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  • German High Court ruling threatens EU bailout
  • Ukraine erupts in violence
  • Janet Yellen era begins

February was a positive month for all major asset classes, bringing returns for 2014 into the green for all groups except emerging market equities.  After lagging in 2013, gold is the leading performer so far this year.  Bonds have shown positive momentum in recent months and have had stronger returns than equities year to date:

The selloff in commodities over the last 3 to 5 years has had a strong negative impact on emerging markets, which is reflected in the return graph below:
In early February, a long awaited decision by Germany's Federal Constitutional Court was issued. Germany's own central bank, the Bundesbank, had sued the European Central Bank shortly after they announced their version of Quantitative Easing, known as OMT (Outright Monetary Transactions), in late 2012. The Bundesbank claimed that OMT was illegal, since the ECB is prohibited by law from directly funding member governments (this is the polar opposite of the US, where the Federal Reserve is explicitly authorized to buy US government debt, thus helping to fund our government).
It is now up to the European Court of Justice to decide. Some observers say that the German High Court "punted" on the issue by handing it off to the ECJ, which may rubber stamp their approval of OMT. If they do, another challenge with the same flavor will also be ruled on late in March, where a decision awaits the legality of Germany's participation in the ESM (European Stability Mechanism), or Eurozone bailout fund. If the ECJ instead supports the Bundesbank position, the whole Eurozone financial system could unravel. Most US based investors aren't thinking about this, but it is a big deal to a big market with an important currency. Investors would do well to keep an eye on these developments.


Markets generally gathered strength throughout February, but the calm was shattered on February 18th, as Ukrainian riot police (many of them foreign mercenaries) attacked protestors occupying Kiev's central Independence Square, killing 25, including 7 police.


Ukrainian President Victor Yanukovych (we'll call him Yanu) is widely seen as having stolen their presidential election last year, and has presided over a vast corruption throughout the central government. Rising resentment from the people boiled over when Yanu rejected a deal to integrate with Europe in November, instead turning East towards Russia, which needs the Ukraine badly to supply much of its food and transport almost all of its natural gas west to Europe.
The EU immediately threatened sanctions, while the Russian Foreign Ministry blamed the West for the escalation of violence: "What is happening is a direct result of the conniving politics of Western politicians and European bodies".  (However, the riot police moved in just hours after Moscow gave Yanu $2 billion in aid for its crippled economy, which it had been holding back as it demanded decisive action to crush the protests. Co-incidence?)


Cities in the western part of Ukraine quickly declared independence as protestors took over government buildings and forced police to surrender. Yanu dug in his heels, blocking roads into Kiev and trying to shut down communications with the outside, while firing the Army chief and appointing his own hatchet men.
A fragile truce was broken quickly as the Ukrainian regime massacred over 80 demonstrators on Wednesday, February 20, a day that will likely live in infamy as that country's own "Boston Massacre". The German and French foreign ministers arrived and arranged an out for Yunakovich, who agreed to early presidential elections (December 2014) and the constitutional reforms meant to trim presidential powers (September 2014).


The people had had enough, though, and they forced Yanu to flee the country, taking his two sons with him (who ran their own private Mafia-like shakedown business). Eventually they wound up in Russia, where Yanu is being preserved to perhaps be re-installed as the "legitimate" President of Ukraine.
Events at month end moved quickly.  Documents uncovered showed the vast scale of theft conducted by Yanu, with some $20 billion having been looted from their central bank (but he had to leave so quickly that he left behind $650 million in banknotes!) Yanu funneled millions to build a lavish country retreat, which was opened for all Ukrainians to see ( As a result, the newly installed pro-Europe Prime Minister warned immediately of economic hardship and unpopular actions to come as a result of the mass plunder of the state.


Pro-Russian supporters in the Crimea didn't like this turn of events, so they stormed and occupied government buildings and airports, while Russian warships headed for Ukraine and 150,000 soldiers were sent to their borders. As we publish this journal, Russian forces have occupied all of the Crimea and have issued an ultimatum for all Ukrainian forces to surrender. Will markets remain calm if military actions escalate? We doubt it.
Perhaps on cue, high quality bonds have regained strength, and have now assumed a "positive" trend. Bonds normally assume a "safe haven" or "flight to quality" bid during periods of high uncertainty, and the odds are that we have entered a period of well supported "bids" for bonds:


Of great interest to bond investors was Janet Yellen's first appearance at month end on Capitol Hill. Testifying before the Senate Banking Committee, she did not unveil any new initiatives or changes in policy. The biggest headline was that the Fed wanted more information on how recent soft economic data was impacted by the weather. She reiterated that "tapering" would continue, although some have expressed concern that lack of inflation and weakening economic data support the case for maintaining high levels of bond purchases. All in all, it was a friendly meeting and set a good tone for relations between the Fed and Congress.
As we head into March, the rising tides of U.S. markets look set to meet the rising tides of political conflict that have turned deadly in the Ukraine. It is a very serious situation that is going to dominate the headlines for some time to come. Markets are likely to get bumpier, but U.S. assets should benefit from continued geo-political turmoil. Maybe a little luck of the Irish can prevail in March. It would certainly please old St. Patrick. 
Thanks for reading our Journal, and we'll be back to you in early April.
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