Is this the face Vladimir Putin will make if Ukraine joines the EU? Photo by Mark Wilson/Getty Images.
What will cause the next bear market?
Folks are always asking. Will it be a hard landing in China? The next US budget battle? Debt ceiling showdown? Launching the Affordable Care Act? Syria’s civil war? Some other Middle Eastern conflict? High oil prices? Higher inflation? Janet Yellen tweeting? Ben Bernanke shaving his beard? (Kidding about that last one.) But even though markets are ripping and fundamentals look great today, the next bear is on many folks’ minds.
Something big, bad and unforeseen can always kill a bull before it reaches the end of its natural life, a la mark-to-market accounting in 2007. But assuming this cycle follows the normal and much more common progression, the end should sport three main features: euphoric sentiment and lofty expectations for future earnings, deteriorating fundamentals and something big and bad that threatens future corporate profitability—something few notice.
None of the risks mentioned above currently fit this description. This will be tough to believe—headlines everywhere scream these are big risks! But simply having risky characteristics isn’t enough to kill a bull market. Typically, the event has to be a surprise—something unexpected. Markets, after all, move on the gap between sentiment and reality. Widely known risks like those described above are good for stocks—they lower the world’s expectations, giving reality some surprise pop. The media is doing your portfolio a service by publicizing these factors far and wide. The risks no one notices are what bite—when investors miss something that could hurt earnings looking forward, their expectations are too high. When reality disappoints, prices fall.
So you need something big, bad and underappreciated. Something no one sees but has the potential to take a huge bite out of global commerce. A regulatory change that could disrupt the flow of capital, a big rise in trade protectionism, a massive oversupply of stocks or a massive economic policy error are four examples. (Or Bernanke shaving.) And you need a reasonable likelihood of it coming to fruition.
These risks are out there today—they always are. Right now, none appear to be probable enough to cause a bear. But even an examination of an unlikely risk can give you insight into what to look for in the future. So let’s look at one! It’s highly unlikely to cause a bear market in the near term, if ever—don’t read this and freak out!—but it’s the sort of widely ignored thing that could cause real damage if it significantly escalated.
On the MarketMinder editorial staff, we call it the Crimean Trade War. It’s the 21st century equivalent of that 19th century conflict—Russia vs. Europe, with the Ukraine, home to the Crimean Peninsula in the middle. Tariffs are the new trenches.
After years of conflict over Russian energy giant Gazprom’s alleged price gouging, Ukrainian leaders have grown a bit wary of being economically dependent on Russia. Instead, Kiev is leaning toward joining the EU, and they’re inching closer to the first step: signing an association agreement to gain access to and free trade with the EU’s single market. How big a deal is this for the Ukraine? President Viktor Yanukovich is on the verge of releasing his rival, former PM Yulia Tymoshenko, from prison in order to meet the EU’s terms—something he’s resisted since she was convicted for abuse of power charges two years ago (tied to pricey Gazprom natural gas contracts she negotiated while in office, which EU leaders consider politically motivated, trumped up charges).
dictator President Vladimir Putin isn’t pleased. Since the shale revolution took off, Russia’s economy has been hurting. The Energy sector is the last functioning leg of Russia’s economy. Energy—particularly Gazprom—is a huge source of tax revenue. When oil and natural prices are high, Putin’s piggy bank is full. But with prices down thanks to shale-driven supply increases—and Germany, Poland, Lithuania and other Eastern European states about to start fracking—Russia could soon lose its remaining economic clout. Which just won’t do for Putin—the old KGB agent needs global influence (especially without that Nobel Peace Prize on his mantel)! To hang on, he’s trying to assemble a “customs union” of former Soviet states, essentially making them Russian client-states—a guaranteed source of demand for Russian goods and gas. Kyrgyzstan and Belarus are in, Armenia has signed up (shunning EU overtures), and he’s trying to corral Georgia, Moldova and the Ukraine. But the Ukraine doesn’t want to rejoin the USSR—it wants to be Western! So Putin resorted to economic bullying, throwing up trade barriers and threatened sweeping import bans should the Ukraine sign with the EU.
So far, Russia has banned Ukranian chocolate, Moldovan wine and Lithuanian dairy products, levied a “recycling fee” (read: tax) on Eastern European auto imports and imposed more stringent searches of Lithuanian trucks crossing the border—delays reportedly lasted days. The EU is annoyed. Several nations are peeved over Gazprom’s pricing—Lithuania’s PM estimates prices are up 600% since 2006—and Putin’s rising regional ambitions. They want the Baltics and the Crimean in the EU’s single market, and it seems they’re fighting protectionism with protectionism to make Putin back down. After months of grousing about Gazprom, the European Commission sent the company a strongly worded letter accusing it of unfair natural gas pricing. Lithuania—which currently holds the EU’s rotating presidency—threatened to cut off rail traffic to Russia’s Kaliningrad region. Just this week, the EU took the auto import tax to the WTO. But Moscow isn’t crying uncle.
The risk here is if the squabbling and anecdotal protectionism turn into a full blown trade war between Russia and the EU. And if that potentially escalated due to collateral damage to parties not directly affected. Few talk about this, so it has surprise power. And it could grow big enough, potentially, to disrupt global growth—and, by extension, global earnings. Trade barriers are generally an anathema to markets. An iron curtain, so to speak, between two big chunks of the world economy would be bad and potentially inspire rising protectionism globally. If this came to fruition and investors didn’t notice—if folks didn’t stop to consider the downstream economic impact—their expectations could be too high. Reality could fail to live up, sending stocks downward.
Again, is this at all likely? No! It’s illustrative. Illustrative of the kind of potentially snowballing obscure risk investors should look out for. So when in doubt, start by looking where everyone else isn’t.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.