I can hear it now: nice going FORBES, valuing money over people’s lives. A disclaimer: this is the investment channel. And that means crisis is looked at through the lens of economic pain and gain, not who is a better president: Poroshenko or Putin, nor the history of Crimea and the Donbass. So with that out of the way, investors be warned. There is new political risk along Russia’s border in Ukraine. If this heats up, the stock market boom that has Russia outperforming the world will be revalued in short order.

The Market Vectors Russia (RSX) exchange traded fund is up 38.35% year-to-date in dollar terms. The Micex in Moscow is up 22.3%. Over the past year, the weaker ruble has provided a lift for investors with ruble equity. The Micex is up 24.57%, well above inflation. The ruble, helmed by central baker Elvira Nabiullina, is up 18.4% against the dollar. The Ukrainian hryvnia is down 22%.

While some in the Ukrainian government will tout progress on Europe’s Marshall Plan experiment there, it is clear that the country is in dire straits.

Arent Thijsen, a fund manager in Amsterdam with $250 million under management at T&E Inmaxxa doubts Ukraine will ever join the European Union, despite the roughly $10 billion they are providing the government. “It’s a mess there, a frozen conflict,” he told me. “People have to recognize that Ukraine economically cannot survive without a good relationship with Russia. I don’t see any future for them without Russia, and yet sentiment against Russia is very strong in Kyiv. I don’t see them getting along with Putin anytime soon.”

All of this creates a problem for Russia investors like Thijsen.

Ukraine’s Frozen

Is Ukraine going to hell in a handbasket? And if so, how much does this really matter to Russia?

The only way to look at Ukraine right now is through the Minsk II Accords, which was essentially a cease fire agreement between the pro-Russia separatists and the Ukrainian government. It’s been tame, for the most part. But squirmishes have occurred since in Donbass, an important industrial hub in a region that is known to house a few Russian defense contractors.

The pattern since March of more or less constant exchanges of fire across the line of control, and especially the escalation of such exchanges during the first week of May, demonstrate that any tactical incentives to maintain a low-level conflict are outweighed by the strategic preference for a frozen conflict in both Moscow and Kyiv, says Christopher Granville, a Russia analyst at Trusted Sources, a market intelligence firm based in the U.K.

The positive break in previous trends in this crisis represented by the frozen conflict prospect may already have been priced into Russian markets, but the base case scenario underpins this year’s strong bounce-back in Russian assets. “The greater top-down threat to the consolidation of recent gains in Russian markets may now come instead from volatility in the oil price,” says Granville.

Ukraine is living its own Frozen moment. Like the movie, the two sisters part ways, one believing she is evil and harmful, before the other shows her the error of her ways. They reconcile. They’re sisters again. This will probably happen when Poroshenko and prime minister Arseniy Yatsenyuk are voted out of office. Their approval ratings are currently in the gutter.

Meanwhile, for investors, the current “fog of war” that exists from Shirokino near the Sea of Azov, all the way to Schastye along the no-fire zone near Lugansk is more positive than negative. Whatever tactical incentives or local
initiatives on either side may be responsible for the past two months of fairly constant shooting and shelling, the very fact that this violence has not escalated into another full-blown conflict demonstrates the steady political will in both countries to prevent conflict escalation.

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With Russia’s sanctions expiring in July, it is Moscow’s interest to play the good cop here and keep the separatists in line. If they succeed, and if sanctions are lifted, then the recent rise in oil prices bodes well for Russia. It is unclear yet what it means for Ukraine’s economy, however.

Putin’s track record during the present Ukraine crisis shows that his reactions can be aggressive and destabilizing. But the important point is that something must happen to elicit such a reaction – and that “something” in this context would be another attempt at a military solution by the Ukrainian government, says Granville.

On April 26, Putin was asked by a state TV reporter whether the government would recognize the Donbass as independent from Ukraine, and possibly even annex it like it did Crimea in the Black Sea on March 17, 2014. Putin replied that he preferred not to comment “since whatever I say could be counter-productive”.

Say what you will, but a frozen conflict is better than an escalating one.

In the absence of any serious territorial conflict in the Donbass, combined with the Minsk II process remaining alive, then a typical E.U. compromise decision on sanctions is likely as late as December. It is unclear whether the U.S. will follow, though both Brussels and Washington have walked hand in hand into this with sectoral sanctions first introduced last July, and then again in September. Months later, the ruble traded in the 60s before falling to an all-time low of 70 to 1. Hopefully, those days of instability are behind us.

By Kenneth Rapoza