20 things you probably don't know about the Russian incursion into the Ukraine!

Our hearts and prayers go out to the people of Ukraine, as they undergo both an internal political crisis and what appears to be military intervention from Russia.  For people of a certain age, the current events, with tanks rolling across the Russian border into a neighboring nation that wants to exercise its freedom, it feels a bit like the Cold War days all over again.

Whenever we see troop movements and fires raging in the streets of a capitol city the size of Chicago, our instinct is to assume the worst and move our money to the sidelines.  But is this really the best strategy?  Some commentators see any market downturn as a buying opportunity, since stocks are going on sale simply because of unfounded fear of economic aftershocks.

Here are some facts that you might not know about what has, hitherto, been a relatively quiet new member of the world economic community. 

1) The word "Ukraine" means "borderland" in proto-Slavic.  It appears to have acquired this name simultaneously from Poland, Austria and Russia, referring to the territory that sits across the border of so many European nations and Russia.  In fact, the Polish referred to their troops stationed in this area as Ukranians--that is, borderlanders.  Since the country became independent from the Soviet Union, it is no longer referred to internationally as "The Ukraine."

2) Ukraine's currency is the hryvnia, adopted in 1996 after the country suffered the greatest one-year bout of hyperinflation in global economic history.  (Zimbabwe has since broken the record.)  Today, one dollar will buy 9.6 hryvnias.  A euro will buy 13.3 of them.

3) After Russia, Ukraine has the largest military presence in Europe.  Ukrainian troops have been deployed as part of international peacekeeping missions in Somalia, Kosovo, Lebanon and Sierra Leone, and has engaged in multinational military exercises with U.S. military forces.  NATO has accepted Ukraine as a member pending a national referendum on the matter--which will obviously be delayed until the conflict with Russia has played itself out.

4) Ukraine has one of the world's most active space programs.  The National Space Agency of Ukraine has launched six self-made satellites and a total of 101 launch vehicles.  The country also manufactures the An-225 aircraft, the largest aircraft ever built.

5) Due to low birth rates, Ukraine's population is declining at the sixth fastest rate in the world, behind the Cook Islands, the Federated States of Micronesia, the Northern Mariana Islands, Niue (an island nation in the South Pacific) and the Eastern European nation of Moldavia, which borders Ukraine.

6) Nevertheless, Ukraine's largest city, Kiev, has a higher population (2.8 million) than Chicago, America's third-largest city.  The population of Kharkiv, Ukraine's second-largest city (1.4 million), is greater than San Antonio, San Diego and Dallas, America's seventh, eighth and ninth most populous cities.

7) According to the World Bank, Ukraine's economy is the 51st largest in the world, ranking just behind Peru and the Czech Republic,a nd just ahead of Romania and New Zealand.  But its $7,295 (US) per-capita income (a rough measure of a nation's wealth) ranks 106th in the world, behind Namibia and El Salvador and ahead of Algeria, Micronesia and Iraq.

8) Ukraine co-hosted the Euro 2012 football (soccer) tournament (with Poland), which is one of the major sporting events in Europe.

9) Even though the Chernobyl nuclear disaster occurred in Kiev, Ukraine operates the largest nuclear power plant in Europe.

10) Despite comments that Ukraine is divided between ethnic Ukrainians and Russia, 77.8% of the population is ethnic Ukraine, and only 17.3% is Russian.

11) Ukraine is known as the "breadbasket of Europe" for good reason.  The country is the world's fourth largest producer of barley, 5th largest producer of rye, 11th largest producer of wheat, the 6th largest producer of oats and the 9th largest producer of soybeans.

12) Russia sells approximately 80% of its oil and gas exports to the European Union through pipelines that pass directly through Ukraine.  The European Union receives 25% of its oil and gas from Russian sources through these conduits.

13) Ukraine also happens to be Russia's second-largest customer of petro-fuels.

14) Russia is drilling for oil in the shallow waters of the Black Sea near the Crimean Peninsula, which shows promise of having significant reserves.

15) Among others drilling in the same area: Chevron and Shell Oil.  If they begin production under the Ukrainian flag, it would significantly undercut Russia's oil and gas market share and prices, simultaneously boosting Ukraine's economy.

16)  When the Russians (as the Soviet Union) invaded Afghanistan in 1979, the U.S. and many Western nations boycotted the 1980 Olympic games, which were hosted in Russia.  Is it interesting that Russia decided to move forces into Ukraine immediately AFTER the Sochi Olympics were finished?

