June 2, 2020
The relentless (truly unbelievable) rise in markets is baffling in many ways. There are many different metrics, predictors of economic activity that have proven to be historically meaningful. The Dow Transports tell a story of shipping as does the Baltic Dry Index which is a measure of the price to ship goods. The price of copper is a metric of real demand in the economy, and is often called Dr. Copper.
While the information transmitted by these metrics may be just as suspect in the age of COVID-19, they are generally less volatile than using employment data, or even equity prices. They reflect actual economic activity.
The theory is that when Dow Transports (DT) cross below the Dow Jones Industrial Average (DJ), that markets will fall. Transportation is what allows goods to move through the economy. The complexity of the supply chain means that this has become a bit less certain, but the theory still holds great merit. Here is a weekly chart of the DJ (black) versus the transports (orange). If the theory holds, then economic activity is still constrained. It is worth noting that companies like UPS, Fedex and Amazon are seeing significant activity due to the COVID-19 outbreak, but a significant amount of transport activity is related to rail, air travel and other commercial trucking.
The Baltic Dry Index is another shipping metric that measures the price to ship goods by sea, and it confirms results similar to the Dow Transports. The chart below shows the data on a weekly basis all the way back to 2011. Note that the last time readings were this weak was in 2016, when markets went through seven tough months of volatility.
Worth noting on the BDI chart is the significant decline beginning in July of 2019. If it is possible to apply meaning based on this one data point, this would suggest that the shipping was declining well before the outbreak of COVID-19.
Over the past thirty years, markets have undergone massive changes and one of the more noticeable changes is the shift away from a product based economy to an economy that includes massive growth in technological services. Software, communications, ‘apps’, web services and much more mean that the economy for hard goods has been diminished in importance. That said, copper use remains a significant metric of industrial activity. Its importance gives it a moniker of Dr. Copper.
Below is a chart of copper’s price on a weekly basis over the past five years. While the price is recovering from the COVID crash, it remains stubbornly weak based on recent history.
There are other measures as well, with electricity demand being one of them. The International Energy Agency (IEA), which is primarily focused on Europe has an excellent review of of electricity demand for European Countries and China, with updates to early May. In general it shows that demand is down about 20%. Near term charts are harder to find for the US, but the US Energy Information Administration (EIA) is predicting a 5% downturn in electricity demand for the entire year.
Indicators such as these are helpful in validating a thesis of market weakness, but when the economy is under extreme stress, their value has to be discounted somewhat by the volatility in the underlying information. For example, the marketplace is currently facing an oversupply of many commodities and suppliers are, in many cases, marginally profitable. A significant drop in demand will lead to significant swings that may be unrelated to long term fundamentals. While this sounds like the general situation, the high debt loads being carried by many market participants can exacerbate the price moves. This was particularly apparent in April when oil traded below zero.
Overall, the rise in the markets, returning to where they started the year, when viewed through the various market disruptions and the turmoil being experienced in the ‘real’ world are difficult to reconcile.
- COVID-19 has done significant damage to the economy in 2020 and there is significant risk to the economy in the future through reduced consumer activity
- Trade relationships are being strained due to COVID-19 as well as the US dismantling of significant partnerships and sovereign relationships.
- The US and China appear to be renewing trade disagreements
- The US is undergoing significant social strain with both reaction to COVID policies as well as the unreasonable death of a number of black people who were no apparent threat.
While it is difficult to predict when the economic fundamentals will be accommodated in the pricing of financial assets such as bonds and equities, it is unlikely that the pricing, out of step with those fundamentals, can persist indefinitely.