In the first few weeks of 2016, eight guests who don't know each other drift off to a windswept and tidal island off the coast of Devon. They are hosted by two servants who live in the only house on the island. The owners are absent and all trace of them has been lost. In their guest rooms and servants they find a disturbing nursery rhyme framed on the wall. Talk about ten little Indians. With each verse one dies and in the end there are none left.
The first character to set foot on the island is geopolitics. In the suitcase she carries the North Korean hydrogen bomb, which she does
shaking East Asia, and the assault on the Saudi embassy in Iran, which immediately suggests a further escalation in the great
conflict between Sunnis and Shiites. The New Year's Eve incidents in Cologne and other German cities are gradually emerging as evidence
general of the failure of European reception policies and put Merkel in serious difficulty in her party and in opinion
publishes just as a massive wave of refugees looms.
There is talk of a post-Merkel led by a Schaeuble intent on using guns to push back refugees and, while it's at it, using any means to bring Italy to its knees. In mid-February, however, the geopolitical issue is weakened. North Korea does not have a bomb worthy of the name, the Saudis and Iranians have not declared war on each other and indeed seem to be starting to discuss how to work together to bring up the price of oil. In Germany, Merkel has taken party and coalition back into her hands and Schaeuble's plans for Italy will still have to pass on the chancellor's table first. Schengen is in crisis, but the facade will remain standing. As for the Polish rebellion, Merkel has already started taming it.
The second little Indian is oil, which in mid-January loses 30 percent since the beginning of the year. Its unstoppable slump is being interpreted as a sign of weak Chinese demand, global manufacturing contraction and an impending wave of sovereign and corporate bankruptcies among manufacturers. There are those who go so far as to forecast 20 or even 10 dollars for Brent. Sector stocks fall on deaf ears. On the morning of February 18th, Brent was traded at 34.80 dollars, not so far, on closer inspection, from 35.75 on December 31st. Global demand continues to grow, while on the supply side something, as we have seen, is starting to move.
The third guest to arrive on the island in January is China, with a massive following of problems ranging from collapsing foreign exchange to exploding bank bad debts, via currency reserves plundered by capital exporters and a growth view close to collapse. However, as of February 18, the offshore renminbi, at 6.52, is at the same level as on August 25. Against the euro, the renminbi is now 4 percent stronger than in August.
So if the renminbi is collapsing, the euro is collapsing 4 percent more. Meanwhile, it has been discovered that the capital flight is being caused by Chinese companies repaying their dollar debts early by raising the renminbi equivalent. In the end, China's financial position is even strengthened. The fourth little Indian, the failures, disembarks like Nosferatu from a boat overrun by rats and the plague. The list of possible victims circulating in the markets almost entirely covers the world of oil (including
some of the majors), mining companies and an unspecified number of sovereign countries producing raw materials. The hypothesized failures, of course, are destined to transmit the contagion to the banks and bondholders who financed them, creating a generalized crisis of confidence.
As of February 18, however, there were no bankruptcies worthy of note, either corporate or sovereign. The oil analysts at Goldman Sachs, for their part, took a closer look at the financial situation of the companies they follow and discovered that one-third do not even have a bond repayment to be made in the next three years, while two-thirds, with crude oil at 35, have more cash than debt. We certainly do not exclude the possibility of bankruptcies, God forbid, but the fact that they can be staggered over time could significantly reduce their impact.
The fifth Little Indian, a wave of forced shutdowns of high yield funds, was predicted a month ago by Jeffrey Gundlach, a very brilliant and well-followed manager. Don't buy high-yield bonds, he'd said, even if the borrower appears able to pay. The liquidity crisis that will rapidly involve funds dedicated to the sector will force them to face redemptions by selling everything, with avalanche effects on the entire sector. However, as of February 18, there were no new forced closures after the isolated and limited ones that occurred at the beginning of January.
Sixth Little Indian appeared to be profits, expected to contract in America due to the strong dollar and the crisis in the oil sector and in Europe due to the Chinese crisis. While not spectacular at all, earnings were stable both in
America and Europe. The markets, in their desire to hurt themselves, then directed their gaze to the medium-term forecasts communicated by the companies. Cautious forecasts given the general climate and considering that the managers who showed themselves to be optimistic were immediately taken for mad and therefore punished in any case by falling prices.
The seventh arrival on the island, the banks, has created a situation of real psychosis in the markets. The fire raged without causes that hadn't been known for months, if not years. The most surprising thing is that the contagion has reached American banks, certainly not as profitable as they once were, but certainly solid. We had to invent a much higher exposure of the banks to the oil sector than the real one, which is modest. Despite the psychosis, however, there were no dreaded queues at the branches to withdraw money or internal bailouts after those involving four small Italian banks and the Portuguese Novo Banco. Draghi and Schauble, for their part, have ruled out that the talked-about banks really need capital increases.
Eighth little Indian landed on the island of fear is the recession in manufacturing, herald of a global recession. Indeed, in the fourth quarter there was a decline in industrial production in many countries and a marked slowdown in others. Cutting investment in equipment for the energy and mining sectors was the main cause, but there was also a destocking and weak demand was seen here and there even in some electronics and of clothing. We then worked a lot of imagination on this and delighted ourselves for a few weeks calculating the probabilities of a global recession.
To get a sense of proportion, however, it should be remembered that the contraction in manufacturing was one per cent in the fourth quarter. In 2008-2009 it was at one point 35 percent. However, the good US data relating to January shows a recovery of 0.9 percent in manufacturing. More generally, US first-quarter GDP is traveling at an annualized rate of 2 percent versus 0.7 in the fourth.
The ninth little Indian has been the bogeyman of negative rates in America over the last week. In its psychosis, the market wanted to read the discussion between Congress and Yellen on the legal possibility of negative rates and the possible need for a change in legislation as an unmistakable sign of the fervor with which it is preparing for an imminent and inevitable recession in America too. In reality, the Fed is continuing to think about a cycle of rate hikes. Negative rates are being studied for the next recession just as NASA has plans ready to respond to an alien invasion of Earth. Neither the recession nor the invasion
however, they are given for imminent.
Tenth little Indian, the last to arrive on the island, was gold, which jumped in recent days by 17 percent compared to the beginning of the year. It is the official confirmation, it was immediately said, of the total loss of control of the situation by the central banks and of a generalized crisis of confidence (the markets are afraid of everything, we read at one point in a comment on Bloomberg). For our part, we have long believed that gold has good long-term fundamentals, if for no other reason than the fact that it is grossly underweight in
portfolios and due to the greater turbulence that always characterizes the second half of an expansionary cycle. However, the end of the world is not as close as we thought a week ago, to buy gold it will be better to wait for moments of weakness.
In Agatha Christie's thriller the police find the bodies of all ten victims. In our case, some of the ten little Indians are currently missing. Some of them may have hidden in the caves of the island, ready to re-enter the game during this 2016 which promises to be lively and full of twists and turns. At the moment, however, the long farmers are chasing the short nomads with pitchforks who have made all the raids they wanted in the past few weeks. The retreat of the shorts is hasty because suddenly all the ten factors we have listed seem to have changed sign.
We therefore expect further overshooting recoveries. There are not only shorts to be pressed with pitchforks but also the new underweights, those who have sold too much in recent weeks for fear of the worst and who now find themselves too light. And it is known that, in these cases, no prisoners are taken. The hike, at some point, will be a victim of its success because the Fed, seeing the markets healthy again, will withdraw its rate hike program. However, since the shock of the past few weeks is still fresh, it is possible that the Fed will skip the March hike and wait for June. In this case the shorts will have to return much of the loot they have accumulated in recent raids.
