Investment Insight: Green shoots of a melt up the global economy, risk markets
JOHANNESBURG – The Baltic Dry Index, an assessment of the price to ship raw materials, such as coal, iron ore, cement and grains, and generally viewed as a leading indicator of global demand for these commodities, jumped by a staggering 75 percent from a low in February.
This was after the shipping rates fell by more than 60 percent as China’s industrial production in January and February fell by the most since January 1990 due to the disruption of the Chinese economy as a result of the containment measures to stem the coronavirus outbreak.
According to Fung Business Intelligence, fixed investment and retail sales contracted at the worst pace since records began in the 1990s. The fall in the CFLP manufacturing purchasing managers’ index (PMI) for China was worse than the economy experienced in 2008 and the worst since the start of my records in 2004.
Massive economic stimulation by the Chinese government and the containment of the virus resulted in a restart of the economy. According to Fung Business Intelligence, by the end of March, 99 percent and 77 percent of large and small- and medium-sized enterprises had resumed production with 90 percent of workers returning back to work. The response of China’s economy is truly remarkable. Amid the 2008/09 global financial crisis, it took four months before the PMI broke the 50 point level on the upside to signal economic expansion. This time around, it took just one month to recover. The PMI reading of 52 points in March was also the highest in 29 months.
The recovery in China has already begun impacting positively on commodity prices. The price of Brent crude oil futures for delivery in June is similar to Friday’s spot close and is therefore reflecting the current glut in the oil market. The global oil market is in contango though. The futures price of Brent crude for delivery in September is $35 (R656.36) per barrel or nearly $7 or 25 percent higher than the current spot price of $28. The six-month forward contracts moved into contango in March after being flat in January and February and could reflect the major cuts in supply and an improvement in demand.
The base metals market is also in contango. The gap between the three-month aluminium futures contract and the spot price is opening up and the same is apparent in copper and nickel prices but to a lesser extent.
Perhaps the biggest and most important green shoot is the fact that the world is entering the ex-growth phase of the pandemic as the number of new Covid-19 cases declines. This is especially evident in developed nations such as China. The polynomial growth curve indicates that the number of new cases in developed nations will have reduced significantly by the second week of May this year.
Only six (22 percent) out of 27 selected nations are in an upward growth trend, while the growth rates in 10 nations (37percent) are tapering off or peaking. The growth rate in eight (30 percent) nations, including major economies such as the US and Germany, is on a clear downtrend, while Australia joined the flat curves of South Korea and China. That compares with 42percent of the selected nations experiencing an upward growth trend two weeks ago. Yes, the world is conquering the pandemic. That is no mean feat!
Of significant importance to the global economy is that, if the growth patterns of the number of new cases in the US and Europe over the past week are extrapolated, the curves of the cumulative cases in these two important economic zones will flatten before the end of April. It seems that Europe will beat the US by a week or so, but what it means is that the pace of opening up in Europe will escalate and Trump will get his wish - the US economy will open up soon and is likely to gain traction in May. The massive stimuli in both economic zones are likely to kick-start the economies.
In addition, the threat of China falling into a recession due to difficulty sourcing supply from countries in lockdowns and weak global demand for Chinese goods will fade as order books will be filled.
The movement of goods between the major economies globally will pick up the pace but some supply chains are likely to put a damper on global economic growth in the immediate short term. As developing countries, in general, are way behind the curve with the growth of new Covid-19 cases still a long way off from peaking, the extended lockdowns in these countries will continue to choke some supply chains such as raw materials and intermediate goods. Subdued demand for imported finished goods by developing countries will also be a damper.
The recovery of commodity prices may be brisker than anticipated. An upturn in the developed economies due to the opening up of economies, the ease up of global trade and business and consumer confidence turning for the better, may lead to shortages due to the spread of the virus in developing countries. At the lows of the major sell-off in global equity markets in March, the cyclically adjusted price-to-earnings ratio of the S&P Composite index as per Nobel Laurette, Robert Shiller, hit a bottom of 21 times earnings. According to my models, the number equated to a fall of about 40 percent in the Conference Board’s consumer confidence index.
While April’s number is still outstanding, other recent surveys point to the same severity of the fall. The US equity market rallied since hitting the bottom in March and is currently on a cyclically adjusted price-to-earnings ratio of 26.8 times earnings. The number tells me that the US market is anticipating a rebound of 25 percent in US consumer confidence in May.
Nobody knows whether there will be a second wave of the virus - which would wreak havoc in the markets. As things stand, however, the green shoots point to a melt-up in the global economy and risk markets.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. He has no direct interest in any company if mentioned in the article. You should consult your broker and/or investment adviser for guidance.