Transcript Slide 1

Macro-Trends Update for
Financial Sense Newshour
“In the spring, there will be growth*”
March 1, 2010
* Paraphrasing Chauncey Gardener in “Being There,” United Artists Films, 1980.
Barry B. Bannister, CFA
Managing Director, Equity Research
Stifel Nicolaus & Co.
[email protected]
All relevant disclosures and certifications can be found on page 33-34 of this report and on the research page at stifel.com.
Barry B. Bannister, CFA
Managing Director, Equity Research
Stifel Nicolaus & Co.
[email protected]
•
Barry B. Bannister, CFA – Managing Director, Equity Research, Stifel
Nicolaus & Co. of Baltimore, MD provides investment research to
financial institutions globally in the areas of Engineering, Machinery
and associated strategy related to commodity markets served by
companies in those industries.
•
He is a five-time winner of the Wall Street Journal All-Star analyst
award, four-time winner of the Forbes Magazine/Financial
Times/Starmine top analyst award, Top-10 U.S. Stock Pick analyst for
CNBC/Zacks and two-time Institutional Investor magazine All Star
Analyst (2007, 2008).
•
Prior to joining Stifel Nicolaus and its predecessor Legg Mason
Capital Markets in 1998, he was a senior analyst providing North
American Machinery industry coverage and later co-head of U.S.
equity research in the New York office of the UK investment bank S.G.
Warburg & Company (Now UBS) from 1992 to 1998. Prior to that he
served as an equity analyst for the buy-side firm FTIM/Highland
Capital Management (1990-1992), and before that he was an equity
analyst for the mutual funds and trusts of AmSouth Investment
Management (now Regions Financial) from 1987-1990.
•
He holds an MBA (1987) from the Emory University School of
Business Administration, and a BA from Emory College (1984). He
has held a Chartered Financial Analyst (CFA) designation since 1991.
1
Summary
1.
We believe a slight improvement in civilian (not Census) jobs is all the S&P 500 needs to vault to ~$1,275 in 2Q10.
After the excitement of a spring rally, we think the "bounce" of inventory re-stocking will sputter later in 2010
because the demise of securitization is to the consumer sector what the 1970s energy shocks were to the industrial
sector.
2.
We still see the S&P 500 forward 10-year total return (incl. dividends) as 7% (i.e., a double), back-half (2015-19)
loaded. We believe investors will look back in five years at an S&P 500 that touched about ~$1,500 three times, 2000,
2007 and 2014, but was flat for 15 years.
3.
Secular bear markets feature multiple bottoms for stocks divided by commodities. We see commodities having their
last major price rally this cycle ~2013-14, possibly in tandem with inflation, and we still expect oil to remain ~$75/bbl.
+/- $10/bbl. narrowly speaking the next year.
4.
China's rise is "real," but the country is caught on a hamster wheel of strong total factor productivity leading to high
corporate and consumer savings rates and an undervalued currency that are then recycled into still more fixed
investment.
5.
Just as a centralized economic system can allocate capital more quickly than a free market, a free market (individual
agents maximizing utility) can allocate more efficiently than a centralized system. That describes "Team China" vs.
"Team U.S.A.," in our view.
6.
The U.S. is liquidating land, labor and capital and floating the U.S. dollar while the Chinese are employing massive,
rapid expansion of bank loans and currency intervention to avoid such adjustments. The U.S. approach is much
more sound, in our view.
7.
Besides fixed investment or asset bubbles, China risks inflation, so policy is tightening. We see inflation pressuring
emerging market P/E multiples in general while disinflation lifts P/E multiples for traditional U.S. "growth" stocks.
2
Deflation vs. Inflation
1.
The S&P 500 came quite close to the 8% correction to $1,050 we called for in our 1Q10 Macro-Slides “MacroUpdate: 1Q10 Correction, ‘Growth Scare’” published January 21, 2010.
2.
The S&P 500 needs a civilian jobs recovery within a year of the price bottoming, and the S&P 500 trough was
March 09. Slight improvement in civilian jobs is all the S&P 500 needs to vault to ~$1,275 in 2Q10, in our
view.
3.
After the excitement of a spring bounce, we postulate that reduced securitization has permanently ratcheted
down consumption in the U.S., preventing anything more than a “bounce” in inventory re-stocking in 2010.
4.
The Fed and Treasury are using their last non-inflationary bullets in an attempt to restart private credit.
Consumer leverage is too great to expect a meaningful resumption, so debt deflation could resume by 2011.
5.
The U.S. historically chooses taxation and inflation (1930s/40s, 1960s/70s) rather than revolutionary
expropriation to deal with deflation. The end result is similar, the former just gives investors time to prepare.
3
Historically, the S&P 500 “needs” a recovery in civilian employment within ~11 months of the stock market bottoming
(left chart), and since the S&P 500 bottomed March 2009 it has been trending sideways with nervous anticipation since
January 2010, waiting on job market signals. Slight improvement in civilian (non-Census) jobs is all the S&P 500 needs to
vault to ~$1,275 in 2Q10, in our view. But since we believe many jobs dependent upon consumption and asset inflation
(ex., finance and retail) are gone for good, and government debt is being used to forestall private sector debt default
(right chart), we foresee at best a weak full cycle jobs recovery, with unemployment unlikely to fall much below 6%, as
well as sporadic difficulties unwinding the consumer debt bubble.
Civilian Non-Institutional*
Employment to Population Ratio
versus S&P 500 Index (log scale)
120%
Change in debt since the peak as a % of GDP (bps):
72
Civilian Employment to Population Ratio (Left Axis)
71
S&P 500 Index (log Scale, Right Axis)
70%
12
m os.
60%
65
50%
14
m os.
40%
63
10
Jan-70
Jan-72
Jan-74
Jan-76
Jan-78
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
55
Source: FactSet prices, St. Louis Federal Reserve, Stifel Nicolaus format.
2015Q1
2011Q3
2008Q1
2004Q3
0%
?
1997Q3
56
10%
2001Q1
57
20%
Since the S&P 500 bottomed
in Mar-09, and equities lead
employment/population by
~11 months, jobs must turn
in 1Q10 for equities to
survive the “employment
test,” in our view.
1994Q1
58
9
m os.
1990Q3
59
12
m os.
Thus far, increased
government debt has
offset decreasing private
debt, hardly a test of deleveraging, in our view.
30%
1983Q3
61
60
100
9
m os.
1952Q1
62
1987Q1
64
1980Q1
66
80%
1976Q3
67
1,000
1973Q1
68
90%
1969Q3
69
*The civilian non-institutional population
consists of persons 16 years of age and older
residing in the 50 States and the District of
Columbia who are not inmates of institutions
(for example, penal and mental facilities and
homes for the aged) and who are not on active
duty in the Armed Forces.
