Scotland's Referendum

Scotland's referendum to break away from the union jack is a big currency moving event, already the pound has tumbled to a ten month low on news that 51percent of Scots support the yes vote for an independent Scotland, according to a recent YouGov poll.

Whether the Union Jack would look the same, or Londoners would need a visa to visit Edinburgh Festival to listen to some fine music, should the Scottish yes vote win, might well be an interesting question to ponder over, but that would deflect us from the big issue. 

Perhaps it’s the politics behind Scotland's independence and its far reaching consequences on finance and politics, not only within the UK but beyond its borders, that merits us taking a closer look.

While a financial meltdown and economic collapse has been averted or delayed, following the financial crisis in 2008 and the longest recession in history that ensued, the populace frankly don't feel the recovery. Real incomes have not recovered for millions of workers struggling to meet daily expenses and the jobs that have been created in the service sector are lower paid and less secure. To some extent this economic recovery sustained by loose monetary policy has been built on a sandcastle of debt and cheap money. UK Industrial Product and construction remains stubbornly below pre 2008 financial crisis level, youth unemployment at 20.6 percent in Scotland, which is 0.5 percent above UK national average, according to May 2014 figures. Meanwhile, we have stock markets at record high, unaffordable property prices and low bond yields. So the economic policy pursued may have aided and abetted an unbalanced economic recovery, where there are relatively just a few gainers and many losers. When the populace voice their concerns the government's and central bank's solution is the same; more austerity and loose monetary policy. 

Then it is no surprise that the electorate feels unrepresented, disconnected and alienated from the political establishment who fail to address the electorate's basic needs for better job security and wages, affordable housing, functioning essential public services and more employment for the youth. If the Scottish people believed that their political needs were being addressed by the leading coalition Conservative party in Whitehall in London, or even the main opposition Labour party, they would most likely be less support for the “yes” vote in the forthcoming Scottish referendum on independence.

So this political alienation has to some extent created a type of political vacuum, a situation where the electorate no longer feels represented by the mainstream political parties, and it can manifest itself in several forms. On one end of the spectrum is voter apathy typified by low voter turnout while on the other more dangerous extreme end of the spectrum is radicalisation. With Muslim extremists on the rise in Britain that might lead us to the politically explosive Rivers of Blood by Enoch Powell's and it’s best not to go there. 

However, with respect to Scotland's rise for the “yes” to independence, could that then be a kind of anti-elite and anti-establishment vote by the disenfranchised Scottish electorate. Perhaps that's a moot point but what is more clear is that this rising political uncertainty is not beneficial for business. Large scale capital investment tends to be delayed or put off by private enterprises during a climate of political ambiguity. Investment in Scottish real estate is being put on hold until the outcome on the September 18 Scottish Independence Referendum. Some real estate agents believe that property prices have already discounted the political uncertainty and could rebound strongly if the “no” vote wins. Alternatively, if the “yes” wins some analysts are predicting property prices to fall a further 15 percent one year after the referendum.

So the “wait and see,” or expand elsewhere approach to business investment as a result of the political uncertainties might act as headwinds on the UK’s economic growth. 

The political and financial fallout of an independent Scotland could also have ramifications in Europe too. It might give further impetus to the Spanish Catalans to push for independence from Spain. Catalonia is also facing a referendum and no doubt how Scotland votes will be closely watched by the Catalans. In many ways the two regions share similarities, Scotland is wealthy due to its natural resources such as oil and Catalonia is the most industrial region of Spain. Like Scotland, Catalonia believes its paying too much into central government and gets less in return, thereby bank rolling the poorer autonomous regions of Spain. So it too sees central government as a drain and believes it would be financially better off independent. 

It seems paradoxical that on the one hand the architects of the European super state, the EU, are peddling for more integration and austerity amongst its members as a solution to Europe's woes. Meanwhile, the autonomous regions within the EU states are pushing for separation from their central government. Believe it or not there's even a push for independence in the country where the EU parliament is situated, Belgium, where independence movements are growing stronger.

No doubt the Belgians too will be watching the outcome of the Scottish Independence referendum on September 18. With all this in mind an independent Scotland might have more than just an impact on sterling. Could it herald in a new era of anti-globalisation and the super state? If so, then its impact on the Euro and beyond might be wider than anticipated.

