The Rule of ThreeFebruary 26, 2015
Good things come in threes, and over the past two weeks negotiators have achieved solutions to three of the major headwinds facing the global economy: Ukraine, Greece and the West Coast Port slowdown. Of course, stability is still in question on both questions in Europe and the ILWU has to approve the port settlement, but from our point of view these agreements go a long way toward clearing the path for more aggressive risk taking by investors. Now, we are back to more traditional market concerns, like when the Federal Reserve will start the tightening process; how will ECB QE affect Europe; and how long will energy prices remain low. These risks, though significant for investment decisions, are far easier to hedge in financial markets. The most talked about remaining Black Swan is ISIS and instability in the Middle East. We continue to see this as more of a news story and a political concern than a risk to the global economy or investment decisions. Bottom line, uncertainty limits risk taking—which restricts capital investment and growth—and since we last wrote, uncertainty on these three issues has been substantially decreased.
There will be many articles over the next several days about who won and lost in these negotiations, but to us the major insight is simply that agreement occurred. We see the relatively quick settlement of all three issues as a sign that the world’s economic winners are more willing to bear a bit more cost in settling with weaker participants, rather than trying to squeeze out the last drop of blood from the stone. This is a sign of growing confidence that whatever concessions were made, a strengthening economy will generate enough benefit to offset the cost.
The tenuous Ukraine ceasefire appears to be primarily an agreement not to have a full scale war, but to ignore ongoing infighting. Though the US remains more confrontational, Germany and France appear more interested in returning Russia to its role as a viable customer by limiting its aggression. Though many have focused on Russia’s weakening economy as oil prices and the ruble exchange rate have fallen, Ukraine’s economy is even worse with a massive collapse in their currency and still weak global prices of their grain exports. Western Europe, which is just beginning to see the first green shoots of recovery, is in no hurry to confront Russia with military involvement. Europe has adopted a wait-and-see approach evaluating whether the impact of Russian economic weakness—and perhaps further sanctions—will lead to an uncomfortable stability for now.
In Greece, the Europeans (read Germans) have taken a similar stance, electing to kick the can down the road for another four months. The major concession appears to be allowing Greece to run a slightly smaller primary surplus of 3 percent in 2015, but returning to an austere 4.5 percent next year. This may allow some modest progress on Syriza’s campaign promises, but the new government will still have to submit reforms to European authorities—no longer called the Troika. Bottom line, there appears to be an agreement to agree to disagree—and see how it goes for another four months. If greater European stability in Ukraine and Greece, plus lower oil prices and lower interest rates (thanks to QE) generates growth for the EU over those four months—with or without Greece—we expect another can kicking will occur.
Finally, the reopening of full activity at the 29 west coast ports will eliminate the bottlenecks that have developed since the start of the year—likely before the end of the first quarter. Ports should be back to work 24 hours a day— with lots of overtime—by Monday. The improvement will occur fastest for perishable exports, which have been the slowdowns greatest casualties. Meanwhile, since roughly half of US outbound containers leave empty, any delayed non-perishable exports should find exit quickly. For imports, activity will move from roughly 20 percent below normal in January to as much as 20 percent above normal with overtime. The biggest catch up will come in four weeks when the lack of new freight on the water—due to the recent advent of Asian New Year’s celebration—allows any remaining backlog to be quickly cleared. We doubt the slump will even show up in quarterly GDP numbers. Indeed, the greater impact will be a rapid decline in shipping premiums and an end to transshipping to gulf and east coast ports.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.