Investability bulletin 01/03/22: Getting defensive

Defence contractors soar as Europe wakes up to the threat from the east

Photo by UX Gun

Stocks in Europe were looking steady in early trading, flat to slightly negative for the DAX, CAC and Stoxx 50, while the FTSE 100 added 0.4% at the open before turning a bit lower. However, selling pressure intensified as the morning progressed, seeing the DAX in Frankfurt trade over 2% lower for the day, while the FTSE was off 0.5%. Banks and travel & leisure enjoyed a brief reprieve at the start of the session, but investors quickly returned to selling these names again. US futures are also looking about -0.5% right now.

On Wall Street, after a plunge for the futures markets, stocks held up quite well: the S&P 500 declined 0.25%, 130pts above the implied overnight low on the futures. The Nasdaq 100 ended up 0.4%. Speculative tech did well – the ARK Innovation ETF (ARKK) up 4% and Tesla (TSLA) 7.5% higher for the session. JPMorgan says selling stocks now carries too much risk, noting that fundamentals for equities remain supportive. Citi (C) dropped over 4% as it revealed a $10bn exposure to Russia, whilst defence stocks like Raytheon (RTX) and Lockheed Martin (LMT) jumped.

Looking at defence stocks, this is about not just German policy shift to 2% of GDP, but broad European rearmament that will need to take place. Italy’s Leonardo (LDO) rose again this morning, the defence firm is up 25% in the last 5 sessions…Draghi this morning saying Russia threat is an incentive to invest more in defence. Hensoldt (HAG) also up another 8%, taking its 5-day gain to +88%, Rheinmetall (RHM) also +5% this morning. After dipping at the open, BAE Systems (BA) is also up more than 1% to add to yesterday’s strong gains.

We got the volatility on the Globex open on Sunday night/early Monday morning as futures markets turned sharply lower on the weekend sanctions moves…but the fade came pretty fast and cash equities held steadier, declines were less than feared. There is something about the internal dynamics of the market about this; futures are trade in thinner volumes usually, out of the main trading hours. People are trading the index – the FTSE 100 – as a single thing, not as a basket of individual stocks, each with their outlook. Once the cash equity open happens the big boys come out to play and start to look at each company not just the index. Futures out of the cash equity hours are a bit of a guessing game – even more than regular trading. 

S&P 500 record highs yesterday included General Dynamics (GD) L3Harris Technologies (LHX) Northrop Grumman (NOC) Raytheon Technologies (RTX) Chevron (CVX), CF Industries (CF) Nucor (NUE) and Atmos Energy (ATO). 

Russia exposed stocks under pressure still: Polymetal (POLY), JPMorgan Russian Securities (JRS) and Petropavlosk (POG) all sharply lower again, whilst Evraz (EVR) and Ferrexpo (FXPO) tried to rally a bit before turning lower. Sberbank in freefall, down 94% in the last two weeks in London, with the Treasury adding the bank to its list of sanctioned entities. After trading at $15 two weeks ago it’s now under $1.  

The ruble has come off its lows and trades around 91 to the US dollar. At the moment it looks as though the Russian central bank is doing a not terrible job of supporting the currency, but through some pretty tough measures – massive rate hike and capital controls. How long can this last? 

Shell followed BP (both a touch lower this morning) by pulling out of Russia by pulling out of projects with Gazprom. Now the pressure is on Glencore, which still has a 0.5% stake in Rosneft and 10% stake in En+, whose largest shareholder has been sanctioned. TotalEnergies (TTE) said it won’t invest in any new projects…but nothing on its current links in Russia, which accounts for about 16% of its total production. Shares in the French company dipped almost 4% this morning. I note signs investors are not just applying a dispassionate view of Russia exposure to their PnL but also ascribing some moral values and distancing themselves from anything with links to Russia.

As for Russia and Ukraine….the dreadful situation gets worse as heavy shelling of built-up areas shows us what is to come. Talks yesterday didn’t get far but the two sides have agreed to try again as a massive Russian convoy starts to encircle Kyiv. Bombing of civilians will harden Western public opinion against Russia – voters are already taking a pretty hard line across Europe. Unified public opinion complicates matters for governments who might prefer to base policy solely on the advice of their military intelligence and strategic advisors. But that is the way of things.

For markets, this means the question of direct sanctions on oil and gas exports from Russia is a matter of when not if. Canada has already unilaterally banned Russian oil imports, though these are microscopic compared to Europe’s appetite for Russia’s crude and natural gas. Talk of a Nato-enforced no-fly zone needs to be ignored – who really wants the RAF to shoot down Russian jets and risk WW3? The problem of public opinion again… 

Oil remains bid, with Brent back above $100 this morning, nudging it back towards the early Monday morning high near $102. WTI trades a little under $98 in a broadly similar pattern.  

Bitcoin spiked yesterday afternoon and kept going – could be on the Swiss move to mirror EU sanctions, ending decades of neutrality, but more likely it reflects a belief that we are entering the end of dollar hegemony and the beginning of a bi-polar financial world. Or maybe it’s just Russians scurrying to park their fiat currency – be it USD or RUB – in crypto assets that can avoid sanctions. Bitcoin jumped to $44,200, up almost 29% from its Feb low. 

On the dollar…we are seeing FX basis swaps widening, which tends to suggest a higher cost of USD funding. Uncertainty could be driving widening, or it could be due to the Russian removal from Swift. At the moment there is still plenty of dollar liquidity it seems but the moves in EUR basis swaps tends to suggest that it’s not macro uncertainty but more euro-area specific…ie spillovers from sanctions affecting the Eurozone more than others. This could see EURUSD push lower. Yesterday the cross retested the Jan lows which were the weakest since Jun ‘20. Upside momentum seems to be stalling this morning however.

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