David Joy: Tensions in Ukraine bring geopolitical risk into the spotlight

Tensions in Ukraine bring geopolitical risk into the spotlight
The S&P 500 fought its way to a new all-time high last week, despite lingering questions about the economy, and rising military tension in Ukraine. The index rose 1.3%, lifting it into positive territory for the year. But, its ability to hold onto those gains has begun to be tested this week in response to the situation in Ukraine, and a host of economic reports in the U.S.

The Economy
Even Fed Chair Janet Yellen, in her Senate testimony last week, cited the weather as obscuring the true condition of the economy. Yet, she gave no indication that it was causing the Fed to reconsider its pace of tapering. In fact, there was just enough good news on the economic front last week to keep alive the assumption that activity is firmer than it appears. New home sales, durable goods orders ex-transportation equipment, the Chicago area Purchasing Managers Index (PMI), and the University of Michigan Consumer Sentiment index were all firmer than anticipated.

The problem is that there were also a number of reports that were weaker than expected, including the Chicago Fed National Activity, the Conference Board’s Consumer Confidence index, and initial jobless claims. And in the week ahead there is no shortage of data releases to add to the debate.

At the top of the list is the February jobs report on Friday, which is expected to show the creation of 150,000 new non-farm jobs and an unchanged jobless rate of 6.6%. Also on the calendar are both ISM reports on manufacturing and non-manufacturing for February, personal income and spending, the Fed Beige Book and motor vehicle sales.

These reports are expected to be relatively firm, but not enough so to put to rest the debate over the weather. That is now likely to have to wait until April when March data becomes available, although March itself is starting out with difficult winter weather in much of the country. First quarter growth rates continue to be revised lower in recognition of the impact, but the behavior of stocks suggests that investors continue to give the better growth story the benefit of the doubt.

That may not be the case in China, where the Markit flash manufacturing PMI index fell to a seven month low in February, remaining below the expansion/contraction line. In contrast, in two welcome developments in the Eurozone, the final February PMI for manufacturing actually firmed slightly, as did consumer inflation. And in Japan, both retail sales and industrial production rose along with consumer inflation.

Geopolitics
Until recently, the concept of geopolitical risk has been notably absent from most discussions of what to expect in 2014. Tensions between China and Japan in the Sakhalin Islands have been on the radar screen, as well as have negotiations over Iran’s nuclear program. But these, and a few other ongoing sources of tension, have been generally viewed as unlikely to escalate into something more problematic. However, suddenly the concept of geopolitical risk is being reassessed after the Russian army has mobilized along the eastern border of Ukraine and taken control of strategic interests in Crimea.

The new Ukranian Prime Minister has said the country was prepared to fight to protect its sovereignty. The response of the west, toward which the Ukranian uprising turned, is so far focused on applying economic sanctions and international isolation on Russia for disregarding the right to sovereign determination of the Ukranian people. And the focus is likely to stay there. No one is interested in a military confrontation. Economic sanctions can be effective if applied with conviction and in solidarity. But the situation is tense, and uncertain.

As trading resumed this week, risk assets moved lower and safe haven assets rose in response to developments over the weekend. Asia stocks generally retreated across the board on Monday, with Japan’s Nikkei index dropping 1.3%. A notable exception was the Shanghai Composite, which rose almost 1%.

European markets, which of course are in much greater proximity to Ukraine, reacted more strongly. The Stoxx Europe 600 slid 2.3% and the German DAX index was down 3.4%. U.S. stocks took a hit, too, with the S&P 500 closing down 0.7%.

Indexes in all three regions of the world regained ground Tuesday, following remarks from Russia’s president, Vladimir Putin, indicating that the country would not exercise military force in Crimea for the time being.

Until the tension in the Ukraine is defused, it will preoccupy investor attention and the economic data will take a backseat, just as perhaps it is about to get better.

Disclosure
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.

The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.

The Shanghai Composite Index is a capitalization-weighted index of all stocks on China’s Shanghai Stock Exchange.

The Chicago Purchasing Managers Index is a monthly measure of the business conditions based on surveys of purchasing managers across Illinois, Indiana and Michigan.
University of Michigan Consumer Sentiment Survey is a rotating panel survey based on a nationally representative sample that gives each household in the coterminous U.S. an equal probability of being selected. Interviews are conducted throughout the month by telephone. The minimum monthly change required for significance at the 95% level in the Sentiment Index is 4.8 points; for Current and Expectations Index the minimum is 6.0 points.
The Chicago Fed National Activity Index (CFNAI) is a monthly index designed to gauge overall economic activity and related inflationary pressure. The CFNAI is released at 8:30 a.m. ET on scheduled days, normally toward the end of each calendar month.
The Conference Board Consumer Confidence Survey® is based on a probability-design random sample. It is distributed monthly.
Markit’s U.S. Manufacturing PMI survey panel comprises over 600 companies. The flash estimate is typically based on approximately 85%–90% of total PMI survey responses each month and is designed to provide an accurate advance indication of the final PMI data.

The Eurozone Manufacturing PMI® (Purchasing Managers' Index®) is produced by Markit and is based on original survey data collected from a representative panel of around 3,000 manufacturing firms.

The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalisation companies across 18 countries of the European region.

The DAX (Deutscher Aktien Index) is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange.

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