Global Economy Heading For “Mother Of All” Supply Chain Shocks As China Locks Down Ports
Over the past month, as Wall Street turned increasingly optimistic on US growth alongside the Fed, with consensus (shaped by the Fed’s leaks and jawboning) now virtually certain of a March rate hike, we have been repeatedly warning that after a huge policy error in 2021 when the Fed erroneously said that inflation is “transitory” (it wasn’t), the central bank is on pace to make another just as big policy mistake in 2022 by hiking as many as 4 times and also running off its massive balance sheet… right into a global growth slowdown.
The Fed is going from one huge error (inflation is transitory) to another huge error (4 rate hikes and runoff won’t crash markets).
— zerohedge (@zerohedge) January 11, 2022
And, as we have also discussed in recent weeks, one place where this growth slowdown is emerging – besides the upcoming deterioration in US consumption where spending is now being funded to record rates by credit cards before it encounters a troubling air pocket – is China and its “covid-zero” policy in general, and its covid-locked down ports in particular.
But what until recently was a minority view confined to our modest website, has since expanded and as Bloomberg writes overnight, the effects of restrictions in China as the country maintains its Covid-zero policy “are starting to hit supply chains in the region.” As a result of the slow movement of goods through some of the country’s busiest and most important ports means shippers are now diverting to Shanghai, causing the types of knock-on delays at the world’s biggest container port that led to massive congestion bottlnecks last summer that eventually translated into a record number of container ships waiting off the coast of California, a glut that hasn’t been cleared to this day.
With sailing schedules already facing delays of about a week, freight forwarders warn of the impact on already back-logged gateways in Europe and the US and is also why HSBC economists are warning that the world economy could be headed for the “mother of all” supply chain shocks if the highly infectious omicron variant which is already swamping much of the global economy spreads across Asia, especially China, at which point disruption to manufacturing will be inevitable.
“Temporary, one would hope, but hugely disruptive all the same” in the next few months, they wrote in a research note this week first noted by Bloomberg.
For those who have forgotten last year’s global shockwave when China locked down its ports for several days, a quick reminder: it led to an unprecedented hiccup in global logistics and shipping which hasn’t been resolved to this day. That’s because China is the world’s biggest trading nation and its ability to keep its factories humming through the pandemic has been crucial for global supply chains.
While the outbreak of omicron in China has been small compared to other nations (if one believes China’s official data, which is a big if) authorities are taking no chances, especially with China’s continued “zero-covid” policy. In recent weeks scattered infections of both the delta and omicron variants have already triggered shutdowns to clothing factories and gas deliveries around one of China’s biggest seaports in Ningbo, disruptions at computer chip manufacturers in the locked-down city of Xi’an, and a second city-wide lockdown in Henan province Tuesday.
Below is a brief timeline of the most recent events courtesy of Deutsche Bank:
- China’s first Omicron outbreak was detected in the city of Tianjin over the weekend. On the morning of Jan 8, two patients in Tianjin who actively sought medical treatment were confirmed as being infected with the Omicron variant. The local government immediately locked down certain districts, restricted travel, and conducted large-scale screening. A total of 41 positive cases have been reported as of the morning of Jan 11.
- The source of the local cases in Tianjin is still unknown, and community transmission is possible, according to local disease control officials. All previous local Omicron cases in Tianjin belonged to the same transmission chain. However, the above cases cannot be confirmed to be in the same transmission chain as the sequences of the imported cases of the Omicron variant that have been found in Tianjin. The early confirmed cases do not have any travel history outside Tianjin either. The specific source of the local cases found in Tianjin is still unknown at this time.
- More alarmingly, the same Omicron virus strain has already spread to outside Tianjin. Two positive cases were found in Anyang, Henan on Jan 8, and were later confirmed to be the same Omicron variant found in Tianjin. Through contact tracing and gene sequencing, the source was identified as a college student who returned to Anyang from Tianjin on December 28, 2021, and who did not show any symptoms. 81 cases have since been confirmed in Anyang over the past few days. This suggests that (1) the Omicron virus may have been transmitted in Tianjin for almost 2 weeks; and (2) other travelers might have already carried the Omicron virus from Tianjin to elsewhere in China.
