Odd Lots - Marko Papic on What Markets Got Wrong About Russia's Invasion of Ukraine

Episode Date: September 29, 2022

When Russia invaded Ukraine, there was a widespread expectation of a surge in prices for numerous commodities. That happened initially, but by and large things have not played out the way many investors would have anticipated. So what did markets get wrong? And what are they getting wrong now? On this episode of the podcast, we speak with Marko Papic, a geopolitical expert and the chief strategist at Clocktower Group. He offers his view that the war is entering a stage of stasis and stability that will persist for some time to come. He also spoke about why China continues to pursue a Covid Zero strategy, despite the seemingly high cost to the economy. See omnystudio.com/listener for privacy information.

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Joe, what's going on in Russia? That is such. I can't even start a convert. No, it's more than a leading question. Like the idea that I would be able to like answer that in any meaningful way that doesn't make me sound like a complete idiot. I'm not trying to set you up to sound like an idiot. You're trying to set me up.

I'm trying to start the part. podcast with a summary of current events. But there was some big news out of Russia recently, which was they were calling up reservists and basically forcing them to go to Ukraine and fight in the war. And the reason I bring it up is because it wasn't just big topical geopolitical news, but it became a big thing in the market as well. We saw quite a bit of reaction to it. And it kind of crystallized in my mind this idea about just how. hard it is for investors to try to judge these geopolitical risks. Because on the one hand, I saw some people going, you know, this is great for the West. It means that Putin is really struggling right now and

Ukraine is going to win the war and everything's going to be fine. And then I saw some commentary basically saying this is a massive escalation. And if anything, we should be seeing risk premium on things like European assets and natural resources and grains and things like that actually going up. So the fact that there are these two extremely different or interpretations of the same move just really struck me. Yeah. I mean, look, it's so hard to understand like what this means for markets. It feels like we're in some sort of uncharted territory. And maybe some people will perceive that to be positive that Russia has suffered setbacks in a war, that it's lost some territory that it had captured in Ukraine, but then others will say,

yeah, this, as you say, this just massively increased the risks. Vladimir Putin gave a speech that was widely perceived to be highly bellicose. I think it's just a sense of like extreme uncertainty and chaos. And there's already so much going on. We're recording this September 23rd, when there's just so much concern about inflation and energy and monetary policy and recession and all these other things and on top of this huge geopolitical wildcard. Again, I feel like many investors are truly swimming at sea, experiencing things that they have never seen in their careers. Right. And it's funny kind of how earlier this year, how many investors suddenly stood up and declared themselves to be like military experts in World War II armchair strategists. But even if you

think you know everything about how a military invasion actually works, that doesn't naturally translate itself into, well, here's my investment strategy playing off of that. So in an effort to understand exactly what is going on with Russia and Ukraine, and also in an effort to understand exactly what it might mean for investors, we're going to be speaking with Marco Pappich. He is the partner and chief strategist at Clock Tower Group. He is also the author of geopolitical alpha and investment framework for predicting the future. So he basically wrote the book on this topic. Marco, thank you so much for coming on all thoughts. It's such a pleasure and honor. I love this show, so it's great to be on. Oh, thank you. So maybe just to begin with Russia calling up its reservists, what was your initial

take on that, your interpretation? Well, I mean, I think that it's clearly a sign that things have not gone well for Russia in Ukraine. Russia has a professionalized military force in 30 years of post-Soviet reforms, like 30 years of effort to reform Russian military has focused on deepening and strengthening its strategic rocket forces, so nuclear weapons for good reason, and creating a professional expeditionary force that can fight quick, short wars in its near abroad, such as the 2008 Georgia intervention as a case in point. And so the fact that they now have to like revive the third pillar, which they have eroded on purpose. And for good reason, like, we're not going to need to mobilize ever again. We have nukes. No one's going to attack us. The fact that they're now,

like, resorting to something that they've actually let follow, that they've not focused on, that they've eroded in the effort to strengthen the other two parts of their reforms, it just tells you that it is a desperate move. And it's not clear to me that it's going to effectively escalate the war. So my initial reaction was that this is a nothingberger. You know, it's a geopolitical nothing burger, if you will, because at best, Russia can use, let's say, 100,000 to maybe 300,000 troops if they manage to get them all activated. As rearguard, they can help support supply lines, they can defend the rear of Russian forces, allowing the veterans and the professionals who have been fighting in Ukraine to step up

and defend against the Ukrainian offensive. I think this gets us faster to an equilibrium, to a stasis, to an established line of control. I don't think this allows Russia to really effectively widen the conflict in Ukraine. So what does this stasis or equilibrium look like in your view? So that's a very important question, Joe. And I think it's a controversial view that I hold. But basically, most wars that don't end in a capitulation of one side to another, end up in some form of a stasis where a line of control is established.

