hit, there’ll be nobody around to count the rest. That’s not going to happen now for the same reason it didn’t happen during The Cold War of the 1950s through the 1980s; nuclear weapons’ only real strategic use is as a deterrent. If you use them, you both lose – it’s just that the other guy loses five minutes sooner than you did.
Let’s veer back toward reality then. Military analyst Mick Ryan – a retired Australian major general – sees three scenarios. The first is stasis, in which the two sides essentially settle into World War One-style trench warfare and the conflict goes on for years. The second, which is what we’re seeing at the moment, is battlefield progress on the part of one combatant, and in this case, that’s Ukraine.
“Because such progress would show that Ukraine can take back its territory with western assistance, the military aid of the past six months is more likely to continue,” Ryan writes for Australia’s ABC media network. “That said, many types of equipment and munitions from western stockpiles are probably running low and will necessitate a ramping up of defense production in the United States and Russia.”
But the third scenario is the least predictable one: what Ryan calls a “strategic surprise” because, apparently, black swans are commonplace in Australia. (Who knew?)
“Examples might include the death or deposing of a national leader, a precipitous collapse in military morale and cohesion, or even a significant economic event in one of the belligerents,” according to Ryan, an Afghanistan veteran who later worked with the U.S. Joint Chiefs of Staff.
He notes that, if it’s the Ukrainians who are “surprised,” Western governments would either need to commit troops or consign Ukraine, a NATO/European Union wannabe, to its former status as a Russian client state. Whatever choice each Ukraine-supporting state makes, its current government would face an uphill reelection campaign. If the “surprise” is on the Russians, that could either destabilize the government in Moscow or, alternately, “result in an embittered and more dangerous Russian state.”
Gush to judgment
Like so many wars over the past century, you can’t dismiss access to oil reserves as an incentive for American involvement in Ukraine. Our national default has always been to isolationism, although the Cold War tested that to its limit. Still, we didn’t hesitate to go into Iraq twice in a generation. It was the oil fields of the Caucasus that attracted Axis attention in 1942, and Ukraine and Russia were just in the way.
Anyone who doesn’t think that oil is at least part of Vladimir Putin’s calculation needs to pull into a Chevron station. He presides over a country with about 5% of the world’s petroleum, and historically has been the biggest exporter to the European Union. In 2020, Russia supplied 29% of the EU’s oil, compared to the runner-up, the U.S., at 9%. While Hungary, Austria and Italy all produce some oil, if you combined it all together, it’s almost a rounding error. Norway, which isn’t an EU member but rather a friendly neighbor, exports almost as much oil there as the U.S. does. The largest petroleum producer in the EU had been the United Kingdom, but that didn’t work out so well.
It's a similar picture for natural gas, for which Russia supplied a whopping 43% of the EU’s demand. With Putin’s hand on the spigot – and with his army on its back foot because of Western support for Ukraine – that is being dialed down to essentially 0%. So, baseboard heat won’t be available to Ukrainians for any price short of surrender, and the rest of western Europe has already paid the price. It amounts to the weaponizing of energy, and the EU is being attacked via economic warfare for its opposition to Russia’s adventurism.
While energy prices are now coming down quickly in the EU, it’s only because the governments went on spending sprees, offering whatever it took to get their reserves up to comfortably ride out the winter. Still, prices remain high for both oil and gas there.
But what’s that got to do with our local Chevron? For the past three years or so, the U.S. has been energy-independent while our amiable next-door neighbor Canada has been one of the largest energy producers in the world for decades. It shouldn’t really matter what’s happening in the rest of the world, should it?
But oil is fungible. If other wealthy nations are willing to buy more of our oil at a higher price – and pay the freight costs and the additional burden of refining American crude to European standards – it’s just good market capitalism to sell the goods to the highest bidder. As a result, there’s less oil and gas available for American consumption, so the price per gallon or BTU is bound to rise here. Then, because oil is an input to any manufactured or transported good, you can expect broader inflation at the supermarket, on the car lot, at the furniture store, and at every other point of sale.
In the accompanying column, we’ll discuss coping mechanisms you can incorporate into your portfolio right now to protect against Ryan’s “strategic surprise”. Still, it’s a good idea to vet these ideas with a trusted financial advisor.