Alternative Investments

Ferrari 1962 250 GTO  Source: blog.classiccars.com

Can you believe it, 38.1 million USD for a set of wheels! What’s more you'll still have to wind the windows down, there's no GPS, power steering and no heated seats to keep your rear warm on a subzero winters' morning either. But who cares because if you have got that kind of loot to burn on wheels, your rear pocket would probably be bulging with a wallet so stuffed with notes that it would be bullet proof. Fair enough, this isn't just a regular runner to take the little darlings to school and pick up a few provisions at Tesco. Not at all it's a Ferrari 1962 Ferrari 250 GTO, an elegant mechanical masterpiece on wheels. Nevertheless, 38.1 million USD for a chassis an engine and four wheels seems incomprehensible.

The recording breaking amount of cash shelled out for the 1962 Ferrari 250 GTO Berlinetta that sold this month at the Bonhams Quail Lodge auction in Carmel, Calif was just one of many that set records. Nine other Ferrari models set records, as did a Rolls-Royce once owned by Elvis Presley, and several Maseratis. Even a 1962 Austin Mini sold for a record $181,500. The week’s sales total hit $400 million, a 28 percent increase from a year ago.

All this has not only grabbed news headlines but it has also revved up the entire classic car market. Consequently, it has got many investors asking; What about the classic car market, as an alternative investment option?

Hagerty’s Blue Chip Index of 25 classic cars rose 34.5 percent over the last year, which far outperformed major stock and bond averages. “Without exception, we’re seeing every segment of the market, and nearly every model, hitting new all-time highs,” said McKeel Hagerty, chief executive of Hagerty Insurance, which specializes in insuring collectible cars and produces a price index (similar to the Dow Jones industrial average) for car collectors.

Maybe the classic car market might be next great asset class. However, the message from some observers is not to let your optimism run too wild. Bearing in mind that even a Mini these days is selling for six figures, so perhaps we are experience that all too familiar bubble. Apparently, something like that happened back in the late 1980s when prices for Ferraris and Jaguars escalated only to come crashing back down again.

Perhaps this is a classic story about what happens in a prolonged period of loose monetary policy, where central banks pump the market with funny money, what we end up getting is a small elite club, who have access to the cheap money and they distort the asset values of such rare items. If there is any trickle-down effect, lowered down the income scale its likely to be swallowed up by inflation.

“I’m becoming increasingly uneasy,” Scott Grundfor recently wrote in his newsletter for car collectors. (Mr. Grundfor’s company also restores and consults on classic cars.) “I’ve firmly believed at least 50 percent of the dramatic rise in car values can be attributed to the printing of money and the manipulation of interest rates by central banks.”

So the implication here is should the Fed start tightening its monetary policy we might also see price corrections in the classic car market too. Until that happens, classic car prices continue to appreciate.

What about at the other end of the food chain, is there any value to be gained by investing say between 1,000 to 5,000 pounds on a “potential” classic car, A ford Capri might not be every-ones cup of tea, but surprisingly this car has approximately doubled in the last 18 months. Current prices for a Capri vary from 2,000 to 10,000 pounds. Remember the Peugeot 205 Gti, they are also starting to move up, typical price varies between 1,000 to 3000 pounds. An MGB that could have been bought five years ago for 5,000 pounds could now set you back more than 10,000 pounds.

But you'd have to ask yourself this question, how much money was spent on spare parts, and labour (your time if you are mechanically minded) in keeping that MGB roadworthy during those five years? If you had to take it to a workshop every time something went wrong, it might just be a bottomless money pit. Maybe a more suitable  option for the motor enthusiasts than the pure investor.

What about buying wine for profits and pleasure? Apparently, there's a general rule followed by gentleman wine collectors. It goes something like this; buy five cases of claret and store them in a cool, dry place out of the sunlight, preferably a cellar if you are fortunate to have one. Then just wait 10 years, meanwhile for your patience you get to drink two of the cases. What about the remaining three cases; sell them and from the profits realised, there will be enough to buy another five cases of younger wine and start all over again.

