2020 ended in ‘risk off’ mode as central banks ramped up their support. But will Wall Street continue in party mood, despite the growing problems on Main Street?
Oil
High oil prices normally lead to recession, as consumers have less spare cash to spend on the discretionary items that power economic growth. The chart confirms that central bank stimulus only postponed this impact rather than removing it.
✦ HIGHLIGHTS
- Brent prices marked time over Christmas, closing Friday at $51.80/bbl
- Current US demand for refinery products (gasoline, diesel, jet fuel etc) remains down 13% versus 2019
- But H2’s price recovery led to a 41% rise in the US rig count in Q4 – so supply should start to increase in Q1
- Libyan oil exports are back at 1.24mbd; Iran will also increase volume as/when the US re-joins the nuclear deal
- Q1 demand is likely to be weak due to the new lockdowns, with further downside if the US has the forecast warm winter
- OPEC+’s new monthly meeting schedule increases the opportunity for argument over quotas
WATCH FOR
WATCH FORHedge funds starting to close their “Sell the US$, Buy Commodities” trade.
S&P 500
Consensus commentary is now starting to highlight our concerns over the contrast between today’s bubble-like stock market and the weak state of the real economy.
✦ HIGHLIGHTS
- The S&P closed last week at a new record level of 3756, with the VIX fear index having risen 6% to end at 23
- The FAANMG stocks remain key to the bubble, but retail investors also expect a major recovery in energy and banks
- Nobel Prizewinner Prof Robert’s Shiller’s CAPE Index highlights the boom/bust cycles over the typical 10-year period
- Current levels have only been surpassed in history during the dotcom bubble
- Typically, high CAPE levels are followed by recession – as has happened this time
- The difference is that investors expect the Fed to keep supporting prices – and so eliminate the risk of over-paying
WATCH FOR
Investor concerns to pivot to the impact of the new Covid strain (and to the Georgia Senate run-offs if Democrats win).
Interest rates
Rates remained range-bound over the holiday, with some commentators talking up the prospect of a strong V-shaped recovery in 2021 whilst others focused on rising risks from sustained job losses.
✦ HIGHLIGHTS
- The US 10-year rate slipped back to 0.92%, whilst the MOVE volatility Index rose 16% to 49
- Interest rates have always fallen in recessions since 1970, and so the key question is around the strength/timing of a recovery
- Euphoria over expectations of a dramatic rebound due to the new vaccines has been damped by delays in administering them
- The impact of the new Covid variant has also led to worries about the potential for a quick rebound in employment
- Commentators continue to hope for a rapid rise in inflation and interest, but the history of the past 40 years suggests they are likely to be disappointed
WATCH FOR
Rising concern over the economic outlook to lead to lower expectations for inflation and interest rates.
Global Outlook
The chemical industry is the best leading indicator for the global economy. And as the chart shows, changes in its Capacity Utilisation (CU%) have a very close correlation with actual IMF GDP data.
✦ HIGHLIGHTS
- The 2020 outcome is not yet finalised, but October’s IMF forecast and November’s CU% data are showing the usual correlation
- The 2020 position is, however, strikingly different from anything seen since the CU% data began in 1988
- It is far weaker than previous recessions in 1990, 2001 and 2009
- This might be a sign that a strong rebound is still likely, or a warning of underlying changes in the economy
- As we have discussed last year, a number of major paradigm shifts now seem to be underway in demand patterns
WATCH FOR
Investor reaction to likely early moves by the Biden administration on Climate Change and the Green economy.
Summary
We expect reality to catch up with the market’s euphoria before too long, but experience tells us not to ‘fight the tape’ in the short-term. Our positioning is therefore broadly neutral for the moment.
Oil
S&P 500
Interest rates
Market view today
Positive
Wildly positive
Expecting inflation
Our current view
Negative medium/long-term
Reversion to mean inevitable
Expect long-term deflation
Positioning began
December 2020
December 2020
December 2020
Confidence level
Initial
Today
.
.
.
Relevant positioning
Neutral Oil – Brent/WTI
Neutral major Western market indices
Neutral 10-year and longer-dated Treasuries
Confidence level: 
= 100%, = 75%, = 50%, 
= 25%
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