The Nasdaq is now officially in a bear market as defined by a 20% decline from the highs, while the S&P 500 and Dow Jones indices are in corrections, with losses greater than 10%. The Russian invasion of Ukraine and the economic sanctions brought against Russia in response are a major deal for the global economy. It’s unbelievable how quickly things have escalated. Russia is a major producer of essential commodities such as oil and natural gas, and these economic sanctions are far beyond what we have seen before. Unsurprisingly, the result is sky high energy and food prices, dramatically worsening the highest inflation we have seen since the early 1980’s.
This is a very dangerous conflict with extremely high stakes, being that the primary player is a major nuclear power. What concerns me is that I don’t see an easy path to a resolution after how much damage has already been done. Russia’s aggression into Ukraine’s capital is extremely provocative, while the West’s scorched earth sanctions have devastated the Russian economy. Putin has a lot on the line after taking so much damage with this disastrous decision to invade. There doesn’t seem to be an exit where he can save any face, barring sadly taking Kiev and negotiating from a perceived position of power, so my fear in the short-term is that things are likely to escalate. NATO countries are discussing providing aircraft and bases for Ukraine, which Russia says would constitute an act of aggression. Obviously any conflict extending beyond Ukraine would raise the stakes materially. I don’t know how this will play out, as I truly thought there was an opportunity for a peaceful resolution, but it looks like things will get worse before it gets better as things stand now.
From an investment standpoint, I believe we are very well positioned given the circumstances. All year we have been writing about taking a very conservative approach, selling put options way out of the money, while also incorporating covered calls on our long positions. This has us in a very good position where if all our stocks ended the year right where they are now, we would still end up quite positive on the year, despite what is now a bear market. Volatility has gone through the roof so most options are a lot more expensive, but at expiration, volatility and time value go to zero and that is where you will see the full benefit of the strategy. We’ve been able to harvest some profitable investments in energy, defense, and gold stocks, which we can redeploy into some of these names that have gotten really cheap.
Friday’s jobs report was excellent and the unemployment rate is extremely low. As Covid-19 fades, people are out and about spending money. If we can get a sustained cease fire, we could see a strong recovery in stocks. We’ve had big positions in companies such as Exxon, Cleveland Cliffs, Kinder Morgan, Enterprise Product Partners and Barrick Gold. All these companies are benefiting from these higher commodity prices. We recently took advantage of the big rally in Defense Contractors Lockheed Martin and Northrop Grumman, as they reached our target prices. AGO and MBI continue to perform well, as Puerto Rico’s restructuring of debt marches on. Municipal finances haven’t been this strong in decades thanks to all the stimulus money from the last few years/ There is a key court day coming up later in March, which if all goes well, should be very good for those stocks.
AIG reported an amazing earnings report a few weeks back and the stock traded comfortably in the $60’s, only to fall to the mid $50’s today. The business is operating the best it has since the early 2000’s, and this should be a fantastic year for it. Banks have pulled back a lot over the last two weeks, with many such as Citigroup trading at huge discounts to any conservative estimate of liquidation value. It has always paid off for us owning these stocks at these levels, and I think the upside is quite substantial. Our portfolios have very high dividend yields, which are quite secure. The underlying companies can buy back their own stock at these cheaper levels. In summation, we are built well for this type of environment.
As terrible and tragic as the situation in Ukraine is, from a strictly economic standpoint, this is nothing like we saw in 2020 when much of the global economy was paralyzed, but it is significant due to the inflationary impact. Let’s pray for peace as soon as possible. Barring a nuclear escalation or a true World War, we should be in quite good shape and I’m very glad we structured things conservatively going into this.