Looking at the recent data, China’s Covid outbreak this winter could be worse than in the previous winter – as shown in the chart below more provinces have detected Covid outbreaks this winter. Entering Q4, there are 12 provinces which have found more than 19 local cases in the past 14 days. More significantly, the total number of new cases in the past 14 days in Shann’xi has already exceeded 1500, which is a record high, except for in Hubei when Covid first occurred in early 2020, and this has happened despite China now having very high vaccination rates and strict regulations such as lockdowns. In addition, comparing the differences between months near Chinese New Year in 2021 and 2022, not only have the number of news cases been larger this year, the provinces hit by Covid outbreaks this year also tend to have higher GDP and population density.
As Bloomberg adds, Henan and Guangdong, which also has an outbreak, are centers of electronics production. If cases continue rising there, it could impact the supply of iPhones and other smartphones.
This also brings us to what Bloomberg calls the paradox of China’s aggressive “Covid-zero” strategy: while on one hand it helps contain the virus spread, to do so usually requires significant disruption or lockdowns as authorities limit the movement of people. The repeated mandatory testing of whole cities interrupts businessess and production, although nothing to the extent seen in places like the US, where the omicron wave caused an estimated 5 million people to stay home sick last week, leading to further economic slowdown (as discussed in “A March Rate Hike? Not So Fast“)
That risk of disruption for factories is already prompting companies to spread their risk by ensuring they have alternative production facilities, Stephanie Krishnan, a supply chain expert at IDC in Singapore, told Bloomberg.
“We are starting to see companies mitigating risk, seeing where they can increase capabilities for production of different products in different factories so they can shift that around,” she said.
Echoing what we said last night in “New Year Brings New All-Time High For Shipping’s Epic Traffic Jam“, Krishnan doesn’t see an end to the global supply crunch anytime soon and cautions it could take several years for the snarls to unwind. It’s a sobering outlook to start a year that many had hoped would mark the beginning of the end of the Big Crunch which dogged producers and consumers through much of last year.
Clearly what happens next is critical, and how China’s control of the virus plays out will ultimately be crucial, said Deborah Elms, executive director of the Singapore-based Asian Trade Centre. Those companies whose supply chains are fully located inside China may be insulated by the country’s mitigation strategy. But that won’t apply to everyone, she said.
“Lots of products in supply chains come from outside China,” Elms said. “Given challenges elsewhere, even zero Covid doesn’t solve all the issues of disruption.”
* * *
In its assessment of next steps, Deutsche Bank expects the government will try to contain the Omicron outbreak with more lockdowns and quarantines rather than taking a “live with Covid” approach. This will pose downside risks to near-term growth. The impact on consumption could be significant, although probably not as large as what happened in 2020.
While Omicron is far less deadly than other Covid variants, it is still deadly enough to cause healthcare service shortages in China, at least in some regions. Vaccination has proven to be ineffective in preventing Omicron from spreading, and while it offers protection against hospitalization, China still has some 20% of the population who are not vaccinated and will face serious health risks if Omicron becomes widespread. As such, DB says that a containment approach is still the government’s optimal choice for this winter regardless of how fast Omicron spreads in the next few weeks. It will be good news if travel restrictions, lockdowns and large-scale testing and contact tracing work in containing the outbreak. Even if outbreaks cannot be contained in some regions, these measures will still be considered necessary in flattening the curve and preventing hospitals from being overwhelmed nationwide.