It's a geographical reality where the two forces basically establish, you know, a front line that ossifies that is well defended. Think about the Korean War. You know, the Korean War has not ended. It is still going on. There has not been a peace treaty between the two Koreas. The two Koreas are de facto sovereign entities defined by a line of control that was established at the end of the conflict. The Cyprus conflict, you know, which basically pitted the Greek-supported

Cyprus versus the Turkish-supported northern Cypriots ultimately ended in a line of control. And the country Cyprus has a line of control that, in de facto terms, creates the northern Turkish Cyprus, which is not recognized, but is a political entity that exists. Another conflict that basically ended in a line of control. The Dayton Peace Accord in Bosnia, was also concluded, and the current split between Republica Serbska and the Federation, the Bosnia and Herzegovina, and the Federation of the Croats and the Muslims, is defined by a line of control. And usually what happens at the end of the war, as both sides are getting exhausted, they accelerate their military maneuvers in an effort because they know what's coming. And what's coming is some sort of a negotiated

ceasefire that will establish borders for a long time. So what you did, do is you accelerate offensives. We saw that ahead of the Dayton Accords and after the Dayton Accords in Bosnia, where the Serbs went on a huge offensive trying to establish as much territory as they could before the bargaining began. And I think that's what's happening right now. We're in the stage where the Ukrainians are trying to get as much as they can through their offensive. And the Russians are responding by saying like we need to halt this offensive because when the line of controls is established, we need to prove domestically to the Russian population that the war was worth it and that we acquired some form, some territory. So I think that's what's happening right now. And a lot of the

commentary out there is basically saying the war is going to last forever. Now, that may objectively be true, just so we're clear. Like again, Korean war is still going on, guys. It's never been, they never ended. So while, you know, armchair geopolitical strategist may be right that this war may continue forever, I think the market has stopped caring about this war. Honestly, I think like three months ago. Yeah. Yeah, I kind of agree with that. And this sort of goes back to Joe, when we were talking about China and the idea that in a normal environment, everyone would be talking about basically the Chinese economy being, well, large parts of it being closed, that impacting manufacturing, the housing crisis in China. But there's so much going on in developed markets with

yields and inflation that it just seems to have fallen by the wayside. And a similar thing with Russia, even though these two very big developments, China and Russia, are arguably driving the inflation situation. I would argue that China is very relevant still from a macro perspective. I mean, one of the reasons I've been short in commodities since May is China. You know, we have a very bearish view of China. But Russia, I think the Russian involvement in this war has led to some of the most fantastical and I would argue idiotic, sell-side research I've ever read in my life. I mean, look, this is a profound moment in world history. I don't want to understate that. But the argument that this war is going to cause some sort of calamity in the commodity markets has been epically wrong. I mean, look at the chart of like Brent and wheat. They are down to pre-war levels. I mean, Brent has fallen now, what, four or five percent in September 23rd, just as a date check so people know. But, you know, there are far more important things going on in the world than the Russia-Ukraine conflict for the maximum.

like the big macro assets, namely what the Fed is doing. And of course, I would argue China too, the slowdown in the U.S. economy and so on. So I think one of the biggest mistakes I think that a lot of cell side research did at the beginning of this war is imply supply loss of commodities out of Russia. And that had to do with the EU oil embargo. Very quickly after the EU oil embargo was imposed in Russia, it became clear to me, at least, that it was a PR effort. Like the EU embargo against Russia, the Western embargo against oil is a PR effort. It is not a genuine effort to remove Russia's oil revenue. Why do I say that? Because when the U.S. imposed sanctions against Iran, it also imposed secondary sanctions, which are very effective. So if you're a Chinese or an

Indian company wanting to buy Iranian crude, you are at risk of running afoul of the U.S. Justice Department. With Russia, that was like maybe debated for a week and then everybody was kind of like, yeah, let's not do that. Why? Because the oil embargo against Russia is designed with its six-month implementation phase to literally allow Russia to find other customers, literally. And that's happened beautifully.

There's no loss of supply out of Russia. There might be at the end of the year, maybe 500,000, 300,000 barrels, but that's it. And given the demand problems with China and U.S. slowdown, like, who cares about that? So there was a huge overstated risk of like the shutings of production of Russia, problems with logistics. None of that has happened. And the reason is that, you know, at the end of the day, Emmanuel Macron and Schultz and the other leaders of Europe simply wants to be able to say at the end of the year, we are not importing any more oil from Russia. The fact that China and India are gorging themselves, bathing themselves in Russian crude,

is not like a bug, it's a feature of the sanctions. And so that's the first issue that I think overstated the relevance of the conflict. The other one is the idea that Russians have an existential, that Ukraine is somehow existential to Russia. And that comes from reading some of the President Putin's essays and so on. And I would argue that it isn't. But this is more than a philosophical question. Because if you're an investor and you think that Ukraine is existential to Russia, then you think they will double, triple, quadruple down on the conflict.

But if you understand that Ukraine and the war in Ukraine is merely a way to export domestic political angst abroad, if that is your perception, then yeah, this conflict could very well taper off, enter stasis, and, you know, just be one of many conflicts that we're going to experience in this new era of geopolitical multilateral. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories. Episodes are published throughout the day with the latest information and data to keep you informed.