Financial debt
Peak: 1Q09 Change:
-700 bps
Private household Peak: 2Q09 Change: -100 bps
Private business
Peak: 2Q09 Change: -100 bps
Public debt
Bottom: 2Q08 Change: +1,700 bps
= Total debt/GDP up from 354% (2Q08) to 370% (3Q09)
100%
1962Q3
70
110%
1966Q1
73
1959Q1
74
Debt as a Percentage of U.S. GDP, by Category
10,000
1955Q3
75
Financial Debt / US GDP
Public Nonfinancial Debt / US GDP
Private Nonfinancial Household Debt / US GDP
Private Nonfinancial Business Debt / US GDP
4
Most of the arguments for domestic GDP recovery that we hear involve an inventory re-stocking argument. (Commodity
recovery appears to depend on Chinese bank loans, but we discuss that later). We postulate that the demise of
securitization (issuance of securities that ‘package’ many individual consumer debts such as credit cards and mortgages)
in the current era is analogous to the 1970s energy shocks. Recall that the 1973-1974 first energy shock rendered a large
swath of industrial America effectively obsolete in the 1970s due to its inefficient energy intensity (think Chrysler’s first
bail-out). That capacity limped along until it was finished off by the second oil shock in 1979-1980 as well as U.S. Fed
moves to deal with price inflation (high real interest rates, a strong dollar). We suspect that the demise of securitization has
permanently ratcheted down U.S. consumer spending, reducing the need for anything more than a “bounce” in inventory.
Weaker retail and financial capacity may limp along for a few years until it is finished off in a shake-out, in our view.
Source: Bank Credit Analyst
5
U.S. GDP per capita for 209 years has grown at 1.6%/year, with population growth of 2.0% and real GDP growth of 3.6%.
Recent trends have supported at least 2% growth in productivity, and for the past decade the U.S. population has grown at
a fairly consistent 1.0%. This indicates that at least 3.0% (2% + 1%) U.S. real GDP growth can be maintained in a normal
credit environment, in our view. If deleveraging the consumption side of the U.S. economy causes U.S. per capita real
GDP to converge on the long-term trend shown in the chart below; however, such a process would be a headwind for
growth shaving perhaps 150bps/year from U.S. real GDP/capita over perhaps five years, which is not “fatal,” in our view.
Log of U.S. Real GDP per Capita, 1800 to 2009
4.8
Trend growth since 1800 of 1.6%, with population growth of 2.0% and U.S. real GDP growth of 3.6%
4.6
4.4
To return to
trend U.S.
GDP would
have to
decline 12%
(twelve
percent) at
once, or
somewhat
less over
time.
Trend 1.6%
U.S. GDP/capita
growth
4.2
4.0
3.8
3.6
3.4
3.2
Source: Historical Statistics of the United States, Millennial Edition, U.S. Census.
2010E
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
1890
1880
1870
1860
1850
1840
1830
1820
1810
1800
3.0
6
Years of credit growth have created excessive liquidity in its broadest measure (M3, left chart), because such liquidity
is the by-product of debt (banks make loans, loan proceeds are deposited, banks hold back a small required reserve
and make more loans, “creating” money) and foreign purchases of U.S. debt. But debt has perhaps grown too
excessive to expect more aggregate debt (red line, right chart) to again bail out the system as it has done in the past.
As a result, liquidity balanced against all of the assets created via indebtedness has caused risk asset markets to
trend sideways and be quite volatile, while risk averse assets (ex., U.S. Treasury Bonds) have been in a bull market. We
do not expect the S&P 500 to break out of its 2000 to 2010 price range of ~$667-$1,576 until 2015.
Growth of Components of U.S. M3 Money Supply ($ bil.)
The Ratio of M3 to the Monetary Base
(Measures whether currency plus bank reserves can be
$15,000
$14,000
$13,000
The multiplier has
subsided, hence
fiscal stimulus and
quantitative easing.
Sum = M3
Institutional Money
Funds
converted into more money via bank lending in the fractional
reserve banking system) vs.
20.0x
U.S. Total Debt / GDP
4.00x
19.0x
$6,000
Small Denom.
Time Deposits
$4,000
Savings Deposits
14.0x
2.75x
13.0x
2.50x
12.0x
11.0x
2.25x
10.0x
2.00x
9.0x
M1 = Below
$2,000
Demand & Other
Check Deposits
$1,000
Jan-81
Jan-82
Jan-83
Jan-84
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
$0
Currency &
Travelers Checks
1.75x
Total
Debt/GDP
(Right)
8.0x
$3,000
3.00x
7.0x
1.50x
6.0x
1.25x
5.0x
1.00x
Jan-10
Retail Money
Funds
$5,000
M3/Monetary
Base (Left)
15.0x
Large-Time
Deposits
M2 = Below
$7,000
3.25x
16.0x
Jan-98
Jan-01
Jan-04
Jan-07
$8,000
Repos
Jan-74
Jan-77
Jan-80
Jan-83
$9,000
3.50x
17.0x
Jan-62
Jan-65
Jan-68
Jan-71
$10,000
3.75x
18.0x
Jan-59
$11,000
A combination of
importing the
savings of emerging
markets and using
leverage (money
multiplier) to grow
money supply.
Eurodollars
Jan-86
Jan-89
Jan-92
Jan-95
$12,000
Source: U.S. Federal Reserve, U.S. Federal Reserve for M3 (SA) 1959 to 2005. For M3 2006 forward we use: M2 + Large time deposits + Money Mkt. Balance + Fed Funds
& Reverse repos with non-banks + Interbank loans + Eurodollars (regress historical levels versus levels of M3 excluding Eurodollars), Stifel Nicolaus format.
7
The chart below, which we introduced last year near the S&P 500 lows, shows the widening amplitude for S&P 500
EPS growth (top chart, pink diverging lines) with little change in average growth. Perhaps indebtedness is a zero sum
game on a system-wide basis, e.g., for every Goldman Sachs there is a Bear Stearns (i.e., Bear was a failure without
requiring a “push” from the authorities), with a sacrificial lamb (ex., Lehman) tossed into the inferno. Note also the
downtrend of S&P 500 price recoveries (bottom chart, green line), the reason for which we theorize on the next page.
