Where we are now. Better said, where we might be now.

I was a soldier during the Vietnam war. My first duty station was in Colorado, with the 10th Mechanized Infantry. My company had maybe 30 armored personnel carriers that we went on practice maneuvers in all the time. Or at least we tried to. But we’d start out with the full complement and arrive in the field with 20, if we were lucky. Later it came out that the government massively understated the materiel losses in Vietnam and made up the difference by taking all the spare parts from combat units in the US and Europe and secretly sending them to Vietnam. So even though we were classified as combat ready, we were nowhere close to that.

In ranger school, my class field-tested new shovels, ponchos and rucksacks we were told the Army was thinking about buying for combat troops because they were lighter than older models. But the shovels only worked in sand, the ponchos dissolved in water and the rucksacks raised giant welts on our backs. We all wrote the most negative possible reviews and patted ourselves on the back for having saved the Army from dreadful mistakes. Several months later, on line to get equipment in Vietnam, I saw ahead of me big piles of the same shovels, ponchos and rucksacks. Nothing to match the Colt M-16 scandal, but still…

My point? I’d forgotten about all this until reading about the apparent surprising ineptitude of the Russian army in Ukraine. My take is that Moscow is afflicted with a gigantic case of the corruption that plagued the US all those years ago. Not just that, but Putin seems to have had no clue about his military’s shortcomings.

About stocks, though? The question is what areas of economic weakness are there in Russia that we don’t know about.

Oil is the biggest area I’d be concerned about. On the one hand, in every case of price controls or sanctions I looked at during the better part of a decade as an oil analyst (though admittedly a long time ago), the sanctioned oil was relabeled as something else by middlemen and sold to customers who were not vitally concerned with its origin.

My question about oil from Russia, however, is how much of its output is lifted by, and therefore depends on access to the expertise of, international oilfield services companies. Yes, the withdrawal of BP is an issue, but I suspect this is mainly an access to capital question. Suppose half of Russia’s typical oil output stays in the ground because there’s not enough domestic expertise.

Two implications: maybe considerably higher oil prices in the near term, and increased impetus on making the switch to electric cars and trucks.

Banks and other financial companies are another. Banks that have lent to Russian clients, even in dollars or euros, have two big issues. One is that the collateral backing loans has likely fallen due to ruble depreciation. The second is that governments facing the kind of balance of payments deficit developing in Russia typically end up imposing capital controls, so that borrowers aren’t legally able to service debt to foreign banks, even if they want to.

World stock markets seem to be shifting away from economically sensitive stocks. Thinking in the simplest terms, economic problems in Russia are somewhat like an emerging markets debt crisis–e.g., Brazil or Argentina. Currency depreciation hits both firms with plant and equipment in the country, because their balance sheet value is reduced, as well as firms that make things elsewhere that they sell in the affected markets. Turmoil lowers the wealth of the emerging market buyer, resulting in lower ability to pay for foreign goods and services. The companies typically most affected are the industrials that investors have been buying over the past six months or year to defend themselves from the weakness in tech. My sense is that investors are at least searching through the tech rubble for names that have been excessively sold off.

more tomorrow

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