The wine expert reassured me that if it were done on a year-on-year basis I would have a constant supply of excellent wine, more over it would be self-financing due to the wine's inclination to increase in value. He was a damn good salesman because I bought the idea. I figured that I couldn't lose because if things went pear shaped I'd be stuck with a few crates of fine quality wine and that wouldn’t be too unpalatable.  

Supermarkets

Remember the notion of cyclical and defensive stocks. So if, for example, you reckoned that we were at the top end of a boom economic cycle you'd rotate your investments from cyclical into defensive stocks. The idea behind the strategy being that during economic down periods defensive stocks fared better because demand for the company's product or service remained relatively unaffected. Don't confuse defensive stocks with companies involved in the manufacturing of munitions and arms, it has nothing to do with that. The most accurate way to define a defensive sector stock is one that tends to provide constant dividends and stable earnings, regardless of the overall state of the stock market. So pharmaceuticals, utility companies and to some extent supermarket stocks are examples of defensive stocks. Cyclical stocks are the inverse of defensive stocks. These stocks tend to rise and fall with business cycles so they tend to perform well when the economy is on the upturn. Construction sector, consumer durables and leisure and entertainment are examples of cyclical sectors.

But it is the supermarkets, with particular reference to Tesco, that was once perceived as a classic defensive stock, and is currently under performing and is no longer behaving like a defensive stock. Indeed, on September 1 the share price hit an 11 year low and was one of the biggest fallers on the FTSE 100 index on Monday slashing 1.3 billion pounds of its share value. Such volatility in a defensive stock is rare. Apparently, Tesco's long-term shareholder US investment fund Harris Associates recently revealed it had cut its stake because the supermarket was "too risky". The supermarket on Friday issued its third profit warning in eight months and slashed its dividend. That sent shivers down investors spine sending other supermarket retailer's shares down. Morrisons was the biggest faller, down 2.4 percent to 173p, while J Sainsbury was off almost 1 percent at 287p.

That is unusual since food retailer stocks were viewed by investors as defensive stock plays, so what is going on?

Economic fundamentals are fairly bearish, then it stands to reason that investors are unlikely to be flocking out of defensive stocks, selling their tesco shares to buy cyclical to profit from an anticipated upturn in the economy. Many UK analysts believe that the best is now behind us, so with that in mind capital rotations in the stock market ought to be going the other way, in other words from cyclical to defensive stocks. If that were the case, then the food retailer's share price should be moving north, not south.

However, the reverse is happening. So perhaps the likely reason for a sell off then, in a number of food retailers, suggests something more alarming. Could there be a structural change going on in the economy that is influencing income distribution. There's a raft of data suggesting that middle-class income, which contributes to the bulk of national consumption, has not recovered since the financial crisis of 2009. Or, to look at it in another way, the middle-class share of the national income has actually fallen since 2,000. This phenomenon appears to be happening in a number of developed economies. US middle class incomes have shrunk 8.5 percent since 2000. With respect to Britain it’s no different, surprisingly even in the Telegraph, known as the country's “Torygraph,” being more on the centre- right of the political spectrum, an article by Lucy Mangan reports that, “the middle-class are being squeezed and stripped – of jobs, income and security – like never before.” The Guardian notes that real wages have fallen by 4.2 percent over the last year.

Meanwhile, the top 1 percent are getting a larger slice of the income distribution cake, about one third of the income distribution now goes to 1 percent of earners in the UK. This might be due to the fact that more income now is being generated from investment returns rather than wages, interesting but not entirely relevant to this article.

What is relevant however is how this distorted income distribution is changing the consumption landscape. So what we could be seeing is the downsizing effect of the middle-classes as their incomes and job security are being mashed.

This might explain why the discount retailers like Aldi, which is approximately 40 percent cheaper than its more expensive rivals are booming. In other words middle income earners who might have been squeezed out of Waitrose are now downsizing to Aldi. What is interesting to note is that Aldi, which use to originally target more socially deprived areas, is now opening up in Newbury, Winchester, Ely and Cowes on the Isle of Wight.

