Markets have one main function in life – price discovery. If I want to buy, and you want to sell, the existence of a market allows us to discover the price at which the market will balance in terms of supply and demand.
History, however, provides many examples of times when rulers decided they knew best, and destroyed market economics. The Soviet Union was one recent example, where the Central Committee of the Communist Party would decide what was going to be made and where, and the price at which it was being sold. That system of course collapsed with the Berlin Wall in 1989, but the collapse took decades to happen.
Today, we have another central organisation which is attempting to carry out the same manoeuvre – the main central banks in the West. They have also destroyed price discovery by flooding markets with endless supplies of free cash. The evidence for this statement is in the 3 charts shown here.
The chart above shows capacity utilisation (CU%) in the global chemical industry – the best real-time indicator that we have for the global economy. New data from the American Chemistry Council shows CU% fell yet again in August to 78.7%, nearly 2 percentage points below August 2015:
This pattern has only been seen before in 2001 and 2008, which were not good years for the industry or the global economy
It has now fallen every month this year, and the 2009 – 2016 average is nearly 10 percentage points below the average seen before the Financial Crisis began in 2008
The second chart confirms the downturn underway. It shows earnings for the UK’s FT 500 Index since 1985, set against the price/earnings ratio. As one would expect, given the CU% decline, earnings have been tumbling in the past year:
They peaked at almost 400 in mid-2011, and had eased to around 200 by mid-2015
Since then, they have more than halved to just 93 on Friday
Normally, of course, this would mean that market prices also fell, as the outlook for earnings worsened.
But the opposite has in fact happened, as the central banks have simply pumped out more and more free cash. They have even taken interest rates to negative levels in many major markets such as Japan, Germany and the UK.
Investors, increasingly desperate to try and meet their target returns for paying pensions etc, have responded by bidding up the price/earnings ratio from 18 a year ago to 49 today – easily the highest level ever seen in the period.
This takes us to the 3rd chart, showing the IeC Boom/Gloom Index. It measures sentiment versus the US S&P 500 Index, and shows this has fallen back to danger levels once more.
All the investors to whom I talk, recognise that the market is being completely rigged by the central banks. But, they say, “what can we do? We cannot go into cash, as it yields nothing, and benchmark Western government bonds also yield nothing”: $12tn of bonds even have negative yields. The fact that some of the best performing US$ debt markets in Q3 were El Salvador, Mongolia and Zambia highlights how desperate the “search for yield” has become.
How long will the central banks be able to keep markets artificially high and defy economic reality? We cannot know. But we do know they are providing a fertile breeding ground for populist politicians, as I will discuss on Wednesday.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Petchem demand remains strong”
Benzene Europe, down 54%. “European derivative demand was struggling after the traditional seasonal slowdown in August. Many in the market had been braced for a strong upturn this month and into the fourth quarter, but this has yet to materialise”
PTA China, down 41%. “Some producers increasing their offers due to turnarounds in China and South Korea”
HDPE US export, down 27%. “China’s import prices fell in the week tracking lower offers of import cargoes from some suppliers”
S&P 500 stock market index, up 11%