Orange anxiety

  • Beyond ‘fintech’
  • Time for recession
  • Count up, oil down

We think we may be becoming neurotic. Or is it paranoid?

Maybe it’s both.

But just prior to boarding our flight from London to Dublin on Sunday afternoon, we were struck with panic.

Was it the fear of boarding an aeroplane? No.

Was it a concern about whom we would be sitting next to on the flight? No.

Was it a worry that we had left something in our hotel room? No.

It was the fact that we were wearing a bright orange polo shirt, and carrying a copy of Tim Harris’s book, Revolution: The Great Crisis of the British Monarchy, 1685–1720 as our on-board reading material.

The book covers what has since been dubbed the ‘Glorious Revolution’.

If you don’t get it, look it up. Then you may understand our anxiety.

We arrived safely at our hotel.

On with the show…

Markets

Overnight, the Dow Jones Industrial Average fell 98.89 points, or 0.46%.

The S&P 500 closed down 19.69 points, or 0.81%.

In Europe, the Euro Stoxx 50 index ended the day down 23.44 points, or 0.66%. Meanwhile, the FTSE 100 closed down 0.17%, and Germany’s DAX index closed down 0.78%.

In Asian markets, Japan’s Nikkei 225 index is down 60.98 points, or 0.30%. China’s CSI 300 is down 0.09%.

In Australia, the S&P/ASX 200 is up 20 points, or 0.35%.

On the commodities markets, West Texas Intermediate crude oil is US$44.24 per barrel. Brent crude is US$46.65 per barrel.

Gold is trading for US$1,252.14 (AU$1,646.76) per troy ounce. Silver is US$16.82 (AU$22.12) per troy ounce.

The Aussie dollar is worth 76.05 US cents.

Beyond ‘fintech’

The Financial Times (FT) reports:

Visa is taking a stake in Klarna in a sign of the Swedish fintech’s growing presence in online payments.

A week after Klarna became the largest European fintech to receive a banking licence, Visa said it was making a strategic investment through the purchase of a stake of less than 10 per cent as well as offering a future partnership.

We won’t put words into the mouth of colleague, Sam Volkering. But if we did, we think they would go something like, ‘fintech, sh-fintech’. The whole idea of fintech seems oh-so last year.

Just as we won’t put words into Sam’s mouth, we won’t pretend to be an expert on fintech, nor on its relationship with the real future of money and technology — cryptocurrencies.

But we just have this feeling that everything the FT article talks about will be obsolete in short order. Especially in this age where innovation and disruption happen at such a rapid pace.

To find out about the real future of money and tech, not the fake future, go here.

Time for recession

Now that we’ve got the good news…the positive news…the optimism…the bright future of technology out of the way, it’s time for us to wallow in our doomy-gloominess.

Again, from the FT:

The leading market indicator of economic distress is flashing orange again, challenging the US Federal Reserve’s insistence on raising interest rates and the stock market’s blithe march to record highs. But could this usually trusty gauge be faulty this time?

The so-called “yield curve” has predicted almost every US downturn since the second world war and is now blinking an ominous colour. It is the slope shaped by the yields of government bonds of various maturities.

Typically it costs more to issue long-term bonds than shorter-term ones, so the curve slopes upwards most of the time. But when the yield curve flattens and eventually inverts, it tends to presage a recession – and the US yield curve has dramatically flattened this year.

Yes. Yes, it has. It still isn’t near inverting yet. But that may not be far off. Check out the chart below. The green line represents the current yield curve. The dotted yellow line represents where the yield curve was six months ago:



chart image

Source: Bloomberg
Click to enlarge

There is a distinct flattening of the curve. The shorter-term rates are higher — hence the green line being above the dotted yellow line towards the left-hand side of the chart. And the dotted yellow line is well above the green line in the remainder of the chart.

It indicates how the curve is levelling. That my friend, suggests trouble ahead.

Why?

In simple terms, lower longer-term interest rates indicate that investors don’t believe there is a threat from inflation. In which case, they’re happy to lock their cash up for a longer time at a lower rate.

Lower inflation expectations typically mean that investors don’t expect there to be much economic growth — a potential forewarning of a recession.

That in turn also indicates that investors think interest rates could go lower, and so they’d rather lock in a higher rate today.

On the flipside, shorter-term rates rise as investors snub those rates, preferring to get the higher long-term rate — again, the expectation is that rates will fall. If they buy a short-term bond today, it may mean rolling into a lower yielding bond in the future, when their current bond matures.

Get the drift?

As we say, the yield curve isn’t even flat yet, let alone inverted. But these things have a habit of creeping up on investors. Many times, investors don’t even realise a recession has started until months after it has already begun.

But coincidence or not, current US GDP (gross domestic product) is around the level it was just prior to the last US recession, which started early 2008 (the red vertical bars mark the last three US recessions):



chart image

Source: Bloomberg
Click to enlarge

Furthermore, you can also see just how quickly the economy can turn downhill.

It doesn’t take much. One jolt to business and consumer confidence, a sudden reluctance to seek and provide credit, and bingo, a recession hits.

That’s the important thing to remember. The big driver of GDP growth is credit. Credit amplifies growth. In a credit-fuelled world, credit results in growth being higher than it otherwise would be.

So when the demand for credit slows or stops, it amplifies the decline. Because when an investor or capitalist withholds (say) $1 billion from the market, it’s not just $1 billion they’re withholding. Due to the credit-multiplier factor, the investor or capitalist may actually be withholding $2 billion, $4 billion, $6 billion, perhaps $10 billion or more. Depending on how much they would have borrowed against the billion-dollar security.

Hence the vicious drop when credit dries up.

Count up, oil down

Once you see one sign of a possible coming recession, it’s hard not to see others. The following chart shows the Baker Hughes Rig Count of US oil and gas rigs. We have marked the years of US recessions:



chart image

Source: Bloomberg
Click to enlarge

We pay particular attention to the amount of time that has passed since the end of the last US recession — eight years. And the fact that the recessions seem to begin as the rig count is on the rise, rather than when it’s falling.

To us, that would make sense. Especially so if it also coincides with a falling oil price. The falling oil price matters, as a rising rig count indicates that drillers are rushing to produce as much oil as they can, before the price sinks further.

Of course, the more they drill, the more the price sinks.

Today, the oil price is below US$44. It’s down over 18% this year. There can be little doubt that’s making things very uncomfortable, particularly for higher-cost producers in the US. Namely, the shale oil producers.

We advise paying close attention to all these factors. A recession and end to the current bull market may occur sooner than most folks think.

Cheers,
Kris