EKIP– Expert Club for Economics and Politics A Different Opinion
A country’s stock market is a leading indicator of the health of its economy. When stock market indices, which measure stock prices, start to rise, it’s not long before the economy follows suit. The theory is that stock prices reflect future expectations about the health of a company and the economy as a whole. If this is true, then the rally in global financial markets predicts a near economic recovery. However, some indicators suggest otherwise.
Trade is one of the most important drivers in the economy, and when we try to determine which part of the economic cycle we are in, it is necessary to include it in our analysis.
The Baltic Dry Index
The Baltic Dry Index (BDI) measures the price of raw material cargo transported by water. As can be seen in Chart 1 below, the index has collapsed by more than 50% since the end of 2011. Longer-term data (Chart 2) shows that before the recession in 2008, the index was around 12,000 before reaching levels close to today’s in early 2009. It is striking that the BDI is relatively volatile, and yet the collapse of the last two months seems frightening. What could be the reason for this? The answer lies in supply and demand. On the one hand, there could be an increase in the number of vessels carrying out trade by water, which could have depressed prices. On the other hand, however, there could be a large decline in demand for this type of transport service. Given the current state of Europe and the overheating Chinese economy, I would rather bet on the latter.
Chart 1: Baltic Dry Index (February 2011 - February 2012)
Chart 2: Baltic Dry Index (February 2007 - February 2012)
Oil and gasoline consumption in the US
Another indicator that raises concerns about the state of the global economy is oil and gasoline consumption in the United States. As the world’s largest economy, the cause and consequences of this decline cannot be viewed in isolation and undoubtedly have a global impact. As can be seen in Chart 3, there is a clear negative trend that began in 2011. Even in January 2012, the decline in oil consumption was 4,000,000 barrels per day. The reason for this can be found in the rising price of oil. However, this price is still far from its peak of almost $150 per barrel of Brent in 2008 (when, as can be seen from the chart, there was no drastic decline in consumption). Another reason for the decline could be increased energy efficiency or even a mild winter in the United States.
All of these factors (without claiming to be exhaustive) have an impact on the decline in oil and gasoline consumption, but the decline seems too large to be explained solely by them. As is well known, the consumption of oil and petroleum products (as well as all other types of fuels and energy sources) is strongly correlated with the business cycle in an economy. In this regard, the trend in Chart 3 does not support the claims of many economists that the US economy is recovering. Rather, it speaks of entering a new recession.
Chart 3: Annual change in oil and gasoline consumption in the US
In this article, I examined two indicators that are useful in economic analysis, but which we should look at critically. Often tossed around in the media, they often either do not show the whole picture or are deliberately manipulated. A recent example of this is the US unemployment report released in early February. The report was heavily criticized by some experts for distorting the data presented in it. And while many of the statistical data for the US point to a path of recovery, when we look at the rest of the world, the prospects are not so good. Data from Eurostat show that in the fourth quarter of 2011, EU GDP shrank by 0.3% compared to the previous one. Although the EU is not technically in recession yet (by definition, there must be a decline in two consecutive quarters), in reality we are most likely in one. Things are not rosier in the East. The real estate bubble in China is starting to burst, the economy is slowing down, and proof of this is the second consecutive reduction in bank reserve requirements to 20.5% on February 17 this year. In January, Japan recorded the largest trade deficit in the history of its statistics. If we consider the above mentioned in this article as pieces of a puzzle, then assembling it illustrates a not very optimistic picture for the global economy.
Methods, I am more bullish on the state of the economy.
First, one of the biggest causes of last year's turmoil - high interest rates on Spanish and Italian bonds - seems to have subsided for now, falling below 5% for 10-year bonds. This will likely affect business confidence and consumer sentiment, which will stimulate demand. And at least cheap loans for home purchases and investments are more available in parts of Europe and the US.
Second, consuming less oil is actually a good thing! This shows that the market economy is working quite well. After all, the price between the equivalent of 1 million BTU of natural gas and oil is more than 7 times in favor of black gold. So there should also be structural changes in energy consumption, which naturally takes time.
Third, the Baltic index is still quite dependent on the available quantity of containers for transportation - small changes in demand can cause serious changes in the price. In fact, the transport DOV has also been recording a slight decline recently, which suggests that we should have a correction in the recent rally in the stock markets. Or we may see a small sideways movement this year, at least until the results of the US elections are clear and some signs of growth appear in Europe.
Since the previous bottom in October, it is precisely the highest-beta sectors that have been the most successful - banks, industrials, technology and cyclical companies, which is also positive for the recovery.
Kosyo, high interest rates on government bonds are not the cause of the turmoil in Europe - they are a consequence. The reason can be found in the high levels of indebtedness of the countries (although the high indebtedness in this case is a consequence of uncontrolled spending). Interest rates on the government debt of certain countries in Europe fell thanks to the three-year program for financing banks in the Eurozone (the so-called LTRO). By receiving loans at an interest rate of 1%, banks earn a spread of 4-5% when buying government debt at an interest rate of 5-6%. This operation of the ECB helped prevent a liquidity crisis in Europe, but it is only a temporary solution to the problem. It is interesting how the banks will repay these loans in 3 years, when they mature.
Well, one thing comes from the other. In the sense that in the absence of free liquidity, banks have problems buying new bonds, interest rates rise and the creditworthiness of countries deteriorates. It can be argued that the opposite is also true, but this does not explain the sharp rise in government bond prices over the last 2 months. Under "normal" conditions for bank financing, things should be much more favorable for countries.
Still, the US had TARP and twice the QE, which so far at least had no close equivalent in Europe, hence the money was not so easy and in general the confidence in the economies and the financial system was lower, which I think led to the escalation of the debt crisis in the fall. Not that everything is resolved and calm now, but with some sensible reforms and the creation of a rescue fund that can buy bonds of threatened countries and lower interest rates to acceptable levels, things will be more or less under control. Of course, the economic situation is far from flourishing, but once growth starts, in my opinion, we will quickly orient ourselves to other problems - such as the rising prices of some energy resources and the threat of inflation.
I don't know how the banks will repay the loans, but if they used the money in instruments with the same maturity, as is generally an unwritten rule in banking, then returning the money to the ECB will be quite easy. In general, it seems to me that there was also quite a bit of speculative intervention from hedge funds and so on, which actually drove down the interest rates on longer-term bonds, like the 10-year ones.
Greetings and Happy March 3rd to the entire Team.
Happy March 3rd to you too, Kosyo. I'll save my comment here, because next week we will publish an article about LTRO and there we will be able to comment more in depth on this ECB operation.