My Diary 366 --- 2008 Market Outlook (II): When China Stops, BDI

 

My Diary 366 --- 2008 Market Outlook (II): When China Stops, BDI Drops; When China Talks, Commodity Pops; When World Economy Softens, Dollar Strengthens

January 8, 2008

Everything that needed to happen has happened on last Friday. NFP came in well below expectations at 18K. The unemployment rate went up 0.3% to 5.0%. We have now seen the unemployment rate move up 0.6% from the lows during this economic cycle.  Looking at the big picture, the latest raft of economic data has been consistently weak, with big downside shocks coming in ISM and payrolls prints.  The focus of market has shifted from short term funding problems in financial sector to rising probability of a sharp deceleration in growth in 2008, and maybe even a recession.  But the key story is still whether US consumer can hold up their spending, instead of Chinese consumers. According to the median estimate of 62 economists surveyed by Bloomberg News from 03Jan to 08Jan, the answer is largely YES, with economic growth will average 1.5% in the 1H2008, matching the 4Q07's pace.

However, I have highlighted in last diary that with commodities riding high and oil hitting a ton, the inflation threat that has been another factor.  It all amounts to a pretty difficult start to the year. The Fed will almost certainly move 25bps in January and the only trade for sure is buy steepener.

Well, it seems that the proverbial wheels is falling off the bus… let us continue on the rest pieces of my 2008 market outlook, starting with BDI index and China….

When China Stops, BDI Drops

The Baltic Dry Index (8756 @03Jan) is down 20% from its all time high recorded in November 2007, felling for a tenth straight sessions in London as Chinese steelmakers scaled back iron-ore imports, the biggest raw material shipped by sea. Overall, I am more agree with Mr. Johnson from JPMorgan that a double-digit growth in steel consumption should keep strong ore traffic for some time to come, even though higher spot ore price has kept the smaller Chinese mills at the side line. This is because China’s domestic ore output only covers about 40% of China’s iron ore nee and has seen decelerating growth over the past few years.

This is said that I continue to believe in China's long-term macro growth, but the markets will likely see a challenging year 2008 due to a series of negative factors, including the expected high inflation numbers, PBOC’s tightening bias, weakening external demand, high-based earning growth consensus and a still rich valuation metric. Positive factors include the expected fund flows from international due to their low exposures to this high growth market ( maybe the only one in 2008), and and from domestic investors due to the QDII or DII schemes.  However, Hong Kong has recently acted more like a emerging market, relfecting the behaviour patternof Chinese investors’ momentum trading and  a uncertain backdrop  of global macroeconomics.  As a result, no doubt will the market volatility persist or even go higher.

On the back of macro/policy uncertainty and market volatiltiy, sectors with high earing visibility and dedenfive business natures will stand out to be good shelters under the cloud of strom, including Infrastructure (Telecom, Toll Roads and Ports), Energy (Oil, Coal and Gas); Consumption (F&B, Utilities and Internet); Services ( Bank and Brokers) as well as High-Tec Equipment (Capital Goods).

When China Talks, Commodity Pops

Nowadays, if one talks about about commodites, China will be the main theme. The latest commodities boom began at the end of 2001, when China’s industrial revolution was just starting. China’s unlimited appetite for raw materials for its industrialization has made it the No.1 consumer of copper, steel, and iron ore in the world, more than the US and Japan combined, and ranking No. 2 of oil and energy products. Also, China’s population of 1.3 billion has become the world’s No.1 consumer of soybeans.

According to Jimmy Rogers, the 20th century has seen three secular bull-markets in commodities from 1906-1923, and from 1933-1955, and 1968-1982, spanning an average of 15yrs. The current bull market is now 6 years old, and he thinks the “Commodity Super Cycle” has many more years to run, albeit with some nasty corrections along the way. 

Overall, I would expect oil and food prices, and their implications to global economy will continue to be areas of focus in 2008.  However, on the back of this long-term picture, the overall commodities complex should trade on the weak side in the coming months, mainyl due to 1) global demand is more likely to be weaker, as growth in Europe starts to soften while the US economy could stay weak for a few Qs; 2) Chinese economy will slow somewhat, making continued acceleration in commodity prices impossible; 3) the expected recovery of US Dollar is also a negative for commodities prices.

Talking about price, Crude price has touched $100/bbl on last Wednesday, just a hair behind the inflation-adjusted record of $102.81 set in April 1980. According to a Barclay's survey of 150 commodity investors, the average price of oil over the next 5yrs is expected to top $100/bbl, with 27% responding $80-$100 a barrel and 16% expecting $60-$80 a barrel. This view is largely backed up by the EIA, the official statistics center of the US. The high forecasts are based on the assumption Saudi's main oil fields could be reaching peak capacity and that the country lacks the political will to develop its energy infrastructure amid a tight labor market, political dissent and the need to use the oil to fuel their own economy. In the NYMEX, oil futures are forecasting 5yrs price at $85-$92 a barrel.

The market implications of $100 oil prices have profound impact to the whole world, ranigng from Auto manufacturers and Airlines to Oil-rich economies and their SWFs($3.8 trillion in assets), and to the global geopolitics and even weathers. On the macro front, the arrival of $100/bbl oil  will add to the pressure on the US economy, which has been punched by a big blow from a drop in housing prices and a wave of foreclosures., while the robust economies of Asia, especially China, have so far swallowed the price surges with relative ease as a result of surging demand in the country, instead of supply shocks as happened in the 1970s and early 1980s. But there are signs of strain. China, in a bid to limit demand and the huge fuel subsidies, announced in Oct07 that it would impose an almost 10% increase in domestic prices for gasoline and diesel fuel.

When World Economy Softens, Dollar Strengthens

The general feeling that there was still more downside room for the US Dollar in coming sessions. The themes of late 2007 are continuing to dominate in early 2008: the obsession with interest rate differential dynamics and the US credit crisis’s knock-on impacts. Yes, the base scenario for the US Dollar is that there is a recovery coming once the market perceives the light at the end of the tunnel for the US economy and credit crisis. However on both counts the situation may be getting worse, not better, in the near term given the latest deterioration in the US ISM survey , housing data as well as Payrolls. Also markets are still expecting interest rate resets volumes on mortgages to rise substantially in 1Q08 from 4Q07 before starting to decline.

To the major curreny crosses, I would pick a short position in the EURUSD for the following reasons --- 1) The growth of EU is likely to slow down on the back of a global  economic slowdown, a stubborn ECB and the lagged impact of a sustained advance in the EUR X-rate. In particular, the Euro market has not discounted any rate cut by the ECB and is still  betting on continued economic strength in the Euro area; 2) The cheapening of US Dolaar has  started to trigger an export growth, offseting the housing negatives; 3) The Dollar is a counter cyclical currency and tends to strengthen at times when the world economy softens.

Good night, my dear friends!