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we're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. You mentioned that several commodities are actually lower than they were at the beginning of the war. Oil is more or less there and wheat has come off a lot. The one other thing, though, that does feel very central and very central to macro is what happens with the future of natural gas. And we know that supplies have been diminished, right? I believe between the pipeline has been curtailed. And electricity prices, gas prices in Europe are insane.

and we've been talking a lot about how they're going to get through the winter and what's going to happen in the following winter and so forth. What do you see on the natural gas front? And do you see, you know, the thing I've been thinking about is this sort of reorientation of the world such that in the future it seems likely that Europe will continue to get a lot more of its gas from the United States. It seems like a pretty big, significant restructuring of world energy flows. So there's, I think, three things that we need to discuss here.

First is the short-term price of natural gas. In the short-term, Europe has had to find alternatives to Russian natural gas. And those alternatives have been extremely expensive. And that has driven up the prices. We all understand that. There's a couple of things that is interesting to me. First of all, if the war in Ukraine was so existential to President Putin, why did he not cut off natural gas early in March or April? Why do he wait until the late summer to really do that?

It seems like an error, or maybe it seems like an effort to maintain a relationship with Europe so that you can't turn the pipes back on once you proclaim victory, however modified those goals may be later on. The second thing that I think President Putin didn't expect is the slowdown in China. The slowdown in China allowed there to be sufficient amount of LNG cargoes floating around for Europe to kind of grab. That was another miscalculation. Now, the short-term spike in natural gas prices is currently being extrapolated by a lot of investors into other assets such as euro, which is a parity, although that's for other reasons too, the Fed hawkishness and so on.

But like the euro is a good example. Or for example, if you look at Eurostock 600 industrial sector relative to S&P 500 industrials, they're at like decade lows. You know, I mean, basically de-industrialization is being priced in as investors extrapolate current natural gas prices into the future. that's like stupid, you know, because the current increase in natural crisis, natural gas prices in Europe is unsustainable. That's a short-term issue. And it's unsustainable for a number of reasons. First of all, if the Ukraine war enters stasis, if it ossifies along a line of control, it is no longer in Russia's interest or Europe's interest to, from Russian perspective, not make the money off of natural gas, from Europe's perspective to continue to shoot itself

in the knee by not accepting Russian natural gas. So once the war ossifies, which I think is coming within months, there is going to be an incentive to resolve this impasse. And so that's the first issue. The second more longer term issue is what happens, as you mentioned, Joe, as America becomes more involved in the LNG trade, presumably the U.S. is going to now export a natural gas in order to benefit from a global price of natural gas, which is extremely higher than the domestic price. By the way, Russia has 50 BCM of LNG capacity coming online in a couple of years, which is ironic because it means Russia will be sending those cargoes to European ports, even though it won't be sending it through pipelines. I mean, this is kind of like the cynical

view of what's going to happen over the next couple of years. But why is this important? It's really important because if you're an investor right now betting on de-industrialization of Europe, don't you realize what's going to happen in the next couple of years? What's going to happen in the next couple of years is we're going to get the Brent price of natural gas. We're going to have a global price of natural gas, which will be the LNG globally traded price, which will raise costs domestically in the U.S. It won't lower them.

It will raise them. And that's going to be a disadvantage to American industry, not European. European prices of natural gas will start to approach and approximate that of the U.S. and vice versa, which will be a headwind to U.S. manufacturing. And the final issue that I would point out is something that a lot of, again, investors are ignoring. Europe has had higher electricity prices for industrial users for two decades. Like, I have a chart of that. This is obvious.

And yet Germany has not lost any export share, nor has America gained export share. So unwind that for a second. For the last two decades, thanks to the Shale Revolution, the United States has had a price advantage on electricity and natural gas. It's done nothing with that price advantage. Nothing. It's gained no competitiveness. So why would you extrapolate the current crisis, which, as I say, is temporary into the

future and somehow bet against the European industry? Now, obviously, there are certain industries, you know, that are going to move to the U.S., those that use natural gas as a feedstock. And we can sit here and be like, oh my God, you know, like European fertilizer sector is done. Let's short Europe. I mean, you know, sure, there will be parts of the industrial capacity of Europe that will have to move because natural gas is a feedstock. But I'm not betting against European industry because of this crisis. In fact, I love the valuation.

If you're a long-term investor, you plow every dime you have into European industry, especially because Wall Street Journal has, you know, an article yesterday. saying like Europe is deindustrializing, this isn't the price guys. And I think it's completely an unsophisticated view extrapolating linearly a current crisis into the future, which makes no sense. So maybe just to back up for a second, how should investors be approaching geopolitical risk and conflict in general? And then secondly, is there something about the Russia-Ukraine conflict that makes it different because it involves so many commodities and inputs? Yeah. So to answer the first question, there's a couple of things. First of all, you know, there's a concept that I call geopolitical alpha, which is when the market mispriced risks, either to the upside or downside. And then, you know, you can profit by generating returns. But there's also geopolitical beta, which is understanding the long-term trends and trying to figure out how to write them. In case of Ukraine, what I would say is that investors confuse objective measure of geopolitical.