Meanwhile, speaking about Waitrose, the upmarket food retailer for the well-heeled with gentile palates, how do you think they are performing in this brave new world? Very nicely, indeed, according to second quarter earnings. Profits are up 6.7 percent on the previous year to 160 million pounds.

How about the other end of the food chain, to the discount retailer, Poundland, apparently, business is booming. Earning reports year-on-year (2013) saw the chain rise 15% in total sales to £880m.

"The discount sector is now a mainstream feature of the UK retail scene," said Poundland boss Jim McCarthy. "Over time I'm confident that we will have over 1,000 Poundland stores in the UK," he added.

Poundland, which sells all its items priced at £1 or less, served 4.5m customers each week in the 12 months to March, driving its pre-tax profit before exceptional items up 29 % to £23.1m.

In short, a brief analysis of the food retailers underscores how a distorted income distribution has changed consumption patterns. Businesses that are catering for the new poor, the once middle classes are reporting good earnings. Likewise on the other end of the income scale upmarket retailers are doing even better. Look at the profits of the luxury goods makers, they are ballooning.

Meanwhile, many once middle income retailers, restaurants are struggling. It’s no surprise then that Tesco´s new boss will be discounting many items to try and win back their cash strapped customers.

For investors it may pay dividends to be mindful of this changing consumption landscape and invest accordingly.

Savvy Investor

There are countless examples were a minority of savvy investors and hard-nosed business people actually prospered handsomely during sharp economic downturns, wars and financial corrections. 

During my journey I have actually had the fortune or misfortune of meeting such people. For example, the stubby limbed, ruddy faced multi-millionaire Australian business man who monopolized the retail local meat market. Hanging on his office wall I noticed a vintage photo of a young man standing on what appeared to be a soapbox and handing out small parcels wrapped in newspaper sheets. The man was surrounded by crowds young and old, but there was one thing that the people in the crowds had in common; their clothes all seemed too baggy and a size or two too large. “That's my father standing on the soapbox”, said the ruddy faced Australian proudly and then he proceeded to tell the story. “During the great depression, like most people my parents were struggling for the bare necessities, including putting food on the table. Never having enough money to buy meat, he would buy offal instead, (the internal organs of a butchered animal). ” “He then realized that if the hungry masses couldn't afford meat, then offal would make an affordable substitute.” It was a winner and the business grew from there onwards to being the most successful meat retailer in the country. That's just one inspirational example of someone flipping adversity on its head and making a success out of it. 

Then there is another example of a shoulder length haired angelic faced man who amassed more than one million USD during the 1960s Vietnam War selling, this is slightly unpleasant, nevertheless a true story, body bags to the US Government! Softly spoken, the man said, “Did you know that I was an active protester against the Vietnam war..... I just saw a legitimate need for my product and supplied it....” He admitted to giving some of his profits to injured servicemen charities. 

Maybe a less palatable and inspiration story, however, it is an example of how some people turn adversary around. Given a miserable situation these people remain optimistic enough to spot opportunities that others are completely oblivious to. 

During the last century's great depression two Wall Street investors Alfred Lee Loomis and his partner and brother-in-law Landon Thorne managed to amass a fortune after the stock market crash of 1929. The two had been leading financiers for the new electric power industry in the 1920s. Loomis was also a scientist, and he became a major supporter of some of the century's greatest scientific minds at his Tuxedo Park home. By early 1929, the two partners had liquidated all their stock holdings and put the gains into long-term Treasury bonds and cash. The reaction by their peers, so many of them forced out of business, seemed more like envy than admiration since "in the midst of so much despair, with the economic situation deteriorating day after day, Loomis and Thorne continued to profit handsomely," writes Jennet Conant, author of the Loomis Biography Tuxedo Park: A Wall Street tycoon and the Secret Palace that changed the Course of World War ll.

So during the last great depression bonds performed well. We know there is an inverse relationship between interest rates and bond prices. Moreover during economic down cycles interest rates are kept deliberately low by central banks with the aim of stimulating investment and the economy. So interest rates were low during the depression and bond prices also soared. High bond prices also pulled bond yields sharply lower during the last depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Bonds returned 6.04% during the 1930s securities or bills returned 3.39% over the same time period. You might be right in believing that there are some striking similarities with the way interest rates, bond prices, gilts, treasuries and yields are performing now to that during the great depression. 

