In December 2013, in a sign of robust global trade driving demand for container ships, the Baltic Dry Index (BDI) peaked at 2,330. By July 2014, rates had collapsed to 730. Today, rates have fallen to 471, the lowest since the recession began. What does this mean and why should you care?
The BDI tracks maritime shipping cargo rates. It is a pure supply/demand metric that responds to how much stuff is being shipped relative to available capacity. Ships take years to build, and only rarely does the BDI move because of changes in supply. Instead, the BDI typically responds to demand. So it’s frequently cited as a way to track global demand.
Simply put, the BDI is sending a very clear signal: the global economy is falling to recessionary levels. Ships are travelling empty and rates are falling accordingly.
Here’s a snapshot of the meltdown.
Whether measured in volumes (container throughput via Hong Kong) or in dollars (US Import/Exports), the pain is the same: 16 months of steady collapse in global trade.
The pain is getting worse. More containers are leaving the US and returning to China empty. From the Port of Long Beach (a major US/China trade port):
- After unloading cargo in the US, over 60% of inbound containers are leaving empty.
- The rate is the highest since the recession began in 2007.
- Since June 2014, every month with only one exception has seen more empty outbound containers than loaded export containers.
If I had to describe what happened in 2015 and what is about to happen in 2016, it is simply this: fake demand out of China evaporated and it has left behind massive amounts of excess factory capacity. On top of that, the resulting collapse in prices means that there is a lot less mad money chasing goods like real estate. Yep, the US housing bubble is popping because it was primarily fueled by Chinese and Russian money. (Did you know that since the recession most homes have been purchased by investors and not home buyers? Well, those buyers are running away.)
So how does all of this get reflected in things like trade cargo? For the better part of a decade, China was on a super cycle fueled by a combination of:
- A capital-intensive infrastructure build-out
- Increasing penetration of global manufacturing
- A credit bubble
- Corporate gambling on real estate, commodities, and other assets
Lots of wealth and mad money fueled a real-estate boom, which requires a lot of steel. Thus iron ore prices soared, for example. Speculators, however, began to buy iron, copper, and other commodities to stockpile them, hoping to make a killing when prices moved up. This created a virtuous cycle: the speculative (fake) demand boosted prices, which made this gambling more attractive, which fueled more buying, which fueled higher prices, and so on. At the heart of this was easy, unlimited credit.
Then the bubble popped in late 2013 when the Chinese government took steps to cool the credit markets. The situation didn’t unwind, it collapsed. Copper prices, for example, quickly tumbled because 60-80% of copper imports were used as collateral for loans. It wasn’t just copper; commodity-backed loans quickly fell out of favor and physical demand began to drop. In 2013 iron ore imports to China surged more than 20%. They have fallen -5% since then.
This has global ramifications. First, prices collapsed and many countries depend on exporting commodities to China (Australia, Brazil, and Chile). Second, factory capacity was expanding based on a rising trajectory, not a flat trajectory. Excess capacity means lower prices as producers seek to unload their supply. Government measures popped the hot-money and flattened public sector spending. Commodities and other assets have overshot because of the unexpected massive excess.
Signs of a Bottom, But What Comes Next?
From China (Hong Kong) to Europe, Taiwan, and Korea a bottom has formed. 2016 will reflect continued price pressure because things always overshoot.
No Bottom for the US
- Materials and agriculture are in bad shape.
- Other exports are contracting at faster pace ($ and units).
- A strong dollar contributes to further US trade deterioration.
When we separate the materials pain from other export pains, we see that US export headline figures are dismal.
- Total exports year-to-date: -$87B year over year.
- For 2015, exports are likely to contract -$100B y/y.
- This cuts GDP by -0.7%.
However, the export numbers focus on commodities. Of the -$87B drop, the majority is in materials and commodities (price drops are the big issue).
- Food/Petroleum/Steel: 70% or -$61B.
- Related equipment: 8% or -$7B.
US exports (ex food, autos, and oil) are shrinking faster. Food and petroleum are removed because price collapses distort the value of trade. Autos because these exports are mostly sub-assemblies shipped to Canada and Mexico and re-imported to the US as cars and trucks. What remains is a true view of demand by US trading partners.
Trade Dulled by Strong Dollar
While total US exports have steadily contracted y/y every month in 2015 except for January, the pace accelerated beginning in August, when the dollar strengthened against global currencies:
- January-July (seven months): -$27B
- August-October (three months): -$23B
Going Forward: Trade Remains Under Pressure
The two engines of growth – China and the US – are stalling again. Chinese demand is again falling back.
The most recent US-China trade data comes out of the Port of Long Beach (November cargo data). Long Beach is a primary port for China/US trade. We’ve already noted the acceleration in empty containers, indicative of even lower Chinese imports from the US.
Further analysis shows:
- Trend reversal: export growth has shifted from slight growth to contraction.
- Nominal export volumes are below last year’s levels and the lowest since 2011.
Key Takeaways
Best Case: A bottom has formed and current activity reflects bouncing off the bottom.
Worst Case: China demand is slowing again, with no change likely until late 1Q 2016.
Simply put, the Bear market has begun and you do not want to be long stocks. Regardless of the China-driven bust in trade, the US economy has peaked. Auto sales aren’t going up, for example. Thanks to the Fed and the rate hike, things just got a bit more expensive. Factor in the aftermath of a collapse in the manufacturing economy and you can see that growth will be scarce.