S&P 500 y/y% Earnings Growth (Trailing 4-quarter Sum)
1955Q1 through 2009Q4
100%
4Q2009
= 246.2%
80%
60%
40%
20%
0%
-20%
-40%
-60%
-80%
1998Q3
2000Q1
2001Q3
2003Q1
2004Q3
2006Q1
2007Q3
2009Q1
2000Q1
2001Q3
2003Q1
2004Q3
2006Q1
2007Q3
2009Q1
1997Q1
1998Q3
1995Q3
1994Q1
1992Q3
1991Q1
1989Q3
1988Q1
1986Q3
1985Q1
1983Q3
1982Q1
1980Q3
1979Q1
1977Q3
1976Q1
1974Q3
1973Q1
1971Q3
1970Q1
1968Q3
1967Q1
1965Q3
1964Q1
1962Q3
1961Q1
1959Q3
1958Q1
1956Q3
50%
40%
30%
20%
10%
0%
-10%
-20%
S&P 500 Price y/y% Change
(Trailing 4-quarter Average)
-30%
1955Q1 through 2010Q1
1997Q1
1995Q3
1994Q1
1992Q3
1991Q1
1989Q3
1988Q1
1986Q3
1985Q1
1983Q3
1982Q1
1980Q3
1979Q1
1977Q3
1976Q1
1974Q3
1973Q1
1971Q3
1970Q1
1968Q3
1967Q1
1965Q3
1964Q1
1962Q3
1961Q1
1959Q3
1958Q1
1956Q3
-40%
1955Q1
Source: FactSet, Stifel Nicolaus, Standard & Poor’s.
1955Q1
-100%
8
Debt appears to be losing its ability to “kick-start” growth. The charts below show that the incremental dollars of
nominal U.S. GDP per dollar of incremental U.S. debt, which we have long termed “Zero Hour,” has already fallen below
zero (due to recession), and we have little confidence in the ability of government spending to create lasting growth in
national income via borrowing from overseas savers and spending the proceeds domestically. These charts may help
explain why the cycles of S&P 500 index price growth shown on the preceding page are growing more shallow.
U.S. Total System-Wide Debt Growth y/y%, 4Q54 to 3Q09
(Red) vs. U.S. nominal GDP growth y/y% 4Q54 to 3Q09
(Green)
Zero-Hour? Diminishing U.S. GDP Returns from Each $1
of New U.S. Total Debt, 1Q 1954 to 3Q 2009 (Not
smoothed)
16%
$1.10
15%
$1.00
14%
$0.90
13%
$0.80
12%
Dollar change y/y in U.S. Nominal
GDP divided by dollar change y/y
in U.S. Debt equals the dollar
increase in GDP per $1.00
increase in U.S. Total Debt. It went
below zero in 1Q09.
$0.70
11%
$0.60
10%
$0.50
9%
$0.40
8%
Two?
1%
2014
2011
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
-$0.10
2%
1975
3%
1972
$0.00
1969
4%
1966
$0.10
1963
5%
1960
$0.20
1957
6%
1954
$0.30
7%
-$0.20
-$0.30
2014
2011
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
-1%
1954
0%
-$0.40
-$0.50
-2%
One...
-$0.60
Source: Federal Reserve Flow of Funds, Stifel Nicolaus format.
9
Why worry about the difficulty creating new dollars via credit? Because creditors will have to repay debt with increasingly scarce
dollars. GDP growth from sources other than productivity has been declining since the leveraging process began in earnest in
the early 1980s, and corporate profit margins are at all time highs (left charts). Corporate profits have benefited from
technology/productivity, inexpensive labor and cheap credit since the early 1980s. But since wage growth has been poor in that
period, consumer credit has been used to supplement pay, enabling consumption to rise faster than compensation (right chart).
Had the gold standard existed, we postulate that real wages after deflation would have been strong and positive (i.e., wage
growth minus deflation would have been a positive number – wages would have bought more things) because winning the Cold
War was a deflationary event (flooding the world with Soviet commodities and Asian labor). But because money was fiat, a great
deal of debt and reserve accumulation ensued, and now deflation if “it” happens here would simply be…destructive.
Source: Bank Credit Analyst
Source: Ned Davis Research.
10
In an attempt to restart the credit process the Fed has been a large purchaser of assets (mortgages). After sterilizing
early intervention in 1H08 with a $300B Treasury sale (point “A”), the Fed repurchased those Treasuries in 1Q09 (i.e.,
so-called Quantitative Easing, shown as point “B”) and that restarted the market’s engine, helping the S&P 500 put in
its March 6, 2009 low of $667. The market liked the Fed’s actions so much that the Fed kept going, buying Agency
debt (point “C”). As liquidity facilities have been wound down (point “D”) the lender of last resort has simply become
the buyer of last resort, hardly a testament to strength.
$ Billion
Federal Reserve Bank Assets & Liabilities
$2,500
Liquidity Facilities
$2,000
Other
D
$1,500
Assets
C
Repurchase Agreements
$1,000
Term Auction Credit
$500
B
A
Securities Held Outright
$0
Reserve Balances with
Federal Reserve Banks
-$500
Treasury Supplementary
Financing Program (SPF)
-$1,000
Liabilities
-$1,500
Other
-$2,000
Currency in Circulation
Source: U.S. Federal Reserve.
5-Nov-09
5-Sep-09
5-Jul-09
5-May-09
5-Mar-09
5-Jan-09
5-Nov-08
5-Sep-08
5-Jul-08
5-May-08
5-Mar-08
5-Jan-08
5-Nov-07
5-Sep-07
-$2,500
11
Concurrently, the U.S. Treasury has increased its debt. Why? Because it can (borrow at a reasonable cost).
The Fed and Treasury are using their last non-inflationary bullets in an attempt to restart credit-driven
growth, but we believe their efforts are counter-productive to the normal market need to liquidate land, labor
or capital when one factor of production is in surplus relative to the others.
Source: Ned Davis Research.
12
The historian Will Durant wrote that "Since practical ability differs from person to person, the majority of such abilities, in
nearly all societies, is gathered in a minority of men. The concentration of wealth is a natural result of the concentration of
ability and regularly occurs in history” (left chart). Currently, the top 20% receive half the income, and we know from other
research sources that the bottom 50% pay no net income tax (only payroll taxes). That seems to us a level of
disenfranchisement(1) not seen since imperial, plutocratic Rome. As a result, U.S. government deficits (right chart) may
reflect poor tax base dynamics. Concentration of wealth due to the concentration of ability produces systemic instability,
which then leads to "…redistribution of wealth through taxation, or redistribution of poverty through revolution," according
to Durant. The U.S. has historically chosen taxation and inflation (1930s-1940s, 1960s-1970s) as forms of confiscation
rather than revolutionary expropriation. The end result is similar, the former just gives investors more time to prepare.
Source: Ned Davis Research.
(1) As the Roman Empire progressed from being farmers/citizens/soldiers with a stake in the affairs of state to a disenfranchised Plutocracy forced to “buyoff” the masses many of which were on the dole, the Empire crumbled from the inside.