The obvious risk of investing in debt is that the debtor might default and that regretfully also happened during the great depression. The history books identified a number of cash-strapped corporations and municipal governments defaulted on their debts during the great depression.

Perhaps if the economy takes a turn for the worst and investors see central banks shy away from interest rate hikes, the gilt and treasuries might still continue its rally. Why? Simply because it’s a safe-haven play. Bearing in mind UK and US sovereign debt score top credit ratings and are formidable nuclear military powers the likely hood of them being invaded by a foreign power is so remote it’s probably not worth considering as a risk. So if investors flock into gilts and treasuries the trend of a gilt/treasury rally will probably continue with a corresponding fall in yields.

Owning your own property without a mortgage or managing rental properties is considered sound during a depression or recession. A place to live is a necessity, irrespective of what economic cycle we are in. With banks hesitant to rent during a sharp economic downturn there's usually a pool of good renters. Although real estate is less of a liquid asset, particularly so during a recession/depression it’s harder to liquidate, nevertheless history shows in the long-term it has been a good asset. Obviously, location is important with tenants paying more if it’s near good schools.

Precious metals such as gold, is another recession, depression proof asset which also performs well in times of geopolitical tensions. However, buying into an already inflated asset has its risks, If you can pick this precious metal up at the support levels, even better. Silver, seems to be neglected at current prices USD19.5 spot troy ounces and might represent value if things go pear shaped. However, silver is a smaller market and can be more volatile than gold.

Keep aside three to six months of living expenses in cash if something unfortunate happens, such as a job loss or unexpected expense might help you keep a cool head to invest wisely and try and spot opportunities were others don't.

Conflict and Portfolio

An overwhelming majority of retail investors tend to agree that the world's conflicts are unpalatable and detrimental to their portfolio of stocks, that's according to 86 percent of people polled recently. So they would almost all be nodding in agreement that the world's biggest skirmishes, for example the Ukrainian situation reaching boiling point with NATO warning of a Russian invasion, Iraq's ongoing civil war threatening to split the country in two, the Syrian civil war, the ongoing Palestinian Israeli conflict and the ongoing war on terrorism is about to wreak mayhem on their share portfolios.

Perhaps that's a fairly predictable poll result and a normal reaction to the effects of war on a portfolio, after all war is terrible and tragic.

However, with respect to having a detrimental impact on your investments, surprisingly this is not how some legendary professional investors view it. Baron de Rothschild once famously, or callously said depending on how you view it, "The time to buy is when there is blood in the streets."

Apparently, if we look back in history to a number of previous conflicts and its impact on stocks we can deduce that despite war being an awful prospect it didn't actually knock stocks off their bullish trajectory. There are a number of reasons why this might be so. The current conflicts seem to be relatively short in duration and confined to small areas of the world to have any significant impact on the global economy and corporate earnings. Obliviously, there are exceptions to this, particularly when the localised conflict involves a strategic region, for example fighting in the Persian gulf could have an impaction on the supply of oil and its price. Skirmishes in the world's most important shipping routes, such as the Panama canal might cause frightened ships to divert their passage to safer but longer routes, this would increase transportation costs. Conflicts in areas containing logistically important gas or oil pipelines supplying other major regions, such as the Ukraine could also result in cuts or disruptions to supplies, which would raise energy costs in Europe.

So with the exception of fighting breaking out in “logistic" or strategic regions of the globe, it would usually take a massive global war to send stocks crashing. Modern market history suggests that even recent skirmishes involving major powers like America and Britain – have not had a significant global economic impact. While the current conflicts raging today are disastrous for those unfortunately involved they are probably unlikely to have any real significant impact on the global economy and corporate earnings.

Take for example the Korean war. The S&P 500, a compressive index with the longest historical data available, initially stocks experienced a rapid sell off, falling by 14% between 12 June 1950, just 14 days before the war began, and 17 July 1950. But just two months later stocks had recovered their losses and were back in the black. Over the entire conflict, from 25 June 1950 through 27 July 1953, the S&P entered a strong secular bull market rising over 25 percent during this period.