17) Among the most likely responses to the Russian/Ukrainian crisis is the cancellation of the upcoming G8 summit in Sochi.  Another possible response might remove Russia from the G8 club.  This would embarrass Russian strongman Vladimir Putin at home and isolate him (and Russia's economy) abroad.

19)  Russia's economy could be the big loser in the aftermath of the Ukrainian crisis.  Share prices for companies based in Russia declined by 10 percent the day after mysterious soldiers took over the Crimean peninsula, also triggering an outflow of domestic currency that Russia desperately needs to invest in modernizing an economy largely (today) based on selling abroad what is pumped or mined out of the ground.

20) The threat of disruption of trade between Western nations and Russia (either due to sanctions or reluctance to deal with a country that doesn't seem to be focused on following international law) cost the Russian economy $60 billion in a matter of days--more than the total cost to stage the Sochi Olympics.

21 (bonus) Let's assume that we are not headed toward a world war.  Several commentators have unhelpfully pointed out that the Crimea became the flashpoint for World War I, but the world is somewhat different today.  There could be some impact from higher energy prices in Europe if the Ukraine pipelines are disrupted temporarily, but Russia needs to sell its oil and gas as much as Europe needs to buy it.  Unless someone is heavily invested in Russian stocks, the crisis will likely be seen as a portfolio non-event.

Has a Correction Started? Does it Matter?

On Monday, the U.S. markets dropped roughly 1% of their value, and Europe and Asia were down by similar amounts the following day. The market (the S&P 500) then fell 2.1% on Friday in a sickening lurch. This combination was enough to cause pundits and investors to ask whether we are now in the early stages of a bear market or, indeed, if the past almost-five years should be considered an interim market rally inside of a longer-term bear market.

The answer, of course, is that nobody knows--not the brainiac Fed economists, not the fund managers and certainly not the pundits. A Wall Street Journal article noted that most of the sellers on Friday were short-term investors who were involved in program trading, selling baskets of stocks to protect themselves from short-term losses. Roughly translated, that means that a bunch of professional traders panicked when they learned that Chinese economic growth is slowing down on top of worries that the Fed is buying bonds at a somewhat less furious rate ($75 billion a month vs. $85 billion) than it was last year.

What we DO know is that it is often a mistake to sell into market downturns, which happen more frequently than most of us realize. A lot of people might be surprised to know that in the Summer of 2011, the markets had pulled back by almost 20%--the traditional definition of a market correction--only to come roaring back and reward patient investors. There were corrections in the Spring of 2010 (16%) and the Spring of 2012 (10%), but almost nobody remembers these sizable bumps on the way to new market highs. Indeed, most of us look back fondly at the time since March of 2009 as one long largely-uninterrupted bull market.

Bigger picture, since 1945, the market has experienced 27 corrections of 10% or more, and 12 bear markets where U.S. equities lost at least 20% of their value. The average decline was 13.3% over the course of 71 trading days. Perhaps the only statistic that really matters is that after every one of these pullbacks, the markets returned to record new highs. The turnarounds were always an unexpected surprise to most investors.

We may get a full 10% correction or even a full bearish period out of these negative trading days, and we may not. But the history lesson suggests an important lesson: if we DO get a correction or a bear market, we may not remember it a few years later if the markets recover as they always have in the past. The people who lose money in the long term are not those who endure a painful market downturn, but the people who panic and sell when the market turns down.

Bogus Effect

This time of year, we often find ourselves reading about the "January Effect," which is sometimes described as a predictable way to forecast returns, and sometimes as a way to know whether this is, or is not, a good year to invest and make some money.

Unfortunately, most of this reporting is nonsense.

Let's start with the predictable part. Wouldn't it be nice if, even for just one month of the year, we

could know whether the market is going to go up or down? That's what market pundits are implying in their January Effect reporting: that markets have a strong tendency to rise in January. Why? The explanation, first offered in 1942, is twofold:

1) Stock investors tend to harvest their tax losses at the very end of the year, selling any stocks that happen to be below the price they paid for them, and, of  course, claiming the loss on their tax returns. This selling activity depresses the prices of stocks generally in late December (Why do we not hear about a negative "December Effect?"), but when those investors buy back into the market in January, the additional buying demand pushes up prices.