What is much more important for the US, global capital markets and the Fed’s monetary policy – which has assumed much stronger growth in 2022 – is that China’s Omicron outbreaks are significant downside risks for near-term consumption demand. Restrictions will likely be imposed nationwide to reduce travel before the Chinese New Year and encourage people to stay where they are. Cities where new cases were found will reimpose lockdowns and social distancing measures. The impact in each city will depend on local authorities. Experience from the past 2 years was that while some cities (such as Shenzhen and Shanghai) can manage outbreaks in a less disruptive way, other cities (such as Xi’an) have resorted to stricter and larger scale lockdowns, causing severe disruptions to consumption and service sector activities. Businesses such as restaurants, as well as those linked to travel, and leisure & entertainment will suffer from sharp revenue reductions or even temporary shutdowns. This may also cause temporary job and income losses and negatively impact consumer goods purchases. Retail sales growth dropped by 3ppt in Jan-Feb 2021 (in 2-year average terms). Retail sales might weaken again in Jan-Feb 2022, though the YoY growth rate might not drop much owing to the low base in 2021.
Nevertheless, consumption will likely recover rapidly once lockdowns are lifted. Similar to what happened before, such negative shocks will likely be transitory and will be followed by strong recovery once lockdowns are lifted and businesses reopen.
Still, the notorious bull-whip effect will emerge once again, as supply chains once again become stretched, and like in 2021 the question will be how the trade off between rising costs – as goods in transit end up stuck on a ship far longer than expected – and slowing growth will impact the Fed’s view on what the optimal policy response is. While the Fed’s prerogative for now is clearly to contain inflation, the reality is that much of the inflation experienced today is on the supply side, something which Brainard told the Senate in her confirmation hearing the Fed is powerless to address. Meanwhile, if we see a “surprise” drop in growth in the coming months, the Fed will have no choice but to delay or at least stagger its tightening as the last thing the Fed can afford to do is hike into another recession, which will then quickly be followed with even more easing.
4 Top Stock Trades for Thursday: AAPL, GLD, BAC, F
It was another brutal day in stocks. I was not happy to see the market gap up on the day, as that made it easy to sell into and that’s exactly what happened….
It was another brutal day in stocks. I was not happy to see the market gap up on the day, as that made it easy to sell into and that’s exactly what happened. The S&P 500 and Nasdaq each dropped about 1%. With that in mind, let’s look at a few top stock trades despite the selling.
Top Stock Trades for Tomorrow No. 1: Apple (AAPL)
Apple (NASDAQ:AAPL) has been a relative strength leader until recently, but it’s now coming under some selling pressure.
I wasn’t sure when we would get the tag of the 50-day moving average, but in combination with last week’s low, it is even more attractive.
On a move back up through last week’s low (at $168.17), bulls can look to trade Apple stock on a bounce, first targeting $170, then the declining 10-day moving average.
A break lower could end up putting the $158 to $160 zone in play, along with the 21-week moving average.
While Apple hasn’t traded that well lately, remember it was a leader before this recent dip.
Top Stock Trades for Tomorrow No. 2: Gold ETF (GLD)
Gold has had a lot working against it, mainly that it hasn’t had any momentum despite robust money printing from the global central banks and inflation that’s been on a tear.
When I look at the chart of the SPDR Gold Trust ETF (NYSEARCA:GLD), however, I see a powerful upside rotation.
Not only is the GLD clearing multiple weeks worth of highs, but it’s also clearing last month’s high as well. That’s the type of rotation that could put fourth-quarter resistance in play, up near $175.
Of course, it’s hard to have too much faith in this one, seeing as though most of its breakouts have not yielded any sustained upside moves. If it pulls back again, see that its cluster of moving averages acts as support.
Top Stock Trades for Tomorrow No. 3: Bank of America (BAC)
Given how the other banks had traded on earnings, it’s no wonder that Bank of America (NYSE:BAC) stock had been trading poorly ahead of the print.
However, it’s also not surprising that the stock’s gap up on Wednesday morning was sold into.
Shares opened right near that gap-fill level at $48.70, then proceeded to fall throughout the session. While its short-term moving averages are supporting it now, there are not a lot of bullish catalysts to go on.
