Markets appear to be continuing to move, slowly but surely, into their expected ‘scary phase’. The reason is the massive distortions that have been created in financial markets, and in China’s housing market, by the $35tn+ of stimulus from governments and central banks since 2009.
Unwinding these distortions will not be simple. The stimulus has not returned us to SuperCycle growth levels, but has instead created extreme levels of debt. And without SuperCycle levels of growth, it is becoming clear that this debt can never be repaid.
The chart highlights how the markets now seem to be breaking down, one by one:
- At the beginning of 2013, the S&P 500 (purple); the $: ¥ exchange rate (brown); Brent oil (blue); and naphtha (black) were all still moving together
- This was the famous “correlation trade” under which all markets rose together, due to the amount of market support being provided
- But during 2013, oil and naphtha markets disengaged, leaving only the $: ¥ and the S&P500 still moving higher
- A year ago, traders thought they saw an opportunity to reconnect them, using their previously successful ‘buy on dips’ strategy
- But although they pushed hard with hype about imminent shortages, the reconnection never happened
- Instead, the yen then became the next market to break the correlation, leaving the S&P 500 on its own
This was the first part of the unwinding of the ‘correlation trade’.
The problem was, and is, that the ‘correlation trade’ meant supply/demand balances in individual markets no longer mattered:
- It kept crude oil prices at record levels, even though supply was increasing and demand growth slowing
- In currency markets, it meant the dollar remained weak to support US exports, despite major problems in the Eurozone and Japanese economies
But now the liquidity tap is being turned off as China cuts back lending and the US Federal Reserve completes its “taper”.
CHINA’S ECONOMY IS SLOWING FAST
Most importantly, China’s leadership is moving in a new direction. As a result, its economy is slowing fast. Railcar movements are always a good real-time indicator of the economy. They fell 1.4% in June versus 2013, whilst steel production managed just a 0.4% gain in H1.
The key China housing market is also now entering a “New Normal“, according to the head of the National Economic Research Institute. July saw house prices falling in all 10 major cities. And as China Daily reports, “Gone are the days when Chinese property developers could make a killing simply by building more houses.“
Instead, a new type of market is developing according to Pan Jun, president and CEO of Fantasia Holdings Group:
“Don’t call us ‘property developers.’ We should try to be ‘community designers,’ offering comprehensive services to improve residence comfort”
But it would be naïve to assume this can be done by simply waving a magic wand. Unwinding China’s past mistakes, as in the West, will be a long and hard road.
WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
Brent crude oil, down 4%
Naphtha Europe, down 4%. “Market is suffering from a combination of falling upstream ICE Brent crude oil prices and slow downstream demand, leading to a sharp drop in prices.”
US$: yen, down 3%
PTA China, up 1%. “Squeezed margins restricted the volume of sales, as producers were unwilling to sell below their costs”
Benzene Europe, up 1%. Prices fell to a six-week low, reflecting downward movement in global markets and limited demand for August”
S&P 500 stock market index, up 6%
HDPE US export, up 9%. “For now, US prices are workable to Latin America”