By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Thankfully, I was not in the global markets during the Black Death, the Great Plague and the Spanish flu pandemic but coronavirus cases have now crossed 40,000 infections and this is way beyond a local Wuhan outbreak. Despite the blowout 225,000 US January non-farm payrolls growth data, I am alarmed by the global recession SOS in the capital markets metrics I track.
One, the bellwether US Treasury ten-year note has tanked to below 1.6% and the Uncle Sam IOU yield curve has inverted once again. Fear, not greed, obsesses the debt markets.
Two, Dr. Copper, the red metal with its mythical doctorate in predicting the global economic pulse, has been in free fall for a shocking fifteen successive sessions, last seen in 1984. Copper futures traders in New York seriously think the slump in demand (the PRC is the world’s biggest consumer) could see copper plunge from the current 2.59 to as low as 1.80 per pound. This is a classic advance indicator of global recession and it is flashing red alert.
Three, West Texas/Brent crude have fallen 19 – 20% in the past month, despite an escalation of geopolitical tensions in the Gulf, Libya’s oil terminal blockade and the fall of Sirte to General Haftar’s militia, rising political violence in Iraq and the Niger Delta, unrest in Algeria and Sudan, and above all, draconian US Treasury sanctions on Iran and Venezuela.
Jet fuel is 8% of global refined products market – and the price of jet fuel has plunged as 50,000 flights have been cancelled to China. An oil economist I greatly respect in a New York investment bank estimate a shocking 3 million barrels a day (MBD) fall in Chinese oil demand, 20% of the Dragon Empire’s daily consumption. No OPEC supply cut, even if Russia and Iraq were on board with the Saudi Arabian “swing producer” strategy, can remotely offset a demand shock of this magnitude. Can Brent fall as low as $45 or lower? Absolutely, yes.
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The Chinese coronavirus is now a global pandemic, moving from the central Wuhan/Hubei province to the Pearl River Delta, Ground Zero in global supply chains and the economic engine of coastal China ever since the late Paramount Leader Deng Xiao Ping initiated his Open Door policy four decades ago. In the SARS outbreak in 2002, crude oil lost one third of its value even as the Bush White House planned to invade and execute regime change in Baathist Iraq. Yet China is vastly more critical to the global economy now then in 2003, a $14 trillion GDP colossus that is the world’s second largest consumer of crude oil. If China GDP growth plunges to 1%, as Wall Street hedge funds believe, Brent could easily fall 50% from its peak or $35 a barrel. This is not Cassandra call but pure black gold economics 101.
Four, I track the Baltic Dry Freight Index like a hawk because shipping freight rates are a proxy for world trade. This index scared me from buying DP World at its IPO price of 1.30 in November 2007 as it had begun falling in that fateful summer. I even wrote an article predicting the IPO would fall from $1.30 to below $1 on the NASDAQ Dubai, though local bankers offering high octane leverage were predicting a $3 – 4 post IPO open, making used car salesmen look like fountainheads of financial conservatism and ethical behavior.
Instead, I flew to Muscat, conducted due diligence on the Gulfar IPO and tripled my money on the deal – and earned $19 million for the family office. DP world plunged from $1.30 to as low as 19 cents – I repeat 19 cents – wiping out thousands of the 50,000 leveraged bulls who had never heard of the Baltic Dry Freight index but trusted their local bankers and brokers (same thing). This index now flashes a global deflation SOS to me as it has fallen from 1285 in December to 430 now. World trade has collapsed, period, as have shipping freight rates. This is beyond scary to me as freight indices don’t lie.
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Five, Germany is the world second largest exporter after China and the Teutonic Fatherland’s GDP is one third of the Eurozone economy. Yet German industrial production has fallen to its worst levels since 2008. Factory orders have shrunk now for two successive years, a first since the 2001-02 recession. The Mittelstand is in deep distress as its capital goods and auto component industry is most integrated with the coastal provinces of the Middle Kingdom. This is the reason domestic factory order books are falling faster than foreign orders. Unmoglich, nicht wahr? Yes, this is unbelievable. Germany is going down and so is Japan.
The German economy in my opinion, has gone into deep recession. Sad but true. I cannot fathom how China’s Politburo can authorize re-opening factories, stores and offices when coronavirus infections are increasing at an exponential rate (a literal viral curve!) and 86 people died on Friday alone, the deadliest single day? “Trust me” is not a reassuring thought when it comes to the Orwellian doublespeak of the Chinese Communist Party, as the world learnt to its horror in the SARS epidemic. Niccolò Machiavelli was spot on when he wrote five centuries ago in Renaissance Florence “put not your trust it the words of princes” – in other words, the brazen lies of totalitarian governments, though I still remember Ben Bernanke telling the world with a straight face in 2007 “Subprime will be contained”. Yeah right.