Even at the height of the cold war period during 1962's Cuban Missile crisis with Khrushchev's decision to put missiles in Cuba, which brought America just a footstep away from a nuclear war with Russia, didn't have a significant impact on stocks. However, the S&P 500 followed a predictable trend of falling initially on the outbreak of the news that the Americans discovered Soviet missiles on the Caribbean Island off the cost of Mexico. Stocks hit support levels, a market bottom, on 23 October, 1962 one day after President Kennedy announced the naval blockade. Markets rose the next day, when Soviet Premier Nikita Khrushchev called the blockade an "act of aggression" and told his ships to ignore the blockade and push on. During this tense period the stock market held firm, there were no sharp sell-offs while the Soviets tested American grit to enforce the blockade. When the Soviet ships turned around on 5 November, that year the S&P rallied up 9% off the October lows low and a secular bull market ran strong from there onwards for more than three years.

With respect to the Middle East, stocks fell in the run-up to the Six Day War among Israel, Syria and Jordan, during June 5 1964 and June 10, but the S&P 500 rose during every trading session once war began.

Most recently in the middle east with the Iraq war Markets fell before both official Iraq Wars - 1991 and 2003 - but soon reversed and finished strongly positive both years. Global markets rose 22.1% in 1991 and 19.7% in 2003 (both in Sterling).

What about the recent war in Europe in the mid-1990s; the Bosnian War? The trend is to repeat yet again. Stock Markets were volatile in 1994 as conflict started to boil, but world stocks bottomed in late January 1995, shortly after NATO air strikes began in Croatia. Stocks gained even as fighting lasted through 1995, despite the past atrocities like the Srebrenica Massacre. From the 24 January low market point through year-end, world stocks gained 23.7%.

So there's enough evidence from history to support the view that on the eve of war the stock markets trends experience a selloff and fall, perhaps this is due to investors overreacting to the event. Then for some reason afterwards, on the sounds of gunfire, the market bottoms out and enters a new cyclical bull cycle, running for three plus years.

There's only one event in history that breaks this trend; Hitler’s invasion of Poland that triggered off WWII, markets remained depressed for years.

Unless you believe we are on the eve of WWIII, which is hopefully unlikely, then the Ukrainian crisis might represent buying opportunities for investors.

Ukraine Update

Petro Poroshenko

It was hoped that the high-level delegates meeting held in the Belarus capital, Minsk on August 26 might have yielded the de-escalation of tensions in the Ukraine. It seemed like an opportune moment, bearing in mind that the attendees could not have been more senior with Ukraine president Petro Poroshenko and his Russian counterpart Vladimir Putin arriving in Minsk for the crisis talks. A number of senior EU officials along with leaders from Kazakhstan and Belarus also attended the crisis summit. Their motives were clear; to defuse the skirmishes between the pro-Russian separatists and Ukraine's government forces and guided the two opposing sides towards a diplomatic solution.

Vladimir Putin

But regretfully, the Minsk summit did little to de-escalate the tensions in the Baltic, in fact it may have had the reverse effect of ratcheting up tensions between Russia and its former colony the Ukraine even further. Letting off some steam Russian president Vladimir Putin fired his rounds accusing the Ukraine and its Western supporters, of stalling efforts to reach a new cease-fire and open talks. Ukraine president Petro Poroshenko’s response was nothing more than pouring fuel on the fire. Poroshenko is now considering a provocative move to push back a law which prevents the Ukraine from joining North Atlantic Treaty Organisation (NATO). That would be like poking the bear in the eye. Think about it, would the US welcome Russian Mig fighter jets on its doorstep, in say Mexico!

Flag of NATO

Assuming the Ukraine actually decides to join NATO, a possible worst case scenario, then the Ukrainian crisis would take on another more dangerous dimension. Article 5 of NATO states that an attack on one member is an attack on all. In other words, Russian forces in the Ukraine would then be the catalyst to draw in other NATO European countries into the war to the defence of the Ukraine. Reluctant European leaders would probably tell their weary electorate, sorry but our hands are tied we have an obligation to defend our new NATO member ally, the Ukraine. So localised fighting in the Ukraine could in theory spiral into a European war with Russia. Once things go down that slippery slope it could even descend into a global war, with Russia calling on its allies. Again, this would be the worst case scenario and let’s hope that the situation doesn't implode on those lines.

