@theMarket: Blood in the Streets

Investors began to focus on events in Ukraine this week as a continuing stalemate between Russia and the West erupted in gunfire. That bloodshed stopped the market dead in its tracks. The question is, for how long?

Up until now, the dispute over Ukrainian territory has been largely a war of words and an excuse to take the occasional profit every now and then. Investors are worried that might change. Here's what we know.

The international agreement forged in Geneva a week ago has broken down with both sides crying foul. We also know that several pro-Russian militants were shot dead at a roadside checkpoint on in an eastern Ukrainian city of Slovyansk on Thursday. It was result of the Kiev government’s military attempt to wrest back control of 10 cities that have been occupied by local insurgents (Russian military?).

Russia's response was to launch new military "exercises" along Ukraine's eastern border. Whether Vladimir Putin is preparing to invade the Ukraine in defense of its ethnic Russian citizenry or is simply bluffing is why the stock markets are on hold. Kiev, fearing an invasion, immediately halted its military offensive.

The fact that the U.S this week has committed hundreds of soldiers to its own military exercises in Eastern Europe simply adds to the tension. It is all well and good to pile on economic sanctions in reprisal for Russia’s new-found adventurism, but if even one of our boys takes a bullet over there, escalation would be immediate and quite dangerous.

Speaking of sanctions, it is obvious that measures levied by the West have not deterred Russia in the least. Granted, it is early days and if new sanctions are invoked, there could be some tough times ahead for the Russian economy. However, the private markets aren’t waiting. They are pummeling Russia’s financial markets in earnest.

The Russian stock market has declined 13.5 percent since the beginning of the year, while its currency, the ruble, has lost 8.8 percent of its value during the same time period. To make matters worse, Russia's economy was already slowing to only 1 percent GDP growth this year, prior to Putin's annexation of Crimea. Russia's central bank has been forced to raise interest rates twice to defend its falling currency and only today hiked them again to 7.5 percent on sovereign debt. That will compound the economy's problems.

At the same time, the debt credit agency Standard and Poor's, cut Russia's sovereign debt rating to its lowest investment grade, BBB-minus, just one step above "junk" status. That is sure to accelerate capital flight which, during the first quarter, topped $70 billion. But is this really a deterrent in the short-term?

Throughout history, the hunger for more political power has always trumped national economic consequences. In fact, the more misery heaped upon the Russian people, the more Vladimir Putin can blame the West. It would be similar to Hitler, who argued that it was Europe and the Jews that were responsible for Germany's post-WWI woes.

Given the reality of blood in the streets of Slovyansk, the stock market's reaction has been remarkably sedate. Many bears are just looking for an excuse to take this market lower. They argue that investors are simply not recognizing the level of risk involved in this confrontation. That may be so.

It is impressive that, instead of crumbling under this geo-political pressure, we find the S&P 500 Index is less than 30 points from its all-time high with the other averages at similar levels.

The bulls point to earnings as a reason to buy. There have been some upside surprises this week in earnings with some big name technology companies releasing surprising numbers. Of course, as is customary in the earnings game, expectations had been driven downward over the course of the last three months by Wall Street analysts, so that even the worst results managed to come in better than expected.

By now, you should be at least 30 percent cash. Clearly, the volatility in the markets is increasing. We are still in a wide trading range.  Russian risk is a concern and could generate more short-term selling. Keep your eye on gold and the yield of the U.S. 10-year Treasury note. If interest rates drop dramatically, while the gold price spikes higher, be prepared for further conflict overseas and a fast drop in the markets.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.