13
In closing this section of our report, investors in 2008 & 2009 were whipsawed by the best and worst years, backto-back, in a half century for stocks relative to long-term U.S. government bonds. The U.S. dollar mirrored those
moves, soaring and plunging. We think this turn of events marks the end, or at least the terminal phase, of creditdriven asset inflation and moral hazard related to guarantees. At this point we are simply interested in the
mechanics of de-leveraging and the implications of consumer credit retrenchment for the U.S. equity market.
Total Return of Large Cap Stocks Minus
Total Return of Long-Term Government Bonds
2009: Best year in a
half century for U.S.
stocks relative to
long-term Treasuries.
60%
40%
20%
0%
-20%
-40%
2008: Worst year in a
half century for U.S.
stocks relative to
long-term Treasuries.
-60%
Source: “A New Historical Database for the NYSE 1815 to 1925: Performance and Predictability” William N. Goetzmann, Roger G. Ibbotson, Liang Peng, Yale
School of Management; 1925-to-present are Ibbotson Associates large-cap total return and Standard & Poor’s data.
2010E
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
-80%
14
U.S. Equity Market Outlook
1.
Longer term, from Dec-2009 to Dec-2019, we expect the S&P 500, dividends reinvested, to produce a backhalf (i.e., mostly 2015 to 2019) loaded 7% CAGR return (i.e., a price double with dividends reinvested).
2.
Intermediate term, we do not expect the S&P 500 to break out of its 2000 to 2010 price range of ~$667$1,576 until 2015, thus forming a classic secular bear market 15-year trading range.
3.
An S&P 500 price of ~$1,100 (close to the current price) is the midpoint of the 10-year secular bear market
range. This price may be thought of as a “ledge” or a “step,” depending on the investor’s outlook.
4.
Short-term, we believe the S&P 500 price moves up from the $1,100 midpoint outlined above, but we
remain alert and have no intention of fighting the tape (a wise strategy in a range-bound market).
5.
The nominal low in a secular bear market is usually ~7-10 years before a new secular bull market begins;
Mar-09 ($667) appears to us to have been the nominal low, although inflation could produce a deeper “real”
or inflation-adjusted low by 2015. We are taking a wait-and-see approach to inflation.
15
Equities have long been a hedge against inflation, and have always recovered from deflation. From December
2009 to Dec-2019 we expect the S&P 500, dividends reinvested, to produce a back-half (i.e., mostly 2015 to
2019) loaded 7% CAGR return (a price double, dividends reinvested), consisting of EPS growth of ~5.2% plus
dividend returns of 2.8% with a flat P/E. If P/E ratios fall due to inflation, nominal EPS growth should rise, all
else being equal, still equaling a 7% CAGR return. We do not expect the S&P 500 to break out of its 2000 to
present range of about $667 to $1,576 until 2015, a classic secular bear market trading range.
S&P Stock Market Composite 10-Year Compound Annual Total Return (Incl. Reinvested Dividends)
Data 1830 to February-23-2010
We foresee a
7% CAGR
S&P 500
total return
to 2019,
back-half
loaded. That
means
investments
made today
could double
by 2019.
22.5%
20.0%
17.5%
15.0%
12.5%
10.0%
7.5%
X
5.0%
After the 1938 low a
new secular bull
market did not begin
until 1949, and after
the 1974 low a new
secular bull market did
not begin until 1982.
2.5%
0.0%
We think 2008
was the low
for rolling S&P
500 total
return.
Source: “A New Historical Database for the NYSE 1815 to 1925: Performance and Predictability” William N. Goetzmann, Roger G. Ibbotson, Liang Peng, Yale
School of Management; 1925-to-present are Ibbotson Associates large-cap total return and Standard & Poor’s data.
2009
1999
1989
1979
1969
1959
1949
1939
1929
1919
1909
1899
1889
1879
1869
1859
1849
1839
-2.5%
16
Secular bear markets flatten in nominal terms (but decline in real terms, after inflation) for ~14 years (average of the past
cycles below), and this secular bear began in 2000. The nominal low in a secular bear is usually seen ~7-10 years before a
new secular bull begins, and we believe 2009 may have been the nominal low in this cycle. We believe secular bear markets
end when equity has been de-capitalized as a percentage of GDP and all types of investors have been impacted, e.g., buy
and hold loses capital or purchasing power, momentum buys high/sells low several times, and market timers lose because
increased awareness of the secular bear market causes rallies to expend the bulk of their return quickly (ex., the 2009 rally).
Real (Inflation-adjusted) Dow Jones Industrial Average (2008$) versus Nominal Dow Jones
Industrial Average - Chart is through most current data
$100,000
2000 to ….
Inflation-adjusted Dow
Jones Industrial
Average
$10,000
2009
was
the
secular
bear
nominal
low, in
our
view.
1966 to 1982
$1,000
1929 to 1942
1907 to 1921
1974
was
the
low
1982
new
secular
bull
market
Dow Jones
Industrial Average
$100
1914
was
the
low
1921
new
secular
bull
market
1942
new
secular
bull
market
1932
was
the
low
Source: Dow Jones, U.S. Census, Stifel Nicolaus format.
2006
2001
1996
1991
1986
1981
1976
1971
1966
1961
1956
1951
1946
1941
1936
1931
1926
1921
1916
1911
1906
1901
1896
$10
17
The left chart shows that the 1910s, 1940s and 1970s secular bear markets featured M2 money supply growth of ~10% y/y and
inflation of ~7%, while the 1920s, 1950s, 1990s and 2000s secular bull markets corresponded with ~5% M2 and ~2% inflation.
The P/E level associated with 2-3% CPI is ~17x, and the S&P 500 P/E associated with 7% inflation is ~11x (right chart). If, for
example, S&P 500 EPS are $75 in 2010 that may be worth ~$1,275 ($75 x 17), but signs of inflation (or deflation, both destroy
capital) could push the P/E quickly to 11x or $825 ($75 x 11) before “damage” becomes apparent to EPS. The S&P 500 recently
found some support at ~$1,050, exactly half way between those extremes as the S&P 500 looks for “direction.”
U.S. Consumer Price Inflation (Inverted, Right Axis)
vs. S&P 500 P/E Ratio (Left Axis)
M2 Growth vs. CPI Growth
Average Annual Growth
10%
26X
-5.0%
25X
9%
-4.0%
24X
-3.0%
23X
1910s
1970s
7%
22X
-2.0%
21X
-1.0%
20X
6%
0.0%
19X
1980s
5%
*
4%
1990s
3%
17X
2.0%
16X
3.0%
15X
4.0%
14X
5.0%
13X
1950s
2%
1.0%
18X
1940s
2000s
1960s
1%
12X
6.0%
11X
7.0%
10X
1920s
-2%
1930s
Trailing 2-year range of actual
M2 growth = 5% to 10% y/y
-3%
M2 Money Supply (Average Annual Percent Growth)
*1940s
inflation
affected
by W.W.