However, the Ukraine crisis is again more prominent on the trader's radar, particularly following the dashed hopes of the Minsk summit bringing a de-escalation of tension in the region.

How will EU and US policy makers respond to the failed Minsk summit? If the answer is more sanctions on
Russia, which then leads to similar tit for tat profit whacking Russian sanctions on EU businesses, then that would not be a desirable outcome either. The EU economy is battling enough headwinds at the moment, liquidity problems, slowing and contracting economies and mass unemployment in the South. More sanctions are probably the least thing that EU policy makers and businesses want on their plate now. Russia is the European bloc’s third largest trading partner and already the fallout from Russian sanctions is making EU businesses nervous.

NATO member countries (orthographic projection)

For example, when it was released to the press in early August that Moscow was mulling over a proposal to ban western carriers from using Siberian air space for routes to Asian cities. European airline stocks unsurprisingly fell sharply. Air France, British Airways and Lufthansa all use Siberian air space for routes to Asian cities. Flightradar24, an aircraft tracking service, estimates that Lufthansa operated 162 flights that passed through Siberian airspace over the past seven days, while Air France had 133 and British Airways had 93. So any move to ban western carriers from using these Siberian routes would push up their fuel bills.

Moscow's embargo on food imports from the EU, as well as from the United States is hitting hard agricultural producers in the south. European agricultural trade with Russia was worth 12 billion euros in trade in 2013, this year the sector is bracing itself for huge losses, due to the Russian sanctions.

Luigi Negro, advisor to farmers in the Apulia region of Italy, said: “The economic blow we’ve received strengthens the resolve of our own producers, but, at the same time, it’s a cause of great concern as well.”

A trade union representing Spanish Catalonian crop growers and cattle ranchers staged a protest, demanding that the EU compensate them for the revenues lost as a result of the escalation of sanctions, which have closed the Russian market to them. Spanish farmers burned the EU flag in anger over Russia sanctions war. The EU has allocated €125 million to help farmers in the immediate aftermath. Finance group ING has estimated that the annual losses as a result of the blocking of the Russian market will amount to €6.7 billion a year, and could result in the loss of 130,000 jobs.

Furthermore, German utility E.ON posted a 12 percent drop in first-half profits, hit by a weakening economy in Russia, and said it was concerned about the impact of the Ukraine crisis on its most important foreign market.

So the effects of tit for tat sanctions over the Ukrainian crisis are biting. Moreover, the Ukraine is a conduit for Russian gas to central Northern Europe, if Moscow were to turnoff the gas supplies to the Ukraine that would cause a spike in energy costs which would be crippling for an already feeble EU economy.

JPMorgan's Alex Kantarovich, in a recent letter to clients, underscores the severity of the problem, “In the worst case scenario, now appearing more likely, severe pressure on stocks may extend. We believe that with the significant deterioration in the Ukrainian situation, markets may treat this as a Lehman-style shock."

Therefore, the Ukrainian crisis is starting to feature prominently on trader's radar again. Should the situation continue to deteriorate the adverse knock-on effects to businesses would be amplified, thereby hitting bottom line corporate profits. Consequently, that might act as drag on the European economy and that could then delay further those long anticipated UK interest rate hikes.

Trade War

Written in early August.
Let’s make no bones about it; the West is now in a trade war with Russia.  The latest round of EU and US sanctions on Russia, instigated by Washington over the Baltic crisis has triggered a retaliatory response from Russia, which is equally designed to strike at the bottom-line of a number of European companies. While, it may be too early yet to estimate accurately the profit damage caused from the fallout of Russia’s retaliatory rounds of sanctions, nonetheless a number of EU companies have been targeted and are likely to bleed.  

First in Russia’s gun site is the banning of European airlines from flying over Siberia on busy Asian routes. The Russian move to restrict air space to European airlines is currently being mulled over by the foreign and transport ministries, according to  a report from an unnamed source in the  Russian business daily Vedomosti.  Banning European airlines over Siberian airspace would force European airlines to make costly detours adding already to their sky-high fuel costs and put them at a disadvantage to Asian airlines. Trans-Siberian route flights benefited primarily Western airlines, particularly European carriers because it is the shortest distance when travelling from Europe to Asian countries such as China, Japan and South Korea.

