Don't Commit New Capital

 | Jul 21, 2014 | 11:25 AM EDT
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We think the market's always right. When it goes up on Friday, we decide: "you know what, the market doesn't care about Russia and Ukraine or Gaza and Israel; in fact, the market recognizes that earnings aren't going to be impacted by either issue, so what is the point of selling?"

But then you come in today, with the market getting hammered, and you recognize that Friday's session was either too glib or too influenced by mechanical forces like options expiration, which might have pushed up stocks because of forced buys made by institutions to close out positions.

The latter, unfortunately, isn't game-able. Believe me, I have tried for years and years to figure out whether there will be option pressure to buy or sell the market. It's been futile. I have seen the market go up big all day off an expiration, and I have seen it go down big another time. I have seen the market reverse direction starkly in the last hour because of options.

You just don't know. But we do know this: there was much more to buy than sell on Friday.

It's the other side of the story that intrigues me, the difficult-to-process events of last week.

It is true that the Israeli incursion into Gaza hasn't impacted earnings per share. But if the Arab states decide that Israel has gone too far, there could be some sort of unforeseen embargo -- at least unforeseen now. We saw it in 1973, we could see it again. I put the odds of it low, but not infinitesimal.

It's the downing of the Malaysian aircraft over Ukraine airspace that's not been factored in correctly until today.

Last week I opined that the stock market didn't seem to care about the crash, even as I think that the incident could have real impact on earnings.

I feared that the U.S. government would pressure Europe to put some real sanctions on Russia, sanctions that have to hurt earnings because you can't hurt the Russian economy and not have an impact, not just on Russia but on Europe as a whole.

It's the latter that's been on my mind.

Yes, it is true that Russia, itself, doesn't have that much of an impact on earnings. If you cut ties with Russia, I mean, really cut ties -- where the U.S. government sanctions businesses that have commerce in Russia -- that's just going to be very bad for all economies around the world. We had a big downturn in the S&P 500 around the time of the Cyprus crisis, which was directly involving Russian investors in Cyprus. There was a ton of news during that spring 2013 period and it certainly wasn't a one-for-one kind of news story.

But it did cut into the commerce of Russia and that did matter to a shaky Europe, and it took about a year before Cyprus cleaned up.

At the time when it first unfolded I urged patience because it would cause the stock market to come down but when it dropped an appreciable amount you had to take action.

I think that we have now only seen mild sanctions and, more important, little reaction from Putin to the sanctions. But if there is "banking interference" and we start treating Russia as a rogue nation, a la Iran or even Cuba, you certainly will see a hit to companies like Mastercard (MA) and Visa (V), which supply millions of cards to Russia. Russia could easily say "we want our own credit card system," which is something they first proposed when the U.S. talked about sanctions. The Russian government didn't pull the trigger on that plan, though, and a momentary hit to the stocks vanished rather quickly. 

 You could also see a drop off in earnings for BP (BP) if Russia just kicks them out as retaliation.

Now, these are big companies. BP can handle the kick out. Russia is very small for both Mastercard and Visa. However, we live in a world of rallies on number boosts and declines for number cuts, so draw your own conclusions.

The bigger issue though, is the impact on Europe from retaliation by Russia. Remember, Russia supplies the natural gas to a lot of Europe and it could take prices up huge or even shut off the spigot. That's not going to be good news for either industry or the consumer. Imagine our economy without natural gas or with a dramatic cutback or a huge increase in prices.

Yep, it would hurt.

That's what I fear about Europe and I think that it's a reasonable enough fear that it should be discounted more heavily by the market.

It hasn't been yet, even as Europe is often about 20% of the business of most of the major industrial companies I follow.

If we were down a lot already because of this issue, I would be singing a different tune. But we are not. If we weren't up as much as we are, I would be singing a different tune, too.

But we are.

So, I say be patient. Let it come in. Don't commit new capital.

Just a prudent way to approach the market.

I was assaulted on Twitter and even at the beach for "going bearish" when I had been bullish.

I was kind of amazed that even if that were true, it is somehow wrong, given the run we have had. At least I didn't "go negative" at the bottom!

However, I am concerned enough that I say buying new stocks here, putting money to work here, betting that prices have bottomed off this crisis does seem more than a little glib.

Sure, we could be in a blow-off phase where nothing matters at all.

But I think that's not the case. If numbers come down because of a slowdown in Europe --something very few are looking for -- I do think lower prices are in the offing. Then we can look at the overall market, especially companies that aren't involved with one of the largest trading partners of the European Union.

If that is shocking, so be it. I don't mean it to be that way. I am saying that after the run with the possibility of a ratchet up in tension, it's been the case that you get a decline.

Can we at least wait to see if it unfolds?

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