Given that the crisis in Ukraine is probably the number one global news story and has had a pretty profound impact on the markets, I wanted to get some thoughts down on it. Specifically, I’ll get into how I think about a large negative macroeconomic event such as this one and how it can affect microcaps.
In terms of structure, I’ll give some of my takes on what’s been going on in general. I’m going to keep this more US-centric as almost all of my readers are in the US and I only cover US/Canadian companies. Then, I’ll give my relatively brief thoughts on how I think this could play out for the three companies I currently cover: AITX, ALPP, and SIRC.
As an initial point, I generally steer away from politics on this site and focus in on more company specific due diligence. So this will be a bit new for me.
That being said, following the news these past few weeks, and especially today, has been fairly troubling for me. I have a close work colleague from Ukraine working here in the US and interacting with them regularly really puts the whole thing in perspective. I could not imagine being overseas and having a foreign dictator actively trying to annex my home country. I personally don’t know how I could go about my day like they have.
I truly hope for everybody’s sake that this just becomes an extension of the 2014 invasion with Russia solidifying its claims to parts of eastern Ukraine. But there’s only one person in the world who knows the answer to that, and I don’t expect them to talk anytime soon.
Sorry if this sounds too “self-help-y”, but I think this can be a moment for all of us to reflect on how fortunate we all are in our own ways.
Impact on the Markets
Armed Conflict Likelihood
When we think about how this plays out, the most likely course of action appears to be some sort of armed conflict between Russia and Ukraine only. As investors, we need to follow the most probable outcome even with the existence of tail risk. Tail risk, in this case, would be essentially World War 3.
NATO and the west have never wavered in saying they will not go to war with Russia over Ukraine. So barring any accidental spillover of combat into Poland, Hungary, or any other nearby NATO member, this will likely be a contained war. As investors, we have to assume this for now, or at least I will.
In terms of market response, we’ve already seen general market trends move downwards as a result of this. I do expect it to continue some until we see more stabilization in the region. But I don’t expect the effects to be extremely drastic on the US economy.
Why do I think that? Let’s get into the potential negative macro level economic consequences.
What I think is the Most Likely Outcome
The most drastic course of action the west is going to take short of all-out war is economic sanctions. In the best case, we see spotty sanctions against certain Russian companies, individuals, Russian government debt, etc. This has basically already happened as of around 3pm EST.
In the worst case, we will see Russia placed on the same level as someone like North Korea, Iran, and Cuba with a full-on trade embargo. This would make it effectively impossible for US companies and persons to do business with any Russian individual, company, etc. It would also cut off Russia from international monetary systems.
This would absolutely crater the entire Russian economy and would effectively move them back into a Soviet-era level of economic isolation.
Let’s remember though that even in the worst case, Ukraine and Russia aren’t exactly economic superpowers. Inflation adjusted, Russia is currently around 6th in terms of GDP and Ukraine is somewhere around 40th. As some more perspective, Russia’s GDP is somewhere around USD 4.3 trillion, while the US is around 22.6 trillion, China around 26.6 trillion, etc.
In the worst case then, US companies will no longer be able to trade with a country about 16% smaller than China. Furthermore, the US only imports about 10bn worth of goods from Russia each year, while exporting only about 4.88bn each year to Russia. For comparison, we export about that amount to Egypt, Sweden, and Poland individually as we do to Russia. At the same time, we export about 255bn to Canada, 212bn to Mexico, 124bn to China, etc.
What I’m getting at in my most likely “worst case” outcome (and man I hope this is as bad as it gets), US companies and individuals on the whole won’t exactly be hurting due to extreme trade sanctions. Yes, it won’t be nice for the guy that imports Russian hats and sells them in Central Park. But if we’re talking macro level, this isn’t exactly the worst thing in the world for US companies.
If we were talking about the US shutting down trade to China or Mexico or something, on the other hand, I’d be telling you to stock up on canned food and gold bars (kidding).
Then why are Markets Down?
Now, we will still feel some effects of this to the general market and some companies’ bottom lines. Why is that? A couple of thoughts:
First, many US headquartered companies conduct significant business in Europe. While it’s likely much more concentrated to western Europe, I expect this conflict will have some over-arching negative effects to Europe much more so than in the US. Russia is still a major exporter to Europe in commodities and energy. Uncertainty around basic inputs will almost always drive-up prices across the board and is generally not good for a stable economy.
While most US companies are not directly engrained in the Russian or Ukrainian economies, the general spillover effect in Europe will certainly be there.
Second, and I sort of touched on it above, but we are talking about probabilities here. Six months ago, the odds of Russia invading Ukraine were much lower. Like 1% as a random example. The market therefore would reflect that and price in the odds of an armed conflict. Now, we’re seeing something like 10% (also random example), so the market now needs to readjust to reflect these new probabilities of something negative occurring.