II price
controls.
Source: Standard & Poor’s, U.S. Census, NBER.org Macro-history Database, Federal Reserve.
7X
10.0%
6X
11.0%
2015E
-1%
9.0%
8X
2010E
11%
2005
10%
2000
9%
1995
8%
1990
7%
1985
6%
1980
5%
1975
4%
1970
3%
1965
2%
1960
1%
1955
0%
1950
0%
8.0%
9X
1945
CPI Growth (Average Annual Percent Growth)
8%
P/E of the S&P 500, 5-Yr. Moving Average (Left Axis)
U.S. Consumer Inflation, Y/Y % Change, 5-Year Moving Average (Right Axis)
18
Crude Oil Factors to Consider
1.
The balance of years in the next several probably favor the price return of U.S. equities over commodities
until such time that inflation materializes, which we do not expect until ~2013, if at all.
2.
Secular bear markets featured multiple bottoms for stocks relative to commodities before a sustained bull
market for equities may begin. We see commodities their last major price rally ~2013-14 for this cycle.
3.
We’re nimbly “trend following” rather than making hard projections, but we think oil has more down than
upside, while the S&P 500 only needs modest – not strong – recovery in civilian jobs to vault higher.
4.
We expect oil to remain ~$75/bbl. +/- $10/bbl. narrowly speaking, and at most $53/bbl. to $89/bbl. very
broadly speaking through 2012. Equities closely correlated to oil prices may follow the trend in oil.
19
Commodity prices are of great interest to us because we shaped our coverage to benefit from commodities about 10 years
ago. The left chart shows that the relative strength versus the S&P 500 of farm equipment maker Deere & Co. since 1927
tracks commodity prices, as does the relative strength of global engineer Fluor Corp., shown in the right chart since 1965.
U.S. Commodity Price Index*, y/y% change, 1912 to 2010 latest, 5-yr.
M.A. versus Deere relative to the S&P 500 1927 to Present
Crude oil and FLR stock relative strength
versus the S&P 500, 1965 to 2010 latest
28%
40%
7%
18%
25%
35%
15%
6%
4%
6%
3%
3%
0%
2%
-3%
30%
20%
18%
25%
15%
20%
13%
15%
10%
8%
10%
5%
1%
-6%
5%
3%
2008
2014E
2002
1996
1990
1984
1978
1972
1966
1960
1954
1948
1942
1936
1930
Dec-09
Dec-07
Dec-05
Dec-03
Dec-01
Dec-99
Dec-97
Dec-95
Dec-93
Dec-91
Dec-89
Dec-87
Dec-85
Dec-83
Dec-81
Dec-79
Dec-77
Dec-75
Dec-73
Dec-71
Dec-69
1924
0%
0%
Dec-67
1918
0%
Dec-65
1912
-9%
* P ro ducer P rice Index fo r Co mmo dities 1907-56, CRB Futures 1957-present
Commodity Price Index, y/y % change, 5-yr. moving average, left axis
Deere stock relative to the S&P 500 (S&P Composite in earliest periods), right axis
WTI oil price relative to the S&P 500
FLR price relative to the S&P 500
Source: Factset prices, Moody’s / Merchant Manual prices split-adjusted, EIA oil prices, Stifel Nicolaus format.
20
FLR price relative to the S&P 500
9%
WTI oil price relative to the S&P 500
Commodity Prices, y/y %,
5-yr. mov. avg.
5%
Deere stock divided by the S&P 500
12%
23%
Commodity price momentum appears to be coming off a cyclical high (left chart), while the S&P 500 total return (price
change + dividend) momentum appears to be coming off a cyclical low (right chart). The balance of years in the next
several probably favor U.S. equities over commodities until (if) inflation materializes, which we do not expect until ~2013.
Commodity prices are cyclical and move in unison
Commodities by category, data 1795 to January-2010, 10-yr. M.A.
Cold War/Bretton
Woods/OPEC
22%
20%
18%
S&P Stock Market Composite 10-Year Compound Annual
Total Return (Incl. Reinvested Dividends),
Data 1830 to Feb-23, 2010
22.5%
War of
1812
W.W. I
20.0%
16%
14%
Civil
War
12%
10%
8%
6%
Easy
credit
specul
ative
boom.
U.S.
industrial
revolution &
overheating /
gold surplus.
W.W. I I
&
Korean
Conflict
17.5%
15.0%
12.5%
4%
10.0%
2%
0%
7.5%
-2%
5.0%
-4%
-6%
2.5%
-8%
-10%
0.0%
Source: Stifel Nicolaus format, data Historical Statistics of the United States, a U.S. Census publication.
21
2009
1999
1989
1979
1969
1959
1949
1939
1929
1919
1909
1899
1889
1879
1869
1859
Fuels & Lighting
1849
All Commodities
-2.5%
1839
1805
1810
1815
1820
1825
1830
1835
1840
1845
1850
1855
1860
1865
1870
1875
1880
1885
1890
1895
1900
1905
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
-12%
The 140-year chart below measures the relative performance of the U.S. stock market (S&P) index relative to commodities.
Note that the 1932 to 1942 as well as the 1974 to 1982 periods featured multiple bottoms before a sustained bull market for
equities began. We believe a bottoming process/oscillation has begun for the period 2010 to 2015.
Relative price strength, stocks vs. commodities, log scale
U.S. Stock Market Relative to The Commodity Market, 1870 to December 1, 2009.
Key: When the line is rising, the S&P stock market index beats the commodity price
index and inflation eventually falls. When the line is falling, the opposite occurs.
100.0
10.0
Populism in U.S.
politics.
Panic of 1907, a
banking crisis &
stock m arket
WW1
crash.
1914 to
1918
1.0
'29
Crash
OPEC '73
em bargo;
1973-74 Bear
Market, Iran
fell '79.
Pearl Harbor,
WW2
1939-45
OPEC overplays hand and
oil prices collapse 1981,
Volcker stops inflation
1981-82, then Reagan tax
cuts, long Soviet
collapse, disinflation &
bull m arket begin.
Post-WW 2
com m odity &
inflation bubble
bursts ca. 1950,
disinflation
ensues,
Eisenhow er bull
m arket begins.
Post-WW 1
com m odity
bubble bursts,
deflation ensues
in 1920, bull
m arket begins.
Post-Civil War
Reconstruction ends in
1877, gold standard
begins 1879,
deflationary boom ,
stocks rally.
0.1
LBJ's Great
Society +
Vietnam 1960s;
Nixon closed
gold w indow
1971, all
inflationary.
