Downside risk remains

Date

2016-02-18 02:21:47

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(MENAFN- ProactiveInvestors - UK) Fuller Treacy Money Tue

Downside risk remains
Thanks to a subscriber for this report from Deutsche Bank focusing on the shipping sector. Here is a section:
Supply discipline is the only resort but looks difficult to achieve
Another 518k TEU of mega vessels will hit the water in 2016 (with 800k more in both 2017 and 2018) which will force Asia-Europe capacity to grow c.10% in 2016 (vs. est.2% demand growth). Liners' supply discipline has also become increasingly difficult to achieve given the widening cost gap. While the latest mergers (Coscon+CSCL; CMA CGM+NOL) should further consolidate market share pricing competition typically intensifies post mergers based on prior experiences. This is due to liners seeking to preserve market share while cargo owners seek to diversify their risks. Moreover the existing alliances are set to break up post mergers creating short-term instability for the industry.
How deep and long will this downturn last?
The sector has traded down to 1.0x P/B vs. 2016E ROE of -19% which still looks expensive. During the GFC the sector troughed at 0.5x P/B vs. ROE of -20%. More importantly investor interest has waned over the past several years as the sector's oversupply was widely expected to persist. This explains why the sector's P/B range has not only moved down but also contracted. We expect a prolonged downcycle; hence value will only emerge when P/B is closer to the GFC trough of 0.5x.

Eoin Treacy's view

Bull markets begin when new sources of demand emerge amid an environment where supply is constrained. Likewise they peak when supply has caught up and overwhelms demand. We occasionally get periods of time when demand falls but then prices retreat enough to encourage consumers to participate again. As a result supply is a more important factor than demand when thinking about how a market is likely to evolve. Bearing that in mind it has often puzzled me why people tend to think about the Baltic Dry Index as being an indicator of demand rather than supply; since that kind of interpretation is contrary to how we tend to look at just about every other commodity related market.

Early Morning Reid
Thanks to a subscriber for this report by Jim Reid for Deutsche Bank which may be of interest. Here is a section:
Talking of Oil and Gold last week we showed a long-term graph of Oil in real adjusted terms showing that the average real price since 1861 was $47. Following on from that one ratio we occasionally look at is the ratio of various assets to the price of Gold. So today in the off we update the Oil/Gold ratio back to 1865 and find that the Gold price has just hit an all-time high at around 44 times the price of Oil. The previous high of 41 in 1892 has just been exceeded. For perspective the ratio was at 6.6 in June 2008 and only 12 in May 2014. The long-term average is 15.5. While this says nothing about where the ratio is going in the short-term surely this looks a good trade to exploit over the longer-term for those who care about such things.

A big reason behind the rally in Gold this year has been a flight to quality and the fading expectations of further Fed tightening in the next twelve months. Yesterday Yellen stuck largely to the script in acknowledging market concerns emanating from tightening financial conditions while at the same time refusing to fully close any doors still open to the Fed later this year. That said the overall tone was certainly of a dovish leaning. Much was made of the passage suggesting that 'financial conditions in the US have recently become less supportive of growth with declines in broad based measures of equity prices higher borrowing rates for riskier borrowers and a further appreciation of the dollar'. Yellen said that should these developments prove to be persistent then they 'could weigh on the outlook for economic activity and the labour market'.

Eoin Treacy's view

When gold was used to buy oil the ratio between the two would have been a powerful indicator of sentiment towards the economy and relative value of savings over investment. That may no longer be the case in an era of fiat currencies but when the ratio hits new highs it tends to turn heads.

Eoin's personal portfolio profits taken as stops triggered

Black-Market Dollars at 136% Mark-Up Show True Pain of the Pegs
This article by Maria Levitov for Bloomberg may be of interest to subscribers. Here is a section:
In Argentina's case the move to a free float in December eliminated the 4.2-peso gap between the official and black market rates. In the months prior to the move it cost as much as 50 percent more to buy the currency on the street than at the central bank rate.

That premium is similar to what currency vendors in Nigeria's capital Abuja are charging for dollars now while hawkers in Tashkent are demanding more than double to convert the Uzbekistani soum. The cost to buy the U.S. currency in unregulated trading in Egypt keeps rising even after the central bank devalued the pound three times last year.

The street rate 'is a better reflection of where a market- based rate should be" said Simon Quijano-Evans the chief emerging-markets strategist at Commerzbank AG in London. It shows 'how domestic participants and individuals really feel about their currencies' he said.

Eoin Treacy's view
The Nigerian Naira has unwound its oversold condition relative to the trend mean following the last devaluation in early 2015. The black market for the Naira suggests the relative strength of the stock market may be pricing in an impending devaluation rather than any particular strength in the underlying shares. With oil prices as low as they are the pressure coming to bear on producers that have not maintained control of their budgets suggests we have not seen the end of devaluations.