Today’s market conditions are some of the most dangerous that I can ever remember.
Of course, markets are always unpredictable. As UK prime minister Harold MacMillan noted in the 1960s, when asked what kept him awake at nights. “Events, dear boy, events”. But today’s markets have a 3-dimensional unpredictability:
- They have the normal issue of trying to understand fundamental levels of supply and demand
- In addition, there is the issue of sentiment – what do people think will happen?
- Plus, there is the highly complicating issue of central banks – will they intervene to artificially boost demand?
The chart above, showing the development of the Great Unwinding of central bank stimulus policies since mid-August highlights all 3 aspects:
- First, there is the question of whether prices for the products in the portfolio represent ‘fair value’?
- Second, has market sentiment been aligned with recent developments, or has it been different?
- Third, are policymakers relaxed about developments, or are they keen to challenge them?
If we focus on China for the moment, it is clear that many players have badly misjudged markets in recent months.
During Q4, they refused to accept that oil prices were falling, and so they built inventory in the expectation that prices would rebound. This proved a costly mistake, so in January they swung to the opposite extreme and assumed oil would fall further to $30/bbl. This, of course, also proved to be a costly mistake.
Today, they are having to rapidly rebuild inventory – which naturally pushes prices higher still.
At the same time, however, nobody is quite clear about policymakers’ next moves:
- Last week’s Chinese Communist Party Policy Conference confirmed new stimulus was unlikely
- Equally, Friday’s US jobs report suggested official US interest rates could start rising by June
- As a result, markets moved further along the Great Unwinding road, pushing the US$ higher, and selling oil
- Yet the European Central Bank is about to add $1tn of new stimulus from today, on top of Japan’s major stimulus
Of course, it is always difficult to judge underlying supply/demand fundamentals, and easy to find oneself positioned wrongly in the market. But it is even harder to second-guess policymakers’ next moves, particularly as they can easily change their minds.
Faced with this level of uncertainty, my only advice is to accept that one cannot be sure what may happen next. Instead, one needs to draw up 2 or 3 key Scenarios, and test out one’s plans against what might happen if any of these happened.
What would you do, for example, if oil prices went to $30/bbl in Q2? What would you do if they went to $70/bbl? And what would you do if they stayed around today’s levels?
Equally, what you do if the US$ keeps rising – the US$ Index jumped an extraordinary 1% in a few minutes on Friday, after the jobs report was published? Or what would you do if it instead fell 10% back to Q3 levels?
The chart highlights the volatility that these cross-currents are creating. We simply have to accept we cannot know what happens next, and plan instead for unexpected “events” to take place.
Winners and Losers in Q2 will instead be determined by their skill in working through the various options, and the effectiveness of their contingency plans.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 49%. “The Chinese benzene sector rather than the US was driving global price direction at present”
Brent crude oil, down 43%
Naphtha Europe, down 39%. “Naphtha is supported by ongoing strength in West African, US and Latin American gasoline blending appetite”
PTA China, down 37%. “Production of PTA in China is likely to increase in March, with downstream demand showing no signs of strong pick-up”
HDPE US export, down 27%. “Prices slipped a little during the week, mostly on lower raw material costs related to a dip in ethylene prices”
¥:$, down 18%
S&P 500 stock market index, up 6%