When you have the world’s second largest economy ($10.36 trillion GDP) growing at 12% per annum, you are going to have a significant upward tug on commodity prices. It did, and it was China and this was happening in 2006 /2007. In 2009, that all changed as the Chinese government began a concerted effort to ratchet that growth down (as opposed to letting it bubble over) to a still-enviable, but much-less-daunting 7%… no more massive cities constructed on the basis of ‘if you build it, they will come’ coupled with a substantial reduction in spending on new infrastructure. The game changed dramatically, but many in the media and punditry corps, failed to pick up on the implication for commodity prices and demand for those things used to obtain those commodities (a la Caterpillar Tractors). The world was moving into what appears to be a secular bear market for commodities, a bad thing if you own or figure in some way in producing them, a great thing if you use them to manufacture your products or fuel your home or automobile. It is not demand. It’s oversupply!
What puzzles me is that every time you get a swoon in commodity prices, the immediate reaction of the media and market is to take this as a harbinger of bad times. The facts would simply not indicate this. On the contrary, bubbling commodity prices appear to be the leading indicator of ill winds for business and markets. A perfect example lies below.
“Weak Commodity Prices Signal Slowing Global Growth”
Randall Forsyth
It is not surprising (considering the source) Randall Forsyth used falling oil and commodity prices, along with a disappointing earnings report (and guidance) from Caterpillar, as the trigger for a broadside on the world economy and the stock market (Barron’s–Up and Down Wall Street, 7/25/2015). If you take Barron’s or the Wall Street Journal, you may click on the title above to retrieve this chronicle of woes.
To Randall’s credit, he did include one paragraph for balance.
As Evercore ISI points out, commodity-price weakness correlates with slower global economic growth. That is consistent with signals such as the Broad Leading Indicator of the Organization for Economic Cooperation and Development rolling over, and with it, global industrial production. But the redoubtable outfit led by Ed Hyman also notes that recessions typically were preceded by spikes in commodity prices, not declines. That would include the oil shock of 2007-08 that sent crude to a record $140, which preceded the financial crisis.
The flip side of Forsyth’s analysis can be found in one of my earlier posts, “What’s so bad about cheap oil?” and a quote from Ian Shepeherdson, Chief Economist, Pantheon Macroeconomics.
“The oil business and everything to do with it is a very small share of the economy. Could it be more than 5% of G.D.P. (G.D.P. = $17 trillion plus)? No, and the other 95% of the economy is saying, ‘Thank you very much.”
Oh yeah, forgot to mention Fed plans to raise rates
That’s bad! It means a stronger dollar, cheaper imports and upward pressure on longer-term U. S. interest rates, maybe. Last week, the 10-year US TSY note closed to yield 2.26%, up only 14 basis points from where it began the year (down from 2.5% in June). This compares with 10-year sovereigns from Spain–1.9%, Italy–1.87% and Portugal–2.5%. Looks like there is a lot of money more afraid of recession and economic weakness than the impact of Fed rate increases.
All of this is very confusing to me!
First of all, why does the US have to pay a higher interest rate for ten-year debt than Spain or Italy? Secondly, why does Portugal only have to pay a 24 basis point premium to the US for 10-year money? Remember, these are the supposed dominos that might fall, if Greece were to leave the Eurozone.
Another anomaly to the continued low rates available on our ten-year debt is the absolute trashing many interest-sensitive sectors have taken (REITs, Utilities, BDCs, MLPs). This would indicate much higher rates are in the offing, and in a short while. Bank stocks are reflecting a similar message.
A former client, a long-short bank stock hedge portfolio manager, told me the other day that he is about ready to call it quits. In his world, based on a reasonable analysis of what the Fed might, or might not do over the next couple of years, bank stocks look incredibly over extended (according to my friend current prices reflect a 2.75% to 3% Fed Fund rate by the end of 2017). But, the market in bank stocks seemed to have detached from fundamentals and have become momentum stocks. He doesn’t want to own them because of their current high valuation, but he doesn’t want to short them because of the irrationality that has crept into the market.
Confusing as this all is, I’m not sure that it is time to “Back up the Hearse … ” Unless you are in the media and get paid to emphasize the dark-side, it is really not that bad out there.
What’s your take?
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Interestingly good comments. And a good conversation too!