2) Mutual funds, who are the biggest stock investors, have to report their holdings as of the end of the year. If they made an embarrassing mistake and purchased a stock which subsequently dropped like a stone, the portfolio manager engages in an exercise known as "window dressing:" she conveniently sells that stock right before December 31, and then reports a portfolio that doesn't include the losing investment. This is a great way to prevent reporters from asking pointed questions about what they might have seen in that dog stock when they purchased it in the first place. And it makes it look like, despite what might have been poor performance throughout the year, the fund is strangely only invested in stocks that went up.

Of course, the cash position is only temporary; the fund will put the money to use in January. Just like the tax harvesting activity, these sales in December and purchases in January, we are told, have a wind-at-the-back impact on share prices in the first month of the year.

So why is this nonsense? Back in 1942, and for some years afterwards, it might have made sense to do all your tax loss harvesting once a year as the holiday decorations were being taken down at the malls. Today, with modern software tools, professional investors can check daily to see if there are portfolio losses they can harvest, so the buying and selling is spread out through the year. Also, today's mutual funds report the contents of their portfolios quarterly, rather than annually, so the window dressing activity (which still goes on), happens each fiscal quarter, rather than all at once at the end of the year.

Moreover, a quick glance at history suggests that returns in the month of January have been pretty random for this century's investors. The S&P 500, in the calendar month of January since January 2000, has delivered returns of -4.18%, +6.45%, -2.12%, -5.87%, +2.04%, -1.73%, +0.89%, +1.53%, -4.74%, -11.37%, -5.22%, +1.12%, +2.77%, +2.44% and -0.77% last January. If you can see a pattern there worth betting on, chances are you're also a genius at the racetrack.

The other January Effect says that if stocks rise in January, they will be up for the year, and if they fall in January, then the market will deliver losses through December. Of course, any time you give the market a head start in either direction, there will be a slight tendency for the rest of the year to follow suit--similar to if you saw an Olympic sprinter break out of the blocks ahead or behind the pack, you would notice a tendency to finish ahead or behind. Not a guarantee, you understand, but a tendency.

Looking at the historical record, when stocks finish the first month down, they finish the year down 58% of the time--almost exactly what you would expect within the statistical probabilities of randomness. Researchers have actually determined that--probably also due to random factors--the returns in September have historically been the best predictor of returns for the year as a whole.

The truth is, none of us have a way to predict even a week, much less a month or a year of market returns. Whenever we read about the Super Bowl winner predicting the market, or the month of January or September or the winning party in the Presidential election, we should recognize that the article is being written purely for entertainment, giving us a chance to fantasize that, somehow, we can, for a moment, know the unknowable future and maybe even profit from it.

A YEAR TO REMEBER!

The U.S. stock market punctuated an extraordinary year with gains on the last trading day, moving many of the American indexes to record highs on the final trading day for only the sixth time in history.  Despite all the uncertainties that we faced (the government shutdown, Boston bombings, the ongoing Syrian uprisings, debt ceiling debates, NSA revelations, the lingering economic aftershocks of superstorm Sandy, nuclear standoff with Iran) people will look back at 2013 as one of the most profitable years for investors on record.

The Wilshire 5000 index--the broadest measure of U.S. stocks and bonds--rose 33.07% in calendar 2013, with 10.11% of the gains coming in the final three months of the year.  The comparable Russell 3000 index gained 33.55% in 2013, posting 10.10% returns in the final quarter.

Large cap stocks, represented by the Wilshire U.S. Large Cap index, gained 32.33% this past year, with 10.22% gains in the fourth quarter.  The Russell 1000 large-cap index returned 33.11% for the year, up 10.23% for the last quarter, while the widely-quoted S&P 500 index of large company stocks gained 29.60% in 2013, with 9.92% returns in the year's final quarter.

The Wilshire U.S. Mid-Cap index index rose 36.78% in 2013, buoyed by an 8.69% rise in the final quarter.  The Russell midcap index was up 34.76% for the year, with 8.39% gains in the final three months of the year.

Small company stocks, as measured by the Wilshire U.S. Small-Cap, gained a remarkable 39.01% for the year; 9.10% of the returns came in the final quarter.  The comparable Russell 2000 small-cap index rose 38.82% in 2013, posting an 8.72% gain in the year's final three months.  The technology-heavy Nasdaq Composite Index gained 38.32% for the year, after posting 10.74% gains in the last quarter of the year.