risk with the market's interpretation of it. So let's assume that the objective measure of geopolitical risk is an uppercase G. This measure, you know, which we're theoretically talking about here, can basically stay elevated. But if it no longer moves up, if it's not increasing, if it's just elevated, the lowercase G, which is the geopolitical risk premium associated with assets, is going to collapse because lowercase G is a derivative of upper case G. Now let's apply that to Ukraine. Ukraine conflict happens, catches most investors off guard. Not everyone, but most. The upper case G goes up. There's stock of nuclear exchanges. Right now there's a Ukrainian offensive. There's a mobilization. You could argue that upper case G, the objective measure of geopolitical risk,

the actual reality on the ground, the political geopolitical reality is still elevated. But it hasn't really increased as a risk. Why? Because on March 25th, Russians withdrew from all of northern Ukraine. Because they have been ineffective. Investors are starting to realize there's material constraints to Russia in effectively pursuing this war. I think there will also be proof that Ukrainian offensive will be halted due to their own constraints. So the lowercase G, which is the derivative of geopolitical risk, the geopolitical risk premium that the markets are pricing on assets starts to collapse, even if oper-case geo-objective measure is flat, but still elevated. So that's the first thing that I think is important for investors to realize. We're now in this multipolar world. We're going to

have a lot more wars between, you know, regional powers. This is what political science teaches us. In a world with no one or two bullies to kind of keep everyone in line, it's every country for itself. This is a very late 19th century, early 20th century kind of a world. And in this world, investors have to become comfortable with this concept, which is that, yes, the war may still be going on. The news may still show refugees and civilian casualties and a lot of bad stuff, but the market desensitizes and doesn't care unless new information somehow meaningfully raises objective geopolitical risk. That's the first thing. The second thing that I think we need to think about in terms of commodities, yes, this is a different war, Tracy. I totally agree with you. And my biggest fear when the war

started was that Russia would play the role of OPEC from 1973. So in the initial phases of the war, I was bullish oil. And then basically by May, they refused to curtail their oil exports. So I think that the EU oil embargo, the Western oil embargo is a farce. I think it's a PR effort. And so I faded that from day one. But I was concerned that Russia would actually then abrogate its own oil supply. And by the way, it would kind of make sense. They can probably make money on the price, even if their volume declines. Why not? Why not curtail two million barrels? If I was running Russia, if I was advising President Putin, I would have been like, hey, you know, why don't we just threaten it? Why don't we cut a million here, two million there? Now, they haven't done it. And I think

that that suggests there are constraints to curtailing your exports that OPEC did not have in 1973. And so I doubt that they're going to pull that lever going forward. What are those constraints? Well, OPEC wasn't fighting against Israel in the Yom Kippur War. It was Egypt and Syria. So a lot of the OPEC countries that were on the sidelines, they had surpluses and they have access revenue and they could curtail all exports. Russia is prosecuting a war that's very expensive. You know, the United States of America, fighting a much simpler war in Iraq in 2003 and 2004, spent like $200 billion on those two wars, more or less, in the first two years. Russia is probably spending more if we associate the economic costs of sanctions. Nobody sanctioned the U.S. in 2003 and 2004, you know,

like Russia, this is an expensive war for Russia. So that's the first issue. That's why I don't think, I don't think they will curtail their own oil exports. The second issue is that they don't want to anchor their own allies like India and China, who I'm sure told President Putin in in Uzbekistan at the recent Shanghai Corporation Organization meeting, like, hey, you can do whatever you want in Ukraine, but do not curtail oil exports. And the third issue is that I think Russians understand that if they do curtail their oil exports, Saudi Arabia, which has been playing nice with them, will take their market share at that point. I think there's also internal elite issues. I'm not sure that Mr. Igor Satchin, who runs the energy clique in Russia, is cool with leaving

money on the table so that Putin can pursue his war in Ukraine. I think there are problems also within the Kremlin on this issue. But the fact of the matter is that Russia has. not been willing to curtail globally relevant commodities. Now, Europe is a different question. They've done it to Europe, but that's a sequestered commodity. The Yomal Peninsula natural gas is sequestered in the Yomal Peninsula. And the only delivery mechanism for that 100 BCM of natural gas is pipelines to Europe. So it matters for Europe. It doesn't really matter for the world. Oil exports, Russia has refused to curtail. And, you know, it's September 23rd. They haven't done it. for now what, seven months, I think that tells you they won't do it.

You know, you mentioned just how expensive this war has been so far for Putin. And you also mentioned that a lot of people were caught off guard by Russia actually invading Ukraine this year. And I think you, correct me if I'm wrong, but I think you were one of those people who had assigned a relatively low probability to the possibility of a full-blown invasion. Could you maybe walk us through, like, what exactly? did people get wrong? Because I think, you know, a lot of the hypothesis seems to have being correct. Like, Putin has a lot to lose if Russia actually invades and it's going to be very expensive and a difficult military conflict and Russia's going to grow even more isolated.

