OPEC and the Federal Reserve hold off reality for a (little) longer

Christmas pantomimes have been cancelled due to the pandemic. But since March, investors have been clapping for their “good fairies”, OPEC and the Fed, to keep market prices flying higher.


Oil

We focus on Brent as the global benchmark.

Brent had its seventh up-week in a row, closing at $52.26/bbl as the hedge funds continued their ‘Sell the US$: Buy oil‘ play.

This ‘fun and games’ has distracted from 2020’s key development, namely the looming end of the Oil Age. As we have forecast, this is being driven by economics, as battery prices confirm:

  • Bloomberg’s New Energy Outlook shows they now average just $137/kWh
  • Over the past decade they have fallen by 89% from $1191/kWh in 2010, declining 19.5%/year
  • Even if they “only” fall by half this rate to 2030 (9.75%), they will still be just $49/kWh

They are now closing in on the “breakeven price” of $100/kWh for Electric Vehicles (EVs) versus Internal Combustion Engine (ICEs) cars, which will likely be reached by 2023. At this point, new car buyers will start “voting with their wallets” for EVs, especially as ICE resale values begin to collapse. Businesses currently dependent on ICE sales now have only a limited time to reinvent themselves, before their industries disappear.

WATCH FOR: OPEC+ and the oil industry to slowly realise that their core transport market is about to disappear.


S&P 500

We focus on the US S&P 500 Index as the world’s major stock market index.

The S&P ended the week up 1% at 3709, whilst the VIX ‘fear gauge’ fell 8% to 22.

The standout feature of 2020 has been the market’s “last hurrah” for the Fed’s stimulus efforts. The March downturn led Jay Powell to come to its rescue yet again, based on former Fed Chairman, Ben Bernanke’s idea that:

“Higher stock prices will boost consumer wealth and help increase confidence“.

But in reality, the GINI Index of US income inequality has been increasing for the past 20 years, since Alan Greenspan invented the “Fed put” concept. The Biden administration will likely want to see the pendulum swing away from Wall Street, back to Main Street.

WATCH FOR: “Events”, as former UK premier Macmillan’s famously noted, to surprise today’s euphoric investors in 2021


FAANMGs

We complete our series on FAANMG valuations, using the Ben Graham formula. Microsoft and Google are left for analysis:

  • Both have P/E ratios of 35, similar to Facebook, suggesting suggesting 12% annual growth out to 2030
  • This seems very optimistic as their size and market dominance makes them ideal anti-trust targets
  • Microsoft would have a Graham Value of $40 in a flat growth scenario, with a P/E of 8.5, versus today’s $220 level
  • Google would have a Graham Value of $435 versus today’s $1726

Overall, the 6 FAANMGs are now a record 650% above their Graham Value.

WATCH FOR: Fundamental reality to start to dawn, as it always does, in the end


Interest rates

We focus on the US 10-year rate, as this is the “risk-free” benchmark for global markets.

The rate closed up at 0.94%, whilst the MOVE volatility index fell 6% to 45.

The key moment for bond investors in 2020 was the Fed’s March decision to start buying $13.4tn of corporate bonds to protect the stock market:

  • It suddenly realised that many companies were about to lose their investment grade rating
  • In turn, that would have forced most asset managers to sell those shares,  taking the stock market much lower
  • So instead, it bought vast amounts of corporate bonds – from near-bankrupt companies, but also healthy firms including Apple

In turn, of course, it removed investment risk from the market, as investors assumed the Fed would always be happy to buy their mistakes.

WATCH FOR: More questions being asked about the Fed’s legal basis for doing this (spoiler alert, there isn’t one).


China

As in 2009, China is leading the global economic rebound. But this time, President Trump’s trade war means it is focusing on domestic growth via the ‘dual circulation’ strategy:

  • China’s stimulus after 2008 was based on debt and the creation of a housing bubble – ‘sub-prime on steroids’
  • This rescued commodity demand and world trade, but meant its debt/GDP % has more than doubled since 2008 to 335%
  • Now the bubble is starting to deflate with defaults underway, as the trade war forces China to refocus on domestic demand
  • This will be a massive change, as consumption is currently less than 40% of GDP (versus up to 70% in the West)

The 2020s will therefore be quite different from the 2010s, as the new strategy is focused on the 560m people who live in the rural areas. Their disposable incomes average just $2400/year, around 1/3rd of those in the cities.

WATCH FOR: More defaults in China’s over-leveraged construction/property sector, and a new focus on ‘value for money’ products and services.

Many thanks for your support in 2020. We look forward to working with you again in the New Year, and will return on 4 January 2021.

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This Research Note has been prepared by New Normal Consulting GmbH for general circulation. The information contained in this Research Note may be retained. It has not been prepared for the benefit of any particular company or client and may not be relied upon by any company or client or other third party. New Normal Consulting GmbH do not give investment advice and are not regulated under the UK Financial Services Act. If, notwithstanding the foregoing, this Research Note is relied upon by any person, New Normal Consulting GmbH does not accept, and disclaims, all liability for loss and damage suffered as a result. The pH Report and pH Outlook are published by New Normal Consulting GmbH.
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