Along the same lines, the odds of full-blown World War 3 occurring just went way up, even if the odds are still low. For example, odds could have gone up from 0.01% to 0.3%. While it’s still unlikely, that’s a 2,900% increase and the market must reflect those odds.
Third, and this is more of a general point, but you have to remember that when we’re talking about valuations, a key component of these are discount rates. Discount rates have a linear relationship to instability. So when we have talks of invasions, annexation, war, trade sanctions, possible inflation, etc., we’re hitting a lot of uncertainty. Even if nothing happens, the uncertainty is/was still there.
This will almost always tend to drive up the general discount rate a market applies to companies. And remember, as discount rates go up, the NPV of future returns go down. This will then lower stock prices for that reason alone.
There’s probably a billion other reasons people can think up, and I’m oversimplifying here, but this is how I’m broadly thinking about the situation.
My Thoughts on Investment Strategy
In the end, you have to trust international governments and capitalism to prevail through turbulent times such as these. The US economy has survived two world wars, the threat of nuclear war for decades, multiple recessions, presidential assassinations, a civil war, you name it. And yet here we are. The world is always having problems, so is the US.
At the end of the day, you have to live your life as if the train that is the US economy will continue chugging along through thick and thin. I personally will continue to invest as if we will still be achieving the typical long-term gains of a mature economy. If we do enter World War 3, it won’t really matter in the end whether I was invested in stocks or bonds or gold bars anyways!
Impact to AITX, ALPP, SIRC
I’d be remiss if I didn’t at least touch on implications for AITX, ALPP, and SIRC because so many of my readers come to read about these specifically. I’ll keep this briefer though.
When we think about microcaps in general, any positive or negative systemic shocks, such as this one, tend to over-correct in microcaps versus blue chips. The smaller the company, generally the riskier and the more difficult it is to weather a storm. I would expect that if this gets any worse, you’ll see a more drastic effect within these three companies.
Now, onto specifics…
For AITX, their security product offerings have absolutely nothing to do with military applications. I couldn’t even imagine how difficult it would be for them to try and implement a ROSA or ROAMEO on a military base. The contracting alone would take a decade! So I see no scenario in which AITX actually benefits from this…
Other than the macro level market shocks I’ve touched on, I also don’t see this being specifically worse for AITX than other companies. It’s not like a war in Ukraine is going to end vagrancy, vandalism, aggressive panhandling, etc. Companies are still going to need security needs satisfied, and AITX will be right there to do it, war in Ukraine or not.
ALPP should be relatively unaffected by this in both good and bad ways. On the negative side, this company has almost nothing to do with Russia and Europe. On the positive side, while ALPP is involved in defense contracting, it is a miniscule part of the company via Thermal Dynamics. In terms of drones, the company does not make drones for military use (that I know of). So don’t expect to see a 10,000-drone order if war breaks out.
There’s really not much to say on SIRC other than it being completely unaffected by this. Suppliers are in Asia, customers are in the US, end of story. Any dips you see because of this are because of macro level effects.
In general, if these three companies don’t have any changes or serious news come out and the price goes down because of Ukraine, think of it as a great buying opportunity. I seriously think these companies are well sheltered from the macro impact of this crisis. The only way I see a major impact is if a serious global conflict breaks out over this, and in that case, it won’t really matter anyways what you invested in!
This is a lot to sum up but think of it this way. This likely will have a relatively small impact on US companies not heavily reliant on eastern Europe / Russia for supplies and/or customers. We’ll likely see further drops in stock prices due to the uncertainty that conflict brings.
I personally will not be changing my investment strategy and will continue to buy through this dip. I won’t, and I don’t think you should either, live in fear of World War 3 breaking out. It’s going to happen or it’s not, but my money is on it not happening. If it does, we’re all screwed anyways!
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DISCLAIMER – AT THE TIME OF WRITING THIS ARTICLE I HAVE A LONG POSITION IN $AITX AND I DO NOT HAVE A POSITION IN $ALPP AND $SIRC. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES. I AM NOT A FINANCIAL ADVISOR. AT THE TIME OF WRITING THIS ARTICLE, PERSONS AFFILIATED WITH THE COMPANY ANALYZED ABOVE MAY BE PROVIDING MONETARY COMPENSATION AS MONTHLY PATRONS THROUGH MY PATREON. THIS COMPENSATION IS NOT PROVIDED IN RETURN FOR ANY SERVICE, WRITING ABOUT A PARTICULAR TOPIC, AND/OR FAVORABLE OR UNFAVORABLE OPINIONS. MY PATREON SUPPORTERS HAVE NO INFLUENCE ON THE CONTENT OF MY ARTICLES.