So all of those were right, but they don't seem to actually have inhibited Putin's behavior. Yeah. So my framework for forecasting geopolitics focuses on material constraints. And I wrote a whole book on that. And, you know, my message to investors is this isn't a foolproof method. I mean, you're not going to be 100% right. But it allows you to start with something that is meaningful, objective, and measurable. So instead of trying to, like, throw darts at the board of policymakers preferences, talking to, you know, consultants who presumably have insights into the inner workings of the mind of people like Putin,

or she, start with something that you as an investor can actually, like, do yourself, which is look at the material constraints to the policymakers. And policymakers will, most of the time, pursue a path of least resistance, political path of least resistance, like water coming down the hill. That's basically the framework I employ. Now, occasionally, policymakers say, well, cool, thanks for that framework, Marco, but I'm going to pursue my preferences. So I signed 50% probability to conflict in Ukraine. I said, look, I hate doing 50-50, but this is a close call. Maybe Putin does it.

Maybe he doesn't. But if he does, here's how it's going to play out. And that part, here's how it's going to play out, has played out basically exactly as I expected. And one of the reasons that I said that this would be really bad idea for President Putin is that Russia doesn't have a military that can successfully execute this kind of an operation. So, you know, like there's an objective fact. Russian military sucks. Like, sorry, but it does.

It has no evidence over the last 20 years of being successful. Its intervention in Syria was a very high ROI because they did it smartly. They sent some Suhoys like, you know, 40-year airplanes to help Bashar al-Assad, and that was it. 2008 in Georgia, they were attacking a country that, like, doesn't have any, you know, mechanized armor. So they've been very smart in how they were deploying their military over the last 20 years. Putin has been very risk-averse, high geopolitical ROI. And so the idea that he would invade a country three times the size of Iraq would double the population and would have a very hostile view towards Russian invasion, unlike Iraq, by the way, where 70%

of the population was either Shia or Kurd and was therefore quite welcoming to the initial American invasion. The point was the constraints were massive on Putin. Now, obviously, in this particular case, the reason I got the decision wrong is because I write investment research on the beach in Santa Monica and President Putin is the president of the Russian Federation. So he gets to decide what he does. But the value in the constraint framework is that as an investor, if you get the initial

decision by policymaker wrong, your framework is still useful. You don't have to adjust it. You just say, like, okay, well, policy makers ignored it. they may be unaware of their constraints, they're about to find out what those constraints are. And so the last seven months has been President Putin and Russian leadership becoming intimately aware of the material constraints as they have articulated themselves in objective reality. And it's been a beautiful thing to watch because it shows the benefit of having a framework in thinking about politics. Yeah, you get the initial thing maybe wrong.

And it's not like I was yoloing and going like long rubble, by the way. I mean, I had a hedge on. You know, like my recommendation was go long wheat and gold. You know, I think those would outperform if there's an intervention. Gold was wrong. Wheat was kind of right. But the point is like then when it happens, you have a view of how the reality will develop given the constraints. Unless you got the constraints wrong, obviously, in which case, you know, like half of Ukraine would not be conquered by Russia. if the constraint framework had really failed me. So that's a really interesting lesson, I think, for myself and for anyone who wants to use a systematic approach to politics and geopolitics. It's not about getting events right.

It's about getting the markets right. And you can still double down on your view if you get the constraints right. In fact, the market will become even more stretched and the offer opportunities will be even greater. This is Caroline Hyde. And I'm Ed Ludlow inviting you to join us for Bloomberg Tech, a daily podcast focusing exclusively on technology, innovation and the future of business. Every weekday, we bring you the top headlines from the world's biggest tech companies.

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And I'm Ed Ludlow in San Francisco. Subscribe today wherever you get your podcasts. I want to go back to what potential stasis looks like. And you mentioned that, you know, in your view, a big part of Putin's motivation at this point has been the sort of export of domestic political angst and that the mobilization, which has got a lot of headlines, is partly out of an impulse to show that something is being accomplished. What is a stasis look like or what type of stasis is acceptable from Zelensky's point of view? Because, of course, he's also had rhetoric about not seating any territory, any ground whatsoever. But obviously,

some parts of Ukraine are in fact controlled and likely to stay controlled, it would seem, by Russia. What is sort of a acceptable stasis from the Ukrainian perspective? Well, we know what the acceptable stasis is from the Russian perspective because they told us on March 25th. On March 25th, the Russian Defense Ministry proclaimed victory, which was, of course, like a joke, because they got their butt handed to them in northern Ukraine. They withdrew from Kharkiv, Shernikiv, and Kiev, more or less. They retained some territories in Kharkiv, which they've not lost. So they withdrew from those northern parts of Ukraine.

They abandoned the assault in Kiev. And they basically said, oh, you silly Westerners, you guys thought we were trying to get to Kiev. That was all a ruse, you know, like, we got you. And then they told us that they're not going to focus on Dombas, which are the oblasts of Lujansk and Dernetsk. And then the land bridge to Crimea, which are the oblasts of Hibati, which are the oblasts of Heron and Zaporizia. So that's it.

