Last week, stocks inked their worst performance since the end of January, or in the past seven weeks, and they look to struggle in the coming week, with tensions mounting over the Russian incursion into Ukraine. This threat of a possible escalation of tensions and the threat of military action will weigh heavily on markets this week.
The Dow Jones Industrial Average lost 2.4 percent last week, the Standard & Poor’s 500 Index droped 2 percent, and the Nasdaq Composite slid 2.1 percent. The Nasdaq is still up 1.7 percent for the year, but the S&P 500 has given back all of its gains for 2014, ending the week at 1,841, down 7 points year-to-date. The Dow, which finished the week at 16,066, is down 511 points, or 3 percent for the year.
As we enter this week, investors will be watching closely for any signs of an escalation of tensions in Ukraine, and particularly for any military action. Over the weekend, a referendum vote was held to decide if Crimea would rejoin Russia. Not surprisingly, 93 percent of those who voted supported reunification. This rejoin was part of Russia for more than 200 years prior to the collapse of the Soviet Union, and many of its citizens are ethnic Russians.
Russian President Vladimir Putin may use the vote as justification to push further into Ukraine to attempt to annex the eastern portion of the country, where more ethnic Russians reside. It is certainly possible that he may try to pull the entire country back under Russian control.
Economic sanctions are unlikely to be effective at suppressing Putin’s desire to acquire Ukraine, especially with regard to energy. Russia is the world’s largest producer of oil, and exports about $160 billion each year to European Union countries. It will likely be more painful for the EU to endure the consequences of cutting off suppliers of oil, natural gas and chemicals from Russia than any negative effects Russian may feel from such sanctions.
There has been some talk of restricting travel for Russian citizens. These measures could pressure Putin since his billionaire friends may find it difficult to travel. So far, top billionaires in Russia have lost about $20 billion of their wealth due to the losses suffered in the Russian stock market. The ruble is losing value as is the Ukrainian hryvnia, causing some rather serious economic dislocations.
After the referendum, the United States, the EU and Ukraine stated that the vote violated the Ukrainian constitution and was therefore illegal. Russia is not likely to change course just because other governments don’t like what it’s doing, however.
Should Putin stop with Crimea and not advance further into Ukraine, markets should stabilize, and could rebound this week. However, if he chooses to continue his push into other parts of Ukraine, and in particular if violence continues or escalates, markets will very likely react negatively.
The S&P 500 broke down through 1,850 again this past week, which represented support on the chart. The 1,850 level now become resistance, meaning that the index will struggle to get back above that level. Many market observers, including myself, have been calling for a significant correction for stocks for quite some time. Corrections of a significant magnitude, or crashes, typically are precipitated by economic or political shocks. An escalation of tensions in Ukraine could certainly qualify as that shock, should investors seek justification for continued selling.
We also have a few housing numbers to parse this week. This information will certainly take a back seat to Ukraine, as all eyes will be focused on Russia’s actions, and the reactions of global financial markets to the growing risk in that region.
Sanctions against Russia could start as early as Monday if Russia moves ahead with its annexation of Crimea. Recent data from China has indicated a slowing of its economy. There has also been a significant shift in China’s official policy regarding corporate bonds. Chaori Solar recently defaulted on its bonds, signaling a major shift. In the past, the Chinese government has always stepped in to backstop companies from defaulting.
We are now seeing companies lining up to default, as excesses in the corporate debt market throughout China are resulting in major cash flow shortages. Combined with a bubble in the Chinese real estate market and slowing overall economic growth, the Chinese economy is showing severe signs of strain that will have major repercussions for global financial markets.
Any of these issues could serve as an effective trigger, causing a major global sell-off in equities markets. The U.S. market has been the leader to date, and will likely be the first to correct or crash, should we see selling begin to mount. Investors should pay close attention to developments with Russia and China this week for any sign of cracks in financial markets.