Gold
nationalized
U.S.$ devalued
in 1933. FDR's
"New Deal" &
reflation
begins.
Tech Bubble 2000,
9/11, Mid-East w ars,
Asian oil use, strong
global U.S.$ dem and
after the 1990s
em erging m arkets
debt crisis, credit
crisis in U.S.
2015E
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
1925
1920
1915
1910
1905
1900
1895
1890
1885
1880
1875
1870
0.0
U.S. stock market composite relative to the U.S. commodity market, 1870 to present
Source: Standard & Poor’s (S&P composite joined to S&P 500), U.S. government (PPI for Commodities joined to the CRB spot then the CRB futures).
22
In the spirit of this momentum market, we’re nimbly “following the trend” rather than making projections, but if
we had to speculate we believe oil is vulnerable for currency (U.S. dollar strength) and fundamental (OPEC
6mb/d over-capacity, as well as refined product over-capacity), whereas the S&P 500 only needs modest – not
at all strong – recovery in civilian jobs to vault higher, especially if the “tax” on consumption of oil prices were
to moderate.
…could be another asset’s
head-and-shoulders.
One asset’s 50% retracement…
S&P 500
Daily price 1/1/05 to 2/18/10
WTI Oil $/bbl. (blue)
Daily price 1/1/05 to 2/18/10
$155
$1,600
$145
$1,500
$135
$125
$1,400
50% retrace
complete
$1,300
An emerging
head-andshoulders?
$115
$105
$95
$1,200
$85
$1,100
$75
$65
$1,000
$55
$900
$45
?
$35
$800
$25
$700
$15
$5
$600
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Source: Factset prices, Stifel Nicolaus format.
23
We see the U.S. status as a debtor nation as the spoils of war, the benefit of defeating the fascists (WW2) and
collectivists (Cold War). The dollar surged after WW2 with the Bretton Woods Agreement in which the U.S. dollar tied
to gold and the world’s currencies floated (usually down) versus the dollar. As capitalism and/or democracy (the
debate rages over whether one can exist without the other) have proliferated, the U.S. dollar has fallen since the early
1970s (break in the blue line, the end of Bretton Woods), mirroring the falling U.S. share of world GDP (red line), the
result not of U.S. “decline” but rather rising wealth in the rest of the world. As the reserve currency country, the U.S.
logically chose to accumulate debt as well as gradually inflate. Given poor debt fundamentals we see emerging
overseas, a rally in the U.S. dollar beyond what we have seen in 2010 would not surprise us.
Nominal Trade-Weighted U.S.$ Major Currency Index, 1935 to 2009 (Left) versus U.S. GDP as a
share of global GDP expressed in U.S. $, 1950 to 2010E (Right)
Bretton Woods
Agreement
began U.S. dollar
bubble; U.S. share
of world GDP
dominates.
90
80
70
28%
26%
Emerging markets
reserves increase,
dollar rallies.
100
24%
22%
20%
Vietnam, social
programs, EU and
Japan recovery weigh
on dollar resulting is
gold outflows.
60
18%
16%
50
2015E
2010E
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
12%
1950
30
1945
14%
1940
40
1935
Nominal trade-weighted U.S. $
110
Fed's Volcker hikes
rates sharply.
U.S. GDP share of global GDP (expressed
in U.S. $)
Fed tightens 1969, dollar
rallies, Martin > Burns Fed
transition 1970 then Bretton
Woods abandoned 1971
120
Source: U.S. GDP with a base year 1990 links the OECD Geary-Khamis 1950 to 1979 series to the IMF World Economic Outlook 1980 to present series, including 2009
& 2010 estimates. U.S. dollar data is from the U.S. Federal Reserve 1971 to present, for 1970 and prior we use R.L. Bidwell - “Currency Conversion Tables - 100 Years
of Change,” Rex Collins, London, 1970, and B.R. Mitchell - British Historical Statistics - Cambridge Press, pp. 700-703. For trade weightings pre-1971 we use “Historical
Statistics of the United States, Colonial Times to 1970,” a U.S. Census publication.
24
After “bursting a bubble” in oil following a “standard” disbelief, belief and euphoria 3-stage bubble 1999-2008 (left chart), we
see oil as range bound until inflation takes hold in the U.S. economy circa 2013-2015. Oil continues to track the U.S. dollar
(right chart), and the DXY dollar index equates to an oil price ~$80/bbl. currently (right chart). We expect oil to remain ~$75/bbl.
+/- $10/bbl. narrowly speaking, and at most $53/bbl. to $89/bbl. range very broadly speaking through 2012.
Crude oil price, $/bbl. (month-end prices)
depicting the "typical" bubble 3-stage bull market
that breaks and segues to a trading range
$150
WTI Oil $/bbl. (blue), U.S. dollar (DXY) (green)
Daily price 10/1/02 to Present
105
$0/bbl.
$140
$130
$10/bbl.
WTI Oil
$/bbl.
100
$20/bbl.
$120
Euphoria
~$55 to $147 (high)
= ~3x
$40/bbl.
DXY U.S. dollar Index
$100
$90
$80
$70
Belief
~$24 to $74
= ~3x
$60
$50
90
$50/bbl.
$60/bbl.
85
$70/bbl.
$80/bbl.
80
DXY
dollar
index
75
Disbelief
~$11 to $34
= ~3x
$40
$30/bbl.
95
$90/bbl.
$100/bbl.
$110/bbl.
70
$30
$120/bbl.
$20
$130/bbl.
65
$10
$140/bbl.
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
Jan-05
Jul-04
Jan-04
1998
$150/bbl.
Jul-03
Source: U.S. Federal Reserve, FactSet, Stifel Nicolaus.
60
Jan-03
1997
$0
25
WTI Oil/bbl.
$110
If oil doesn’t actually cause a recession, we believe it certainly renders the coup de grâce by causing already slowing GDP
to “go negative.” As a result, following oil is critical for any industrial analyst. This chart also shows that particularly deep
U.S. recessions occur at ~$85/bbl. and higher (in inflation-adjusted terms), consistent with our earlier charts.
$140.00
Real Crude Oil prices (left axis, solid area) vs. y/y GDP converted to monthly (right axis)
10.0%
$130.00
9.0%
$120.00
8.0%
7.0%
$110.00
6.0%
$100.00
5.0%
$90.00
4.0%
$80.00
3.0%
$70.00
2.0%
$60.00
1.0%
$50.00
0.0%
-1.0%
$40.00
-2.0%
$30.00
-3.0%
$20.00
-4.0%
-5.0%
$0.00
-6.0%
Jan-73
Jan-74
Jan-75
Jan-76
Jan-77
Jan-78
Jan-79
Jan-80
Jan-81
Jan-82
Jan-83
Jan-84
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
$10.00
Inflation- adjusted Crude Oil $ per bbl
U.S. Real GDP Monthly y/y % chng (left)
Source: U.S. Department of Commerce, BEA, NYMEX.