Currently, 12 European airlines operate 900 flights each week passing over Russian airspace to reach these three Asian countries. Europe’s main carriers which are likely to be hit the hardest are Air France, British Airways and Lufthansa.

A country’s decision to close its airspace is solely a matter for the country in question, according to the Chicago Convention on International Civil Aviation. Indeed, it’s not the first time that Russian has closed its airspace to western nations, during the cold war there was a total ban on European carriers flying over Russian and Siberian airspace.  The news of Siberian flight ban has weighed down heavily on European airline stocks, all are sharply down.   The Russian carrier, Aeroflot shares also tumbled on the news because it reportedly received approximately 225 million Euros a year in fees paid by foreign airlines for the right to fly over Siberian airspace.

Perhaps shorting airlines stocks might offer a short term opportunity for the adventurous traders.

Russian Oligarchs are also beginning to shift their massive liquid wealth to Hong Kong dollars on sanction concerns, which could also be behind the selloff in European equities in recent days.  Russian billionaire Alisher Usmanov, with a net worth of 18.6 billion USD, according to Forbes, is said to be moving his cash holdings into Hong Kong dollars. This move is also being repeated by the world’s largest Nickel and palladium producer, Norilsk Nickel. Additionally, MegaFon, Russia’s second largest mobile operator has decided to keep about 40 percent of its cash in Hong Kong dollars given the global markets disturbances, Chief Financial Officer Gevork Vermishyan said in a phone interview. The Moscow-based carrier has traditionally kept its foreign cash in U.S. dollars and Euros, according to the company.

The Hong Kong dollar has been pegged to the U.S. dollar since 1983, and its fluctuation from the American currency hasn’t exceeded 1 percentage points since then.“Keeping money in Hong Kong dollars is essentially equivalent to keeping it in U.S. dollars because of the currency peg,” said Vladimir Osakovskiy, chief economist of Bank of America Corp.’s Russian unit. “Still, for Russian companies it’s much safer from the standpoint of sanctions.”

In light of this Russian capital flight to Hong Kong dollars it will be interesting to monitor the trajectory of the currency against the Euro.

Russia will also be banning the import of agricultural goods from countries that have imposed sanctions on Russia. This is likely to hit hardest southern Europe, possibly Spain, which is the largest agriculture producer in Europe. Russian government officials have been instructed to draw up a list of western agricultural products and raw materials that will be banned or restricted for up to one year, according to the Kremlin website. The list would include meat, fruit and vegetables, but not wine or baby food. In recent days Russian food safety authorities have banned the import of Polish fruit and vegetables, while McDonald's cheeseburgers and milkshakes are being investigated by a regional branch of consumer protection agency Rospotrebnadzor.  Russia is Europe's second largest market for food and drink. EU exports of foods to Russia rocketed to 12.2bilion Euros in 2013, following several years of double digit growth in Russia.  So EU food stocks, those more exposed to the Russian market are more likely to be affected by the bans.

The ripples are also being felt as far east as Japan. Under Washington cohesion, Japan is also likely to succumb to more sanctions on Russia. Russian foreign minister, Sergey V. Lavrov is calling on Japanese leaders to show more independence from the United States. Nevertheless, analysts reckon that Japan has no choice but to side with the US.

Within the last 48 hours a massive buildup has been reported on the Ukrainian border. Russian troops in the region have doubled in number . The ultimate rat hole for investors to climb into when things look like they’re about to go pear shaped, gold and silver are beginning to move upwards again.

These tit for tat sanctions do appear reckless and irresponsible, particularly at a time when many EU economies are tinkering on the abyss. Where will all this lead to, a war with Russia? Unlikely, since that would be MAD (Mutually Assured Destruction).  Indeed, in a perverse way through the terror of nuclear annihilation most of Europe enjoyed a prolonged period of peace. Surely, there aren’t enough deranged souls in Washington willing to order a military assault on Russia. That would be a chilling prospect.  I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones. ” — Albert Einstein.