Like their goals now are not denatification of Ukraine, whatever that means. It's not conquering everything east of the NEPA, as many people thought because they were doing this pincer maneuver, which is idiotic. Ukraine's the size of Western Europe. Russia tried to do a pincer maneuver with 200,000 troops. It's like they never played risk, you know? Like my kids know not to spread your troops out across different countries. Everybody in my household knows when you get your big reinforcement push, you make one line of attack and you like sweep through it.

But apparently, you know, Putin as generals thought that it would be cool for Russian TV if they had, you know, airborne invasion and like they had an amphibious assault. And it was all like very much like it was like a Brockheimer produced invasion. It was quite ridiculous. And it will go in the annals of history as I think one of the biggest military blunders ever. But look, the point is, cool, they readjusted what they want. And we know what the Russians now wants. Now, the problem for them politically is Donetsk. If you look at a map of conquered territory, there's still a very large chunk of the oblast of Donetsk, not the city, but the oblast of Donetsk is held by Ukrainians. And I think the only reason President Putin has not raised the mission accomplished banner, the only reason he hasn't done that is that that is a sore spot. in the geography of what they have conquered. That's a delay. And throughout the summer, they've failed to deal with this like territory, and I don't know if they ever will. They might have to proclaim victory with half of this oblast, which is an embarrassment, by the way. Donetsk is surrounded

by Russia. It's populated by ethnic Russians, not majority, but like a good chunk of it. And so the fact that they've been incapable of winning in the oblast of Donetsk is beyond mind-boggling. It's stupendous that Russia can't do this. But going back to your point, Joe, which is important, what does Ukraine want? Well, Ukraine wants a lot. I think that Ukraine wants the recovery of all of its territories, including Crimea. But you know, I want rock hard abs. And I'm working really hard to get them, but it's not going to happen. And so constraints are far more important than preferences. And I know it's not politically correct to say this, because, you know, we're all obviously like this is the West. We all have a pro-Ukrainian bias. But the fact of the matter is that I don't think anyone really cares what President Zelensky wants. And I think Zelensky would agree with me because he's been asking for main battle tanks for the past seven months. The Ukrainian offensive has been effective, but it's been effective note where it's been effective in the part of Ukraine where Russians have not really stated they want

Harkiv. Harkiv was logistically important. They've kind of gone back and forth, whether that's their goal. It's not part of Dombos. And so that's the part that Ukrainian offensive has been very successful in. But I would argue that's the part that Russians have cared the least about of the four oblasts they've already conquered. And so I think that what's happening is the West has given Ukraine in sufficient weapons to defend itself very effectively to pursue a limited offensive. But if the West really wanted Ukraine to reconquer all of the parts of Ukraine, then two things would happen. They would have been given tanks seven months ago, which Germany has not done. Germany has asked Spain not to give lepers that Spain has to Ukraine. The U.S. is equivocating

on this issue even when it comes to Abrams' main battle tanks. And second, much bigger. help on Air Force, particularly ground assault aircraft. So you had some retired generals, for example, suggest why don't we give Ukraine A10 warhawks? That would make a really big difference. Ukraine doesn't have those two things. So I would argue that what Zelensky wants is kind of irrelevant because his constraints are that he doesn't have the military necessary to conquer parts of Ukraine where the Russians are entrenched. And that's by design. That's by design because Europeans ultimately are very concerned about Ukrainian sovereignty, independence. Genuinely, I think European voters and policymakers

don't want Ukraine to fall to Russia, but they kind of feel that's been accomplished. Do you think Europeans are going to be paying these natural gas prices eight months from now because of something called Donetsk? Most Europeans can't find Donetsk on a map. So I would argue the answer is an absolute no. And that's what's very relevant for the markets. The idea that the West will retain the current level of support for Ukraine into the future

so the Ukraine can mop up some territories that are effectively the West Virginia's, and no offense to the Montaneers, but West Virginia's of Ukraine, I think, is a very naive assumption. That's not going to happen. The West is going to basically implicitly create a line of control by not supporting Ukraine enough. And that's been the case for seven months. Can I ask you to apply your framework to Xi Jinping and the COVID zero policies that China is pursuing?

Because I think this has been sort of a question mark over what's going on there. Like, why exactly are the COVID restrictions politically beneficial to Xi? I know he made a big point about how China cares about people's lives versus the West, where they're willing to just let people die in order to keep businesses open. So there's that. And there's some argument that maybe it helps, you know, fight capital outflows and things like that. But what exactly is he trying to get here and what are the material constraints that are restricting or maybe even helping him pursue those goals? So I think that the political decision was not to accept, you know, Western vaccines.

And that was a decision, I guess, made what, in 2020, 2021? Once you make that decision, I'm not sure it's illogical to do zero COVID-Balls. So once you have taken perhaps an ideological and a political decision not to import Western vaccines which are effective, once you've done that, everything that's followed in China, I think you could make a logical rational explanation for why China is doing that. its population pyramid is heavily weighted towards the elderly. It doesn't have the hospital beds per capita that it would require to kind of let COVID run through the system.