26
U.S. consumer use of gasoline has historically plunged when inflation-adjusted retail gasoline prices have broken
through $2.85/gallon, equivalent to inflation-adjusted crude oil prices of ~$85/bbl. at more “normal” crack spreads. We
see $85/bbl. as a ceiling for inflation-adjusted crude oil prices for the foreseeable future. Nominal crude oil prices would
thus only exceed $85/bbl. when U.S. inflation accelerates, which we would not expect until ~2013-15 at the earliest.
US Oil Demand vs. Inflation adjusted Retail Gasoline
23
22
4.00
21
3.50
20
3.00
19
2.50
18
17
2.00
US Oil Demand (mil b/d)
Inflation adj. U.S. All Grades Retail Gasoline
Prices ($/gallon)
4.50
16
1.50
15
Inflation adjusted U.S All Grades Retail Gasoline Prices ($ per Gallon)
Source: U.S. DOE and government data, Stifel Nicolaus format.
Jan-09
Jan-07
Jan-05
Jan-03
Jan-01
Jan-99
Jan-97
Jan-95
Jan-93
Jan-91
Jan-89
Jan-87
Jan-85
Jan-83
Jan-81
Jan-79
Jan-77
Jan-75
14
Jan-73
1.00
US Oil Demand (mil b/d)
27
Long-term global oil demand growth has
been 1.5%/year (0%-3% range) between
deep recessions, shown in the top chart,
and we expect this to continue.
4.5%
4.0%
3.5%
3.0%
2.5%
1.0%
2010E
2008
2009E
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
-1.0%
1983
-0.5%
1982
0.5%
0.0%
-1.5%
-2.0%
-3.0%
-3.5%
-4.0%
-4.5%
Non-G7 oil demand (bars), y/y % demand growth (line),
1981 to 2010E: The trend supports +2.75%/year growth
(line) for 89% of the world population that
currently uses 60% of the world's oil.
55,000
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
-5.0%
-6.0%
-7.0%
-8.0%
-9.0%
8.0%
50,000
50,000
7.0%
5.0%
4.0%
+ 1 st. deviation
40,000
3.0%
2.0%
1.0%
35,000
0.0%
-1.0%
-2.0%
30,000
-3.0%
- 1 st. deviation
-4.0%
25,000
-5.0%
Oil consumption (000 bbl/d)
45,000
G7 oil consumption, y/y %
6.0%
45,000
+ 1 st. deviation
40,000
- 1 st. deviation
35,000
30,000
25,000
-6.0%
G7 oil consumption thous. b/d
Non-G7 oil consumption thous. b/d
G7 oil consumption Y/Y%
Non-G7 oil consumption Y/Y%
Source: EIA, BP Statistical Review of World Energy, United Nations, IEA, Stifel Nicolaus format.
The G7 is the U.S., U.K., Japan, Germany, France, Italy, and Canada.
2009E
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
20,000
1981
2009E
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
-7.0%
1981
20,000
28
Non-G7 oil consumption, y/y %
G7 oil demand (bars) and y/y % demand growth (line),
1981 to 2010E: The trend supports
-0.25% growth (line) for 11% of the world
55,000
10.0%
population that currently uses 40%
9.0%
of the world's oil
Oil consumption (000 bbl/d)
With OPEC spare oil producing capacity
of ~6mb/d and Saudi Arabia only wishing
to retain ~2mb/d of spare capacity, and
with Manifa in Saudi Arabia and rising
Iraq production only enhancing future
OPEC capacity, we believe that “excess
spare” capacity of 4mb/d (6 minus 2)
already exists to cover 3 years of world
oil demand growth [1.5% x 85 mb/d world
oil demand = 1.275 mb/d, which divided
by 4 mb/d is ~3 years].
1.5%
-2.5%
The non-G7 is 89% of the world
population and 60% of world oil demand,
with +2.75%/year usage growth (red
regression line, lower right chart),
indicative of demand creation.
The resulting average is [0.40 x (0.25)% +
.60 x 2.75%] = +1.6%/yr., which is close to
the historical average of 1.5% shown in
the top chart.
2.0%
1981
World oil consumption y/y %
The G7 (G7 is the U.S., U.K., Japan,
Germany, France, Italy, and Canada) is
11% of global population and 40% of
annual world oil demand, with a long-term
demand declining trend of ~(0.25)%/year
(red regression line, lower, left chart),
indicative of demand destruction, not
demand deferral.
Y/Y growth of oil demand 1981 to 2010E
Historical growth of +1.5% +/- 1.5% (e.g. 0% to 3%) outside of deep recessions
Future growth of [0.40 G7 demand x (0.25)% + .60 non-G7 demand x 2.75%] = +1.6%/yr.
China: Aspiring or Expiring?
1.
China’s rise is “real,” but the country is caught on a hamster wheel of strong total factor productivity leading
to high corporate and consumer savings rates that are then recycled into still more fixed investment.
2.
Just as a centralized economic system can allocate capital more quickly than a free market, a free market
(individual agents maximizing utility) can allocate more efficiently than a centralized system.
3.
That is why the U.S. is liquidating land, labor & capital and floating the U.S. $ while the Chinese are
employing massive expansion of bank loans and fixing their currency to avoid such adjustments. The U.S.
approach is more sound, in our view.
4.
China’s lending surge is not new, the country pumped up lending in the last recession eight years ago. The
problem is at the margin - ever larger amounts of lending are required to achieve the same effect.
5.
Chinese bank lending ($1.4 trillion in 2009, 29% of GDP) and currency policies are driving rapid Chinese M1
growth. Besides fixed investment or asset bubbles, China risks inflation, so policy is tightening.
6.
We see inflation pressuring emerging market P/E multiples while disinflation lifts P/E multiples for traditional
U.S. “growth” stocks, punishing the herd that is heavily invested in emerging market equities.
29
Just as a centralized economic system can allocate capital more quickly than a free market, a free market (of individual
agents acting to maximize their own utility) can allocate more efficiently than a centralized system. The U.S. is liquidating
land, labor and capital and floating the U.S. dollar while the Chinese are employing massive, rapid expansion of bank loans
and currency intervention to avoid such adjustments. The U.S. approach is much more sound, in our view. Chinese bank
loan growth the past year has been driving exuberance for minerals, especially those used in construction. We spot
“bubble trouble,” however, and note that the PBOC and Chinese banking regulators have already announced measures to
curb loan growth.
China bank loans (billion yuan, bars, left axis) vs.
China iron ore imports (LTM tons, mil., line, right axis)
China bank loans (billion yuan, bars, left axis) vs.
