13 July 2020
$tns of central bank stimulus meant financial markets had a wonderful Q2, even though the global economy collapsed. But can they continue to blow up the bubble, if the promised V-shaped recovery now fails to appear?
We focus on Brent as the global benchmark.
The market closed up $0.50/bbl at $43.29, continuing to trade in the narrow range seen since its June 22 peak of $43.96/bbl.
Prices were supported through Q2 by massive stock-building in key importing countries including China and India. Refiners were also taking advantage of the low prices to make “cheap” gasoline and other products, in anticipation of a quick rebound in demand by the summer.
But China/India’s strategic storage is now full, as we noted last week. And refiners are being forced to cut back their operations due to oversupply of key products, as Reuters notes:
“Refinery margins for making middle distillates such as gasoil and jet fuel have plunged to their lowest since 2009 as lockdowns and recession have cut fuel consumption by millions of barrels per day.”
Similarly, the International Energy Agency warns in its latest Report:
- “Refining margins will also be challenged by a major product stocks overhang from the very weak 2Q20
- OECD industry stocks rose by 81.7 mb (2.64 mb/d) to 3 216 mb in May
- In the US, preliminary data for June show that commercial stocks built by 24.7 mb (0.8 mb/d), led by products”
There was always going to be a rebound from the 16.4mbd collapse in oil demand during Q2. But it is becoming harder and harder to share the oil bulls’ conviction that a V-shaped recovery in demand is already underway.
We focus on the US S&P 500 Index as the world’s major stock market index.
The market continued to bounce around last week, adding 50 points overall to reach 3185. But in reality, the market has been trading in a range for the past month:
- It is hoping for major new stimulus from the US Federal Reserve to support a move to new record highs
- But investors are also uncomfortably aware that major bankruptcies are taking place in some key industries
The chart showing Prof Robert Shiller’s Cyclically Adjusted Price/Earnings ratio (CAPE) since 1946 confirms the extreme nature of the current rally. The CAPE ratio is the basic building block of stock market valuation, and the chart highlights the unusual nature of the period since 1995, when the CAPE ratio hit 20x for the first time since 1966:
- The period from 1946-1995 was one of the best periods in history for economic prosperity, and the CAPE averaged 15x
- Since then, the ratio has almost doubled to average 27x – even though growth has slowed sharply
This confirms the impact of the 3 major central bank stimulus programmes in supporting asset markets at the expense of the real economy – first there was the dotcom bubble, then the subprime bubble and now we are living through the stimulus bubble.
The problem is that these have led to a massive expansion of debt – which is now higher than the peaks seen during World War 2. Companies have loaded up on debt to boost shareholder returns – and now many are facing bankruptcy as a result of the collapse in demand.
Unfortunately, this pressure will likely get worse over the next decade, as growth in the global population will be increasingly dominated by the Perennials 55+ generation, as we discuss below.
We focus on the US 10-year rate, as this is the “risk-free” benchmark for global markets.
The rate fell below 0.60% at one point during last week, and closed down 0.03% at 0.63%
This highlights the underlying contradiction in market behaviour:
- Q2 saw gold rise and US 10-year rates fall, even whilst financial markets were in euphoric mood
- So what would happen if the mood changes and markets start to fall again?
- Presumably gold would go stratospheric and US interest rates would go negative
Essentially, therefore, we would then need to assume that the IMF’s decade-long depression scenario had arrived, and that deflation would become embedded in the economy.
The Perennials 55+ generation
Global life expectancy has more than doubled over the past 100 years, whilst fertility rates have more than halved. Fertility rates in many parts of the world have also been below replacement levels since the end of the BabyBoom in 1970
The chart highlights the unique change now underway in the global population:
- As a result, the Perennials 55+ generation have now become the major growth segment in the global population
- As the chart shows, they will be >50% of total world population growth over the next decade
This has enormous implications for growth. The issue is that Perennials already own most of what they need, and their incomes decline as they enter retirement. In turn, this is a key reason why a return to ‘business as usual’ is almost impossible.