And for some reason, it has been unable to get the elderly to take up the booster shots at a percentage necessary to kind of open up the economy. So once you, you know, like once you accept that there was a political decision, an ideological decision once we accept that, like everything else that's happened makes sense. And that's not a popular view in the West because now we've become so anti-Chinese in the West so thoroughly that everything that happens in China is interpreted as some sort of a Maoist coup. And I think as an objective observer, and I bathe myself in aloof indifference to do my job, I can tell you that five years ago everybody thought China was a friend and now, you know, everybody thinks it's evil.

And so zero COVID policy is seen as some sort of a manifestation of a Maoist policy. But again, there may have been an ideological reason not to take Western vaccines. I accept that. But once they've done that, once they have a less effective vaccine, elderly population, not enough hospital beds, and for some bizarre reason, they're incapable of getting the elderly in China to just take the third and fourth shots, then zero COVID policy kind of makes sense. And this is an important point because a lot of onshore managers in China. And, you know, I have an office in Shanghai, great analysts there, great team.

And we gave a really good read when we produce research in China. We have, I think, a really great read on onshore managers in China. And they've been really hopeful that after the October Congress, there will be a shift in zero COVID. But if you take my view, which is that maybe there is a public health reason to have zero COVID policy, given the initial political ideological decisions made two years ago, then it's not clear to me that those restrictions will be eased as much as many investors think. And I think the onshore sentiment in China is starting to realize this. The shutdown of Chengdu, which is a 20 million people city recently, a couple of weeks ago, has really upset sentiment domestically. And I think that, you know,

there won't be an easy fix after October when it comes to this issue. How's your call option on Putin not being around in 12 months going? So I think back in March, You spoke to some of our colleagues on the What Goes Up podcast, and you said something to the fact that you thought that Putin might not be there in another 12 months time. You still sticking with that one? Yeah. So what I said was, if I was a bookie, I would set the line at 12 months and I'd be taking the under. And then, you know, you guys at Bloomberg, you tweeted it out to the world. And I love one comment, by the way, I love Twitter because one genius went like, I give Marco Poppich 12 months.

and I'm taking the under, says Russian president, Vladimir Putin. You know, that was, that was awesome. So look, what I would say is that, yeah, I think, I mean, I might be cashing in on that option, maybe selling it to some enthusiast right now, but I'm willing to stick with it. I think that Russian history is very clear. Russia is terrible at fighting offensive wars. We in the West, we have a perception, you know, propagated by the Russians themselves, that they have a glorious military history.

And look, let's be objectively clear. Russia saved the West in the Second World War. I think that that has to be said. That is something that I think Russians can take to the end of time that in World War II, they really were, like, they fought the biggest battles. Fair. Napoleon attacked Russia. It destroyed Napoleon.

Fair. But those are situations in which somebody attacks Russia. and they have such a huge territory. They can extend the supply lines of their attackers. They can attack them. You know, that's the benefit of Russia. But those benefits are also disadvantages when they pursue offensive action because their own supply lines are so stretched and huge.

And logistically, it becomes a nightmare to support offensive operations. And so there have been several major wars in which Russia was an attacker and aggressor was on offense where they spectacularly failed. And when they spectacularly failed, the immediate reaction was domestic political unrest. So, you know, I assumed that President Putin was a student of history. Apparently he's not. Because what he has done, he's fallen into one of these traps. And I think that when policymakers in Russia were leaders of Russia did that, they always met and sort of untimely end.

They were either retired like Khrushchev did when he, you know, tried to test JFK over the Cuba missile crisis. or they had to implement reforms as Alexander II had to do after his father failed to win the original Crimean War. Or in 1905 when the Tsar had to implement reforms after the 1905 revolution in Russia, which was sparked by the disastrous Japan War, you know, where basically Russia invaded, tried to defeat Japan and lost all three of its fleets. And then, of course, in 1917, which is the best example, Lenin, used secret documents and communication that proved that the provisional government, which had overthrown the Tsar, was still pursuing World War I for imperial gain. And Lenin basically used that as a spark for the eventual Bolshevik revolution.

My point is that this repeats in Russia constantly. I can't really point to a war where Russia was the aggressor and they won. And I think that's important. and I think that that's going to resonate, whether I'm right in five months or whether I'm right in two years, we'll see. The other thing that I've also been saying is like, look, the polling in Russia is kind of weird.

When Russians are asked if they support President Putin in the Russian military, about 80 to 90% of them say yes. But when they're asked, like, how long do you think this war is going to last? This is all from the Levada Center. They say less than a year. You know, we're like, so less than a year.

