Someone once wrote, “History does not repeat itself, but it does rhyme.”  The current Russian invasion of Ukraine has been compared to the 1938 German invasion of Czechoslovakia.  Like Nazi Germany, Russia made a series of escalating demands on Ukraine and used their lack of compliance as a pretext for invading the country.  The key difference is that the Ukrainians have risen up to fight the Russians, whereas the Czech government was intimidated into acquiescing by a combination of Nazi bellicosity and intimidation of its allies.  It was here that Neville Chamberlain, the Prime Minister of Great Britain, went before the media waving a paper and boasting of securing “peace in our time.”  That peace would last for a year. 

The Ukrainian conflict is entering its sixth week.  Russian progress has been blunted at great cost.  Both sides are committing to sending in both material and soldiers, sometimes in the form of mercenaries.  How long this will go on is anyone’s guess.

Given its pariah status, Russia cannot win even if it prevails militarily.  Most of the rest of the world has severed ties with the country. The architect of the conflict, Vladimir Putin, risks being arrested as a war criminal if he leaves his borders.  His dream of a Russian Empire is out of step with the 21st Century.  Nowadays countries control one another through trade and access to technology.

Which brings us to the chief winner of this conflict: China.  China has proclaimed that it will not stop trading with Russia.  This means that oil and material exports will move from Russia to China.  On one hand, this should be a zero-sum game.  Oil bought by the Chinese from Russia replaces oil imported from other countries.  On the other hand, China will now reduce oil purchases from the middle east, who will now presumably sell to Europe.  Grain purchased from Brazil and the US will now come from Russia, and so on.  Natural gas, which Russia exported to western Europe, will now be replaced by Liquified Natural Gas (LNG) from the US and other countries.

European dependence on Russian energy was advocated by Angela Merkel, the former Chancellor of Germany.  The idea was that by buying oil and gas from Russia, the country would prosper and become closer to its market.  This thinking is classic economics; the problem is that it disregards political intentions. By the time the rose-colored glasses came off, the dependency was established. 

China, being Russia’s only trading partner of any size, will be able to ask for steep discounts from world prices for the commodities it purchases.  Over time, this will reduce Russia to a vassal state of China, or as diplomats put it, a “junior partner”.  China will provide Russia with its only source of technology.  Over time, such technology will make Russia even more dependent on China economically.

While China is smart enough to let Russia continue to exist as its own country, Chinese influence over them will only grow over time.  Having been cut off from export markets for oil, gas, steel and aluminum, Russia is at the mercy of whomever will trade with it. In addition to China, only India has expressed any interest in supporting the country with trade.  Smaller states like Venezuela and Cuba show support but given their size such support is more symbolic than real. 

The next commodity issue is going to be the materials necessary for car battery production for Electric Vehicles (EVs).  Cobalt is a critical material found mostly in China and Russia, along with the Congo in Africa. China has been busy buying up cobalt mines as a way to corner the market in the material, forcing buyers to pay whatever it wants.  It is a similar story with lithium and other earth resources. 

China, through an international public works program called the belt and road initiative, has been constructing a land route from China to Europe.  It has financed this through the foreign exchange acquired by the US’s trade deficit.  It is billed as a modern- day version of the silk road that existed to send tea and spices to western Europe in the Middle Ages.  China’s goal is to make the countries that take its loans to build infrastructure literally in its debt.  As with Russia, China understands the influence of money to a country lacking the same.

China is a clear winner here.  NATO and the western alliances are at best hoping for a removal of Russia from Ukraine.  Given Russia’s capacity for nuclear weapons, such is the best that can be expected.  A change in leadership from Putin may or may not prove helpful.  In a dictatorship, there is no clear line of succession.  If time goes by, perhaps China will have some say. This may not prove to be to the West’s advantage. 

The Economy

Economic activity continues apace. Lower income people are being whipsawed by energy and housing prices, including rising rents, while more affluent consumers are flummoxed by the extent of demand and lack of supply.

By one estimate, there is a deficit of five million housing units in this country.  Most of that is in the lower income bracket.  To build affordable housing here requires a smaller lot size. A neighborhood of craftsman or shotgun style houses can be built on quarter acre lots.

The typical suburban development requires a minimum one acre lots by zoning.  Since zoning is set locally, it does not respond to federal programs; thus, the limited influence economic policy has on housing.

Economic forecasting calls for a decline in growth to three percent this year and two percent next year.  None of the forecasts have been adjusted for the disruptions caused by the cessation of trade with Russia.  Items like steel, wheat, corn, barley, and aluminum are all up due to the lack of supply out of Russia. 


The sharp rise in gasoline prices has upended the middle class, as cuts elsewhere have to compensate for greater energy costs.  The rising cost of diesel and aviation fuel has made inflation a broader occurrence.  Couple this with the irregular ability of most vendors to deliver, and things are very chaotic in terms of pricing of goods.

Since these shortages are the result of supply disruptions rather than demand growth, it would seem that normalizing supply would cause inflation to recede.  The problem is that supply has been disrupted by one thing or another since the pandemic first hit.  It does not seem that supply will normalize anytime soon. 

The forecast is for four percent inflation this year and three percent next year.  This should be considered the minimum expectation.   January saw a new high in home prices.  Until supply catches up with demand, expect this to continue. 

Interest Rates

With inflation showing no signs of ebbing, interest rates are rising to match the environment.  Home mortgage rates are now over four percent for the first time in almost four years.  While some investments are still showing positive returns net of inflation, low-risk investments like government bonds are not showing positive returns at this time.

The Stock Market

The market overall looks to be neutral.  The median stock has a Price/Earnings ratio of 17, in line with historical averages. Two trends may disrupt this.  As interest rates rise, the overall market’s PE ratio tends to decline. 

Second, there have been to date few if any revisions for the write-offs that will have to be taken by companies withdrawing from Russia.  McDonalds walked away from 850 stores in Russia, most of which were company owned.  Other companies made similar abandonment of assets.  The ensuing write-downs of earnings (asset impairments are charged against earnings) may materially reduce the earnings of companies with Russian exposure. 

The aircraft leasing sector is very vulnerable to write-offs.  Because of the danger of seizure, Putin has decreed that all leased planes cannot be flown out of Russia.  This has resulted in what one industry publication calls “Putin’s Great Plane Robbery”.  Putin has said Russia will pay for the planes but has not specified the price. 

Warren M. Barnett, CFA

March 31, 2022

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