Despite a spate of decent, and even great, domestic economic news this week, it is hard to escape the morass in eastern Europe. Surely, the military brass in the Kremlin didn’t draw it up like this? If so, we might not have as much to fear from the Russians as we initially thought.
As for the data, let me posit the following: the US economy continues to be in healthy shape, and activity remains reasonably robust. The labor market is almost back to its health just prior to the pandemic, and corporate profitability has been solid, in aggregate. All told, US GDP should moderate from last year’s feverish 5.6%, but still hover in the acceptable 2.5-3.5% range, with a bias to the higher end of the range (all over things being equal).
To support this contention, this morning, the Bureau of Labor Statistics (BLS) released the Employment Situation – February 2022 report. I won’t mince words: it was stellar, perhaps one of the better monthly releases I have seen in my career for this point in the economic cycle (as confused as it is). According to the BLS, the US economy created 678K net, new payroll jobs last month. That was over 2 standard deviations to the right of the 425K median estimate in the Bloomberg survey. That is pretty rare.
Further, well, let me just rattle off some of the highlights. The official Unemployment Rate fell from 4.0% to 3.8%. The Labor Force Participation Rate increased from 62.2% to 62.3%, which is well off the low of 60.2% back in April 2020. The so-called Underemployment Rate has fallen from 22.9% in April 2020 to 7.2% last month, which would have been roughly the annual average in 2019. Finally, job growth was consistently strong across virtually all primary economic sectors, with the exception of ‘information.’
You would have to have a magnifying glass to find dark clouds in the multitude of silver linings in this report. So much so, BUT FOR the situation in Europe, this report would dominate the headlines and give the Federal Reserve as much ammunition it needs to do whatever it feels compelled to do with domestic monetary policy. However, all of that seems to fade to insignificance when ‘you’ read how the Russians have bombed the largest nuclear power plant in Europe. That seems like a dangerous thing to do, doesn’t it. Who came up with that idea?
In fact, I have been wondering this pretty much since the first Russian troops crossed the Ukrainian border. Let’s just put it this way: it is apparent no one on the Russian General Staff has bothered to read Sun Tzu’s The Art of War, which is a surprisingly easy read. However, Russia seems to be conducting this war as it has virtually all of its wars, acting as a sledgehammer as opposed to a scalpel. You can think of it as the Rocky Balboa of global militaries.
So much so, despite all of the recent buildup in its military material and technology (supposedly), in watching and reading about how the Russians have handled their assault on Ukraine to this point, I am reminded of an animal fable: The Scorpion and the Frog. Interestingly, as it is NOT ironic, despite attributions to Aesop, the earliest known written appearance of this story is in the 1933 RUSSIAN novel, The German Quarter by a long forgotten dude by the name of Lev Nitoburg. However, even that is somewhat debatable.
An English translation would go something like the following (James Nordin for the American Society of Public Administration 6/20/21):
A frog was hopping along the shore of a river looking for a place to cross. He came upon a scorpion sitting on the shore. “Hello, friend frog,” said the scorpion. “It appears you are looking to cross the river. I too want to cross. Would you mind carrying me?”
The frog was taken aback. “Why, if I let you on my back to cross the river, you’d sting me and I would die. I don’t think I’ll do that.”
The scorpion immediately replied, “There is no logic to your concern. If I sting you and you die, I will surely die as well, since I can’t swim. I wouldn’t need a ride if I could swim.”
The frog thought a moment and then said, “Your logic makes sense. Why would you kill me if it would result in your death? Come along and climb on my back and we’ll cross this river.”
The scorpion climbed on the frog’s back and off they went to cross the river.
About halfway across the river, the scorpion raised its tail and stung the frog. The frog was both astounded and disconsolate. “Why did you sting me? Now I will die and you will surely drown and die also.”
The scorpion replied, “I can’t help it. It’s who I am. It’s in my nature.”
Basically, for whatever reason, the Russian military has historically been willing to accept far more losses than the American military, and has demonstrated a preference to bludgeon their opponents, as opposed to outwitting them. The reason appears to be Russia has never been at a loss for manpower, and this has shaped its development.
But what does this have to do with the US economy, the financial markets and even the price of tea in China? Fair enough.
Frankly, not much. In fact, the whole conflict doesn’t have much to do with the US economy or our financial markets. Our combined trade with those two countries in 2021 was $40.50 billion. While that sounds like a lot of money, and it is in absolute terms, our overall trade, with all countries, was $4,588 billion ($4.6 trillion). As a result, our trade with those two countries accounted for less than 1% of our total trade.
Essentially, in purely economic terms, we have two relatively minor trading partners beating each other up half a world away.
To be sure, there are contagion effects and economic tentacles. What does it mean to EU economic growth if it can’t get Russian energy? Food prices due to trade embargoes and fewer acres under harvest this year? Etc. The bricks in the wall of worry accumulate pretty quickly, don’t they?
At the risk of being extremely cavalier, extremely, as long as Russia can get its liquid and gasified ‘dead dinosaurs’ out of the country, by hook or crook, the world will eventually adapt. Look for the so-called Power of Siberia network to be of extra importance to the global energy markets, and you heard it here first. Let’s just put it this way, prior to the recent unpleasantness, Russia was already looking to more than double its energy exports to China within 3-4 years.
As for other commodities, particularly agricultural and especially wheat, which has recently soared, I would fully expect US farmers to plant more this year. This would buck a roughly two decade downward trend in US wheat plantings due to an increasing competitive global wheat market. Shoot, I imagine our friends to the North will also plant more acres in wheat this year. With Ukraine and Russia perhaps out of the way, others will scramble to capture their market share at the recent price levels. Sure, that could mean higher corn and bean prices, or it could just mean more fallow acres under plantings this year…across the globe.
I think you get the picture.
According to data I pulled from The Word Bank for 2021, the combined economies of the Russian Federation and Ukraine accounted for, get this, 2.03% of total global GDP. This is equal to roughly South Korea and/or Canada. Would a recession in either of those countries keep you up at night? Cause the global markets to flummox like they have? Lead to this much wringing of hands and gnashing of teeth? Probably not.
Admittedly, I understand how difficult it can be to watch the red ink every day. I get it, and it isn’t any fun for me either. However, the more we analyze the current situation, the more we come to the following conclusion: IF this doesn’t expand and suck in other countries, this should have a relatively minimal impact on medium and longer-term economic growth. As a result, we don’t want to be ‘sitting in cash’ when the bounce happens, as it has the potential to be very strong. With each negative trade, the potential just gets even stronger.
As such, if we weren’t already near our upper limits in our equity exposure, we would be getting there in a hurry. Obviously, I am writing this piece with my head, and not my heart.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well; may your blessings outweigh your sorrows not only on this day but on every day, and may the conflict and bloodshed in Ukraine end quickly.
Chief Economist
Please not, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.