And when they're asked, do you want the conflict to continue or should the negotiations begin right now? It's split 50-50. And I think that what's going to happen, as Russians are disappointed on their own forecast of how long this is going to last, the percent of Russians who want negotiations to begin is going to rise. And so domestic politics are a critical constraint to how long this war goes. Now, right now, I think Russians are experiencing a natural reaction to this conflict. patriotism is high. They've been labeled pariahs. And by the way, not just the policy makers, regular Russians, visa-free travels gone. You know, they can't leave unless it's to Serbia, Georgia, Turkey, right? So if you're a regular Russian, I'm pretty sure, even a liberal one, you're pretty

angry at the West. You're angry at NATO. You're angry at the U.S. And those feelings are going to help President Putin maintain and prosecute this war for several more months. But those feelings of patriotism dissipate, they always do. They did in the U.S. when the U.S. invaded Iraq as well. Those feelings of patriotism dissipate as you start doing a balance sheet analysis. Has my life improved and what are the gains or goals of our conflicting in Ukraine? And right now, all I can see is that the goals of Russia and Ukraine are to win the West Virginia of Ukraine. Again, and I referred to West Virginia because, you know, Donbos has called. Like, that's it. And you're a Russian in Omsk or Vladivostok or St. Petersburg in Moscow, at some point, six months

from now, you're going to be like, wait a minute, what? What is this war about? I can't travel. You know, like, there's like, I have to buy a car without like anti-lock braking system. I can't fly aeroslav planes anymore because they're not safe because we don't have replacement parts. I have to drive from Omsk to Vladivostok. Yeah, I got to take the Trans-Siberian Railway. You know, these are the things that I think Russians are going to start asking themselves over the next six months. And that's why I do think that time is running out for the Kremlin to get out of this very, very dangerous situation. All right, Marco, we're going to have to leave it there. But thank you so much for coming on odd lots. I'm glad we could finally do this conversation. And it's been

a really interesting discussion. So thank you. Yeah, that was great, Marco. Thank you so much. Thank you, Tracy. Thank you, Joe. Joe, this just proves my point that it's impossible to have a conversation about Russia without someone bringing up World War II. And also, I just feel like there's so many, like, especially like, I don't know, veteran market people. I just feel like a venda diagram of like veteran investor person who sits on their couch has watched a lot of World War II documentaries, has two circles with a lot of overlap. Yeah, but it was, I mean, it was really nice to get that sort of historical depth from Marco.

What I would say is I thought his point about the war not necessarily coming to a definitive end, but sort of this stasis idea. that seems realistic. I thought that was really interesting too. And it's one of these things that it's like people want to look for some end, right? Or some victory or some capitulation or some side giving up white flag or something like that. But I think, you know, look around. And he mentioned, I think the North Korean war is like an extreme example.

But I think if you look around the world, you probably do see a lot of situations in which wars don't really end with a capital E. and there are sort of occasional skirmishes, but they're just some sort of like permanently contested territory or some new territory that one entity doesn't accept but clearly has some sort of political autonomy. And that does not seem like an implausible direction that this would go. Well, I mean, even if you look at the example of Russia annexing Crimea in, what was it, 2014, I mean, that kind of didn't end. There was no definitive like endpoint on that. It just kept going. and eventually kind of morphed into the situation that we have today. You know, that's interesting, too, you mentioned that because I forget, we have had a couple

episodes, I think, talking about how markets got over that really fast and didn't even stop, didn't even stop, you know, buying sovereign debt or anything of Russia's after that, despite like it's clear, like, impulse to sort of wage offensive war. And so to Marco's point, whether it may be uncomfortable for us, but markets can be pretty quick about forgetting the past. Yeah, that was the episode with one of my favorites, Matukalati. But it's true, right? You had this act of aggression from a country that, you know, traditionally by the West has not been seen as a friendly ally at all. And the most that happened was people put in, you know, some language into their bond documents saying, like, it's possible that Russia invades another.

country again. They've done it before. And then life just continued. And the government kept tapping the bond market with relatively, like, little penalty. Yeah. And, you know, I just, just in general, you mentioned history and you started, we started with the World War II conversation. And as Markle pointed out, you know, theorists of war in geopolitics often like to come up with like grand, you know, sort of psychological or psychohistorical explanations for impulses, like how crucial this concept, Ukraine is in some sort of Russian self-identification of what its true nation should be or something like that. It's not to say that those are illegitimate or that Putin himself might not have some

of those same impulses, but those are really hard to like grasp. Whereas certain sort of, as he puts it, the materialist approach, is Russia capable of launching a robust offensive war with stretched supply lines? Like, these are probably good places to start in one's analysis. like things that are a bit more concrete and material. Yeah, I think that makes sense. All right. Well, we could talk about this for a long time, but shall we leave it there?

Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Follow our guest Marco Pappage.

He's on Twitter at Gio underscore Pappage. Follow our producer, Carmen Rodriguez, at Carmen Armin. and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening. Hello, I'm Michelle Hussein, and for more than 20 years, I was at the BBC. But all the time I was delivering the headlines, I wanted to go further than the news of the day, to spend more time with the people shaping our world. And that's what I'm doing here on this podcast, speaking to people from Nigel Farage. Russia needs to be taught a lot.

There's a love you trying. Ever so hard. To tech journalist Karaswisher. And the tech industry is running wild. You know, they've gotten what they wanted and they've seen a huge run-up in their stock prices. This will be a place where every weekend you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to the Michelle Hussein show from Bloomberg Weekend, wherever you get your podcast. You certainly ask interesting questions.