The Shanghai/Shenzhen stock market, the world’s biggest retail casino outside Las Vegas and Monaco, slid 10% last week even though the People’s Bank of China has injected $100 billion plus liquidity into the money market, the Chinese securities regulator has banned short selling and the Big Four state owned banks have been instructed to increase loan growth, as in 2008. President for Life Xi knows the lessons of 5000 years of imperial Chinese history all too well – if 50 million young men are thrown out of work in the Middle Kingdom, the ruling emperor loses the mandate of heaven, even if he is a Marxist Leninist bureaucrat in an Emporio Armani suit.
My four heartbeats of global finance flash a case of imminent cardiac arrest for the global economy. Brent has plunged $20 a barrel since its Jan 8 peak. The 10 year US Treasury bond yield was 2.25% last August and is 1.60% now even though US economic data momentum actually accelerated since the autumn. The S&P 500 index has scaled new highs and trades at an inflated 19.4X earnings even though 1Q 2020 earnings will be gutted by the China lockdown.
Some on Wall Street predict Tesla will rise to $7000 and millions of clueless speculators chase the mother of all bubbles. Remember, Elon Musk was willing to take Tesla private at $420, a number with cosmic significance to Urdu/Hindi speakers, Desis R Us. This means Elon Musk thinks fair value in Tesla is $420 while the puppy trades at $748 a share. I can only recall the immortal verses of the Bard of Avon, the great Will Shakespeare. “Life is a tale told by an idiot, full of sound and fury, signifying nothing”. Tesla trades at 105 times forward earnings and Daimler Benz trades at 6 times forward earnings – welcome to the surreal Alice In Wonderland zeitgeist of global capital markets in mid-February 2020. Our world.
My only true lodestar in the financial markets is not brokers. Not opinions or sell side research but real time prices in global markets I trade from sunrise in Singapore to sunset in Manhattan. The implied Fed Funds futures yield on the Chicago Merc’s IMM exchange has fallen from 1.40% on New Year Day 2020 to 1.12% now. Yet the effective Fed Funds rate is 1.59%, after the Powell Fed in its wisdom hiked its offer rate on excess banking reserves in January. I doubt if most of my readers share my obsessive fascination with the nuances of US monetary policy but it must be obvious that Chairman Powell has tightened balance sheet growth at precisely the wrong moment in the global business cycle.
Powell assumed he could tighten the effective Fed Funds rate because Trump and Xi signed a phase one trade deal in December. He never expected two exogenous shocks in succession. The drone hit assassination of General Qasem Soleimani and a deadly virus pandemic in China. What will be the real world economic fallout from Powell’s latest policy blunder? Uno, a rise in the US Dollar Index as happened last week. Due, a liquidity crunch in risk assets which I expect will begin in the next few weeks. This means Papa Bear eats goldilocks porridge on the S&P 500.
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How will the Fed react after Wall Street is bloodied by Da Abu Grizzly Baba? Another monetary policy U-turn and a desperate 50 basis point rate cut at the April 28 FOMC conclave. This is not the usual Matti-san’s macro crystal ball gazing. It is basic monetary/credit cycle analysis from an acolyte of Herr Friedrich von Hayek, the greatest economist of the twentieth century, a resident of Valhalla with Keynes, Friedman, Ibn Khaldun, Bagehot and Von Neumann. The Powell Fed just took the first step to an imminent, surprise rate cut as I write when it explicitly recognized the coronavirus as a risk factor in the US economy. Wicked. Next Chairman Powell will breathlessly inform us that the Pope happens to be a Catholic! (except in Egypt, where the Pope is Coptic!).
The US central banking elite will learn the meaning of coronavirus blowback when the Q1 2020 earnings of US companies take a hit from the China demand bust. The Fed’s beloved PCE deflator, has fallen to 1.6%, way below the 2% inflation target. Crude oil, the Baltic Freight index, Main Street, emerging markets, China, global exporters and the US dollar all flash real distress. Coronavirus means the economic Cold War with China is over and Uncle Sam has won. No wonder King Dollar soared in February 2020 against all world currencies apart from the Swiss franc and the Japanese yen, classical Armageddon hedges in a world gone mad.
Fortress America will survive but what about Schluss Germanica, which exports 50% of GDP, France with a 30% of export to GDP ratio, Holland (85%) and Ireland (122%)? What will happen to Asian countries dependent on Belt and Road capital flows and Chinese commodities exports? Please, Chairman Powell, this is 1998, 2001 and 2008 all over again, a global economic catastrophe is imminent. So do it. Do the right thing, Homeboy Jay! Do it now – give the world a break with a 50 basis point surprise rate cut. Please let us never never forget Nietzsche’s warnings, not to gaze too long at the abyss, lest the abyss gaze back.