By any measure, these returns were remarkable.  The S&P gains were the highest since 1997, and the 3rd highest since 1970.  The small cap returns are the 3rd highest since 1980, and the Nasdaq returns were the seventh-highest ever.  What makes the year even more remarkable was that nobody was predicting a rampaging bull in 2013, and many economists and pundits didn't think returns like these would be possible.

If anything, the five-year gains since the market downturn have been even more extraordinary.  The Wilshire 5000 has posted an average 18.58% gains over the last 60 months, and the midcap (23.08%) and small cap (23.86%) indices have fared even better.  Investors who got out of stocks during the market crisis of 2008 and worried ever since have missed out on one of the best 5-year bull market runs in American history.

IS this a bull market?  Commentators, investment strategists and economists don't agree on whether we are experiencing a temporary rise in the midst of a long-term bear market, like we experienced during the Great Depression, or the strong early stirrings of a long-term bull like the one which started in 1982.  The truth is, nobody knows, just as nobody knew that the U.S. stock markets would reel off such strong returns after the near-collapse of the global economic system.

Long-term investors can be compared to farmers, who plant seeds with no foreknowledge of the weather during their growing season, and no belief that what happened this year has any impact on what will happen in the next one.  There will be bad years, and good years, but over time, the good years have tended to outnumber bad ones, which is why it makes economic sense to continue planting the seeds each Spring--or staying invested in the stock market when each coming year is a mystery. 

Around the world, the harvest was mostly excellent in 2013, even though returns lagged the booming U.S. market.  The broad-based EAFE index of developed economies rose 19.43% in dollar terms in 2013, aided by a strong 5.36% return in the final quarter.  European stocks were up 21.68%, giving them a strong year despite the constant threats of sovereign debt default and internal trade imbalances. 

Emerging market stocks were a very different story.  In 2013, the EAFE Emerging Markets index of stocks in Latin America, the Middle East, Eastern Europe, Africa, India and Russia was down 4.98% for the year, despite a 1.54% rise in the year's final quarter. 

Other investment categories also lagged their long-term averages.  Real estate, as measured by the Wilshire REIT index, gained just 1.86% for the year, after a modest 0.83% drop in the last three months of 2013.  Commodities, as measured by the S&P GSCI index, experienced a price collapse, losing 26.73% in 2013.  Gold investors, meanwhile, experienced the precious metal's worst annual loss in 32 years, dropping 28% in value over the past 12 months. 

Bond yields remain low by historical standards, but a slow rise in rates caused bond holders to experience paper losses.  Investors in the Barclay's Global Aggregate bond index lost 2.60% in 2013, and 2.02% in the U.S. Aggregate index.  Investment grade corporate bonds are currently yielding an aggregate 3.87%.

In the Treasury markets, 10-year bonds now yield 3.03%; 5-year bonds are yielding 1.74%.    

What's next?  Who knows?  Long-term, stocks tend to reflect the overall growth of the economy.  One possible reason why so many investors remain nervous about stocks is the persistent--and erroneous--belief that the U.S. economy is still mired in a recession.  You hear words like "sluggish" in the press, but in fact, the total output of the American economy has grown steadily since the 2008 meltdown, and the pace of growth seems to be accelerating.  The Bureau of Economic Analysis statistics show an annualized increase of 4.1% in the third quarter of last year (the most recent period for which we have statistics), following a 2.5% rise in the second quarter.

Other economic signs are also encouraging.  Total corporate profits rose $39.2 billion in the third quarter, following an increase of $66.8 billion in the second.  Individuals and corporations are carrying less debt than in the past; total public and private debt in the first quarter of 2010 was up above 3.5 times U.S. GDP; today it stands at 1.07 times GDP.  U.S. home prices recently posted their largest one-month rise in more than seven years, and some markets have seen housing values reach their pre-recession levels. 

Even so, many investors will continue to wait on the sidelines, looking for "proof" that the market recovery is finally for real, while others will keep their money from working on their behalf in expectation of a crash.  The former will finally get back in when prices have peaked, and will, in fact, be our most reliable indicator that the market has become overvalued.  The latter will miss the next downturn, but also lose out on the positive returns that have, historically, outweighed the losses suffered in bear markets.  The past five years have given us a useful lesson: that you plant your seeds in the expectation that there will be bad crops from time to time, but these unexpected booming years will more than make up for the losses.