I guess bulls can be long against the 50-day if they really want to own this one.
However, keep an eye on BAC stock if breaks below $45. That could open the door to the December low near $42.70 and the 200-day moving average.
On the upside, though, the stock needs to clear $48.70.
Top Trades for Tomorrow No. 4: Ford (F)
Let’s keep it short and sweet with Ford (NYSE:F).
The stock knifed right through its 10-day moving average and dipped down to the 21-day.
On a bounce, we need to see the stock reclaim $23, then the 10-day. On a further dip, however, keep an eye on the gap-fill at $21.88. That’s followed by the 10-week and 50-day moving averages.
For now, this is still a name we want to buy on the dips.
On the date of publication, Bret Kenwell did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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Morgan Stanley Turns Even More Bearish, As Accelerated Fed Tightening Sparks Bear Market
Morgan Stanley Turns Even More Bearish, As Accelerated Fed Tightening Sparks Bear Market
Having warned for months that the market is set to…
Morgan Stanley Turns Even More Bearish, As Accelerated Fed Tightening Sparks Bear Market
Having warned for months that the market is set to snap, unlike some of his peers like – for example – Goldman’s David Kostin who has been uber bullish throughout 2021 even though we learned yesterday that the bank was quietly selling, pardon, “harvesting” billions in stock positions for a third consecutive quarter…
… Morgan Stanley’s notoriously bearish chief equity strategist, Michael Wilson has reasons for a victory lap now that many of his peers are scrambling to come up with reasons to turn bearish just weeks after they published their 2022 year-end S&P targets which for 95% of them were above 5,000.
However, Wilson has no time for such flights of fancy, because while we wait for street consensus to follow Wilson into the dark side (giving the all clear to buy stonks), he has decided that to keep differentiating himself he has to be even more bearish, and sure enough in his latest weekly warm up note, he writes that Morgan Stanley’s new Fed forecast “simply brings forward our call for lower equity valuations and raises the risk in the first half of the year” as the median stock “remains expensive even though the most egregiously priced stocks have corrected.”
Here are the details.
Last week, Morgan Stanley’s economics team adjusted its forecasts on Fed policy “given the more hawkish tone in the most recent Fed minutes and commentary from Chair Powell and other governors” and joined the rest of the street in expecting the Fed to fully exit QE by April, increase rates by 25bps 4 times in 2022 and begin balance sheet normalization in the middle of the year. That – needless to say, is a lot of tightening, and fits with Wilson’s general bearish outlook for 2022 published in November. To recall, his Fire and Ice narrative assumed the Fed was behind the curve and would need to catch up in a hurry given the dramatic move in inflation we’ve experienced during this pandemic. As discussed on Friday, consumer confidence measures suggest inflation is the number one concern right now, making this a political issue as much as an economic one especially for Biden, as his rating is now crashing.
And as Biden just said during his press conference, “it is “appropriate for the Federal Reserve to recalibrate” the support that is now necessary to fight inflation, so expect the Fed to keep pushing until financial conditions tighten.
What all that means for equity markets is obvious, but just in case it isn’t, Wilson explains: valuations will have to come down this year via a combination of higher back end rates and higher equity risk premiums. And so, the changes to the bank’s Fed forecast simply mean “it is likely to happen faster now, making the handoff between lower earnings and higher earnings less seamless.”
To be sure, Wilson’s outlook for 2022 already incorporated a fairly hawkish Fed, and while that hawkishness has only increased it doesn’t change the bank’s year-end targets, which are already among the lowest on Wall Street:
Specifically, our base case year-end target for the S&P 500 is 4400, which compares to the median forecast of approximately 4800-4900. This target assumes a meaningfully lower P/E of 18x forward 12-month EPS of $245 at the end of 2022 (down from ~21x today). Our EPS forecast is largely in line with the Street while our target P/E is approximately 10% lower.