China net coal* imports (LTM tons, mil., line, right axis)
45,000B Yuan
110.0mt/y
40,000B Yuan
37,500B Yuan
35,000B Yuan
45,00
70.0mt/y
100.0mt/y
Surge in
lending
coincides
with surge
in net coal
imports.
42,500B Yuan
45,000B Yuan
China bank loans (bil. yuan/month, bars, left axis) vs.
China oil usage (LTM, mil. bbls./day, line, right axis)
90.0mt/y
80.0mt/y
42,500B Yuan
40,000B Yuan
70.0mt/y
60.0mt/y
37,500B Yuan
50.0mt/y
35,000B Yuan
40.0mt/y
Surge in
lending
coincides
with surge
in iron ore
imports.
65.0mt/y
60.0mt/y
45,000B Yuan
42,500B Yuan
40,000B Yuan
55.0mt/y
37,500B Yuan
50.0mt/y
35,000B Yuan
30.0mt/y
32,500B Yuan
32,500B Yuan
10.0mt/y
9.5mb/d
9.3mb/d
32,500B Yuan
30,000B Yuan
40.0mt/y
27,500B Yuan
37,50
8.8mb/d
35,00
8.5mb/d
32,50
8.3mb/d
30,00
8.0mb/d
27,50
7.8mb/d
25,00
7.5mb/d
35.0mt/y
7.3mb/d
-20.0mt/y
25,000B Yuan
30.0mt/y
25,000B Yuan
7.0mb/d
22,500B Yuan
6.8mb/d
-30.0mt/y
22,500B Yuan
22,500B Yuan
25.0mt/y
-40.0mt/y
-50.0mt/y
20,000B Yuan
20,000B Yuan
20.0mt/y
17,500B Yuan
15.0mt/y
-70.0mt/y
20,000B Yuan
12,50
6.3mb/d
10,00
17,500B Yuan
6.0mb/d
15,000B Yuan
10.0mt/y
15,000B Yuan
12,500B Yuan
5.0mt/y
12,500B Yuan
5.8mb/d
5.5mb/d
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
Jan-10
Sep-09
Jan-09
May-09
Sep-08
Jan-08
May-08
Sep-07
Jan-07
May-07
Sep-06
Jan-06
May-06
Sep-05
Jan-05
May-05
Sep-04
Jan-04
May-04
-100.0mt/y
*Met coal +
anthracite +
steam coal
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
-90.0mt/y
12,500B Yuan
China M1 y/y% (Left Axis)
Total
Loans y/y%
(Right of
Axis)
Source:
People’sQuarterly
Bank ofChinese
China,
National
Bureau
Statistics
of China, FactSet, Stifel Nicolaus Metals & Mining research.
36%
36%
34%
32%
30%
28%
33%
30%
27%
17,50
15,00
-80.0mt/y
15,000B Yuan
20,00
6.5mb/d
-60.0mt/y
17,500B Yuan
22,50
27,500B Yuan
-10.0mt/y
25,000B Yuan
40,00
9.0mb/d
30,000B Yuan
0.0mt/y
27,500B Yuan
42,50
45.0mt/y
20.0mt/y
30,000B Yuan
No such surge in
oil usage,
because the
lending program
was geared
toward
“infrastructure.”
30
China’s lending surge is not new in terms of percentage growth, a similar surge occurred during the recession of the
previous decade (left chart). The problem is that ever larger amounts of lending are required to achieve the same effect.
Chinese bank lending ($1.4 trillion in 2009, 29% of GDP) and currency policies are driving Chinese M1 growth (middle
chart). Besides fixed investment or asset bubbles, China risks inflation (right chart), so policy is already tightening.
40%
China bank loans (billion yuan, bars, left axis) vs.
China bank loans y/y % change (line, right axis)
34%
35%
32%
30%
13%
12%
11%
10%
40%
38%
36%
34%
32%
30%
9%
28%
28%
8%
30%
26%
22%
22%
5%
20%
20%
4%
18%
25,000B Yuan
4%
2%
-4%
2%
14%
12%
Jan-10
Jan-10
-3%
Jan-09
6%
4%
Jan-08
6%
Jan-07
0%
8%
-2%
Feb-01
Jun-01
Oct-01
Feb-02
Jun-02
Oct-02
Feb-03
Jun-03
Oct-03
Feb-04
Jun-04
Oct-04
Feb-05
Jun-05
Oct-05
Feb-06
Jun-06
Oct-06
Feb-07
Jun-07
Oct-07
Feb-08
Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
10,000B Yuan
-1%
Jan-06
12,500B Yuan
10%
8%
Jan-05
5%
0%
Jan-04
15,000B Yuan
10%
Jan-03
17,500B Yuan
12%
1%
Jan-02
10%
2%
Jan-01
20,000B Yuan
16%
14%
Jan-00
15%
22,500B Yuan
18%
3%
16%
Jan-09
20%
Jan-08
27,500B Yuan
Jan-07
30,000B Yuan
24%
6%
Jan-06
25%
Jan-05
32,500B Yuan
26%
7%
24%
Jan-04
35,000B Yuan
Jan-03
37,500B Yuan
36%
Jan-02
40,000B Yuan
40%
Jan-01
42,500B Yuan
The issue isn’t that loan growth is
strong, it was similarly strong in
response to the recession a
decade ago. The issue is the ever
larger amounts of debt, and the
circular role debt plays in growth,
leading to more lending capacity.
Jan-00
45,000B Yuan
…and despite
claims of an output
gap, extraordinary
M1 growth is
historically
inflationary.
14%
Chinese bank loans
(and currency
policy) are driving
extraordinary M1
money supply
growth...
38%
China M1 money supply y/y%
China CPI All Items y/y% (Left Axis)
Chinese total bank loans y/y%
M1 y/y% (Right Axis)
Source: People’s Bank of China, National Bureau of Statistics of China, FactSet.
31
The old adage is that if the U.S. catches a cold, the rest of the world gets pneumonia. The crisis of 2008 began in the U.S., but
ironically (though not surprisingly) the flight to safety pushed the U.S. dollar higher! Alternatively, perhaps Chinese and
European currency and debt policies are inherently weaker approaches than the laissez-faire U.S. approach to the dollar. If the
U.S. dollar strengthens for such reasons, we believe that would have the economic effect of “importing deflation and exporting
inflation” to the devaluing countries. As a result, P/E multiples in the emerging markets may compress with rising inflation (left
chart), while disinflation could simultaneously lift U.S. equity P/E multiples for traditional “growth” stocks. All of this would
likely punish the herd that is heavily invested in emerging market equities (right chart). Such is the cruel way of Mr. Market.
Source: Bank Credit Analyst
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