The faster taper and hike schedule brings this valuation risk forward to the first half of the year – and considering that the S&P is now just above 4,500 and could drop below 4,400 tomorrow, one can add that the valuation risk has been “brought forward to this month.” Furthermore, given the much more aggressive timetable for quantitative tightening, we could even see an overshoot to the downside of what Wilson thinks is “fair value.” And what is that?
Our current projected P/E for the S&P 500 is 18x by the end of the year. This target P/E assumed a 10-year Treasury yield of 2.10% and an equity risk premium of 345bps. With our new rates forecast of 2.20% by 2Q and a much more aggressive time line on asset purchase reductions, we think the equity risk premium could easily reach 345bps in the next several months from today’s 300bps, particularly if our forecast for falling PMIs pans out. Assuming an equity risk premium of 345bps and 2.2% 10-year gets us to a P/E of ~17.5x by the second quarter of the year. If we roll forward the consensus earnings forecast we get $230 in NTM EPS by the end of 2Q. 17.5x $230 is 4000.
Bottom line, Wilson predicts that the bringing forward of tapering and rate hikes is likely to lead to a 10-20% correction in 1H22 for the S&P 500.
For those who have a different perspective, below are two tables from Wilson that allow readers to make their own assumptions on both rates and ERP to arrive at the price/earnings ratio that makes sense for the overall market as the Fed attempts to exit this period of extraordinary monetary policy more rapidly. The second table translates these P/E into year-end bull, base, and bear targets for the S&P 500 assuming $245 in EPS for 2023.
What little good news Wilson had to clients, is that markets have been adjusting for months to this new reality, with 40% of the Nasdaq having corrected by 50% or more.
As we’ve noted many times, the breadth of the market remains poor as it goes through the classic rolling correction under the surface as the index grinds higher. This phenomenon is largely due to the relentless inflows from retail investors into equities. On one hand, this rotation from bonds to stocks from asset owners makes perfect sense in a world of rising prices. After all, stocks are a decent hedge against inflation, and much better than owning fixed income. However, certain stocks fit that billing better than others. In its simplest form, it means value over growth stocks or short duration over long.
And while Wilson was completely on board with that view a year ago, he is not as convinced that it’s going to be as smooth a ride in 2022: “First, the Fed is going the other direction now, and quickly. Second, growth is now decelerating rather than accelerating. Furthermore, it’s decelerating faster than many think, and has a ways to go in our view.” Regular ZH readers will not be in the “many” group as we have extensively discussed precisely this accelerated slowdown over the past few months.
Wilson agrees, having made the case for months that PMIs and earnings revision breadth are both likely to fall more than the consensus currently expects. Both of these metrics have a high correlation to stock prices. In the case of PMIs, stocks have already held up better than they should have.
In many ways this looks a lot like late 2019/early 2020, the last time we had such a wide divergence. This has been caused by the extraordinary monetary accommodation from the Fed over the past 6 months, policy that appears way too loose relative to the current economic conditions. And with that policy now changing at an accelerated rate, Wilson expects the relationship between stocks and the PMIs to realign.
What is a Bond Ladder?
A bond ladder is a supportive strategy in which investors layer bonds with different maturity rates into a single portfolio.
The post What is a Bond Ladder?…
Investing in bonds is typically a long-term exercise. As a result, investors need to be forward-thinking in the types of bonds they invest in. Furtermore, investors must be aware of the changing interest rate environment that determines the value of their long-held bonds. Building a bond ladder is a simple way to optimize a bond portfolio, while protecting against external risks.
As the name implies, a bond ladder is a supportive strategy in which investors layer bonds with different maturity rates into a single portfolio. For example, a standard 10-year ladder would have a bond maturing every year, while the other bonds in the ladder continued to pay coupon payments. Investors can keep the ladder going by reinvesting or letting it expire at a target date.
There are many reasons to build a bond ladder, and it’s a highly successful strategy for fixed-income investors. Here’s a better look at how laddering works and why investors use ladders. Moreover, you will learn how to optimize them to improve cash flow or protect against interest rate risk.
How an Ongoing Bond Ladder Works
Before we delve into how to use bond ladders to achieve certain investment goals, let’s take a look at one. Here’s a simple example of a simple 5-year bond ladder:
- Bond A: $10,000 at 2.1%, purchased today, maturing in year 1
- B: $10,000 at 3.2%, purchased today, maturing in year 2
- C: $10,000 at 3.5%, purchased today, maturing in year 3
- D: $10,000 at 3.5%, purchased in year 2 using Bond A, maturing in year 4
- E: $10,000 at 3.5%, purchased in year 3 using Bond B, maturing in year 5
The purpose of laddering is to provide a rolling opportunity to adapt a fixed-income portfolio to changing market interest rates. There are a few important hallmarks to pay attention to in the above example. Some of the features of an effective ladder include:
- Staggering expiration dates spanning each year of the total ladder
- Better interest rates for longer-term bonds that mature later
- Proceeds from early coupon payments fund future bond purchases
As the older bonds expire, investors can use the proceeds from the recouped par value to reinvest in new long-term bonds with better coupon rates. Or, if interest rates fall, they can reassess investment strategies while benefitting from higher-yield bonds that are still active. In either situation, the ladder reduces the effects of market volatility.
Ladders for Cash Flow Management
The other benefit of a bond ladder is consistency of cash flow. Since most standard bond ladders involve U.S. Treasuries, investors can expect twice-yearly coupon payments based on the bond’s maturity date. Strategic laddering allows investors to spread out coupon payments across the year, for more cash flow consistency. Mixing short- and long-term bonds can exemplify this effect. It’s an enticing prospect for fixed-income investors who want to smooth-out cash flow.
Using Bond Funds as Part of a Ladder Strategy
Buying individual bonds isn’t the only way to capitalize on a bond ladder strategy. Bond funds offer another way to benefit from exposure to debt securities, while safeguarding against interest rate risk. Moreover, bond funds can provide more consistent coupon payments due to the diversified nature of the fund.
To build a bond ladder using ETFs, investors need to look for target date bond funds. For example, the iShares iBonds Dec 2024 Term Treasury ETF (IBTE) and similar funds (IBTF, IBTG, IBTH, etc.) offer a chance to ladder ETFs up to 10 years in advance. Buying these ETFs in equal amounts establishes a bond ladder that investors can use in the same way as a ladder comprised of individual bonds.
The chief benefit of laddering through a bond fund is the exposure offered by ETFs, as opposed to holding single bonds that are more susceptible to interest rate fluctuations and bond market activity. Some investors even find it easier to simply buy into a diversified bond fund, like the Vanguard Total International Bond ETF (BNDX), which serves roughly the same function as a ladder.
Tips for Building a Robust Ladder
For investors seeking to build a bond ladder, there are a few tried and true strategies to look at. These primarily focus on best practices for bond diversification, protecting against interest rate risk and avoiding risky bonds:
- Seek to incorporate a mix of bonds, including both Treasuries and AAA corporate bonds.
- Never incorporate callable bonds into a bond ladder! Callable bonds can break the ladder.
- Shorter ladders are better in poor interest rate environments; longer ones for strong rates.
- Inflation-protected securities can be a strong hedge for ladders in poor rate environments.
The biggest thing to remember is that as bonds mature, investors need to be aware and active in how they choose to use the proceeds. Reinvesting them in bonds can keep the ladder strategy going; however, the current rate environment might demand a pivot. Laddering requires critical thinking.
Ladders Protect Against Interest Rate Risk
While many investors use bond ladders as a way to better-control their income from fixed-income investments, this strategy is also a great hedge against interest rate risk. Laddering bonds gives investors the ability to adapt their strategy with each successive year and adjust their portfolio to protect themselves. Whether through individual bonds or target-date bond ETFs, there are plenty of ways to construct and maintain a ladder that continues to deliver peace of mind.
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