The next few CIR articles will feature our 'The Sky Is Falling' series (for Part 1 go here). The primary thesis is that the global markets are entering a serious period of no-to-slow growth that the markets have yet to fully price. We will attempt to capture this thesis through chart analysis across a number of economic indicators globally. Follow us in real-time above to receive notifications on our daily uploads.
There is a concept coined 'The Bullwhip Effect' in supply chain management. The effect is an observed phenomenon in forecast-driven distribution channels for a product. Because demand is rarely perfectly stable, a company must make forecasts to properly position inventory and other resources. Forecasts are based on statistics, and they are rarely entirely accurate. Because there are errors, companies must carry a safety inventory. Moving up the supply chain from the end-consumer to the raw materials supplier, each supply chain participant has great variation in demand and thus, a larger need for safety inventory.
On a macro level, there is a similar occurrence. The world features service economies (Example: US and Europe), manufacturing economies (Example: China), and raw materials economies (Example: Latin America). While each relies on the other, demand is top-down. Market moves are smaller in developed markets than emerging markets, and smaller in emerging markets than frontier markets.
While the introduction of the spot market for commodity prices and futures contracts have attempted to limit such volatility, there is still an underlying cyclicality to supply and demand.
One look at the Import Price Index of Asian NICs (commodities) shows price performance relative to past years:
The index has surpassed 2010 lows and, without a major contraction, is testing a bottom that the globe hasn't seen since the Great Recession. The question then is if this is the beginning of the world's calmest global recession. Undoubtedly, with so many commodity prices declining, raw materials economies that service such commodities are suffering. One must ask that if there were a contraction similar to 2008-2009, would some of the emerging and frontier markets that service raw materials be in trouble?
According to UBS estimates on country balance sheets, the answer is yes:
Important names on this list are Brazil (11.6), India (10.5), and China (10.1). While this doesn't mean imminent default, it does mean increased financial pressure. With declining commodity prices and a low-demand manufacturing sector covered in our last article, hopes of growth very quickly change to hopes of solvency.
And while the chart above focuses on a country by country basis, the situation is the same - if not worse - on a corporate level. As companies prepare for no/slow growth and make long-term preparations to remain solvent, they will cut orders. Suppliers will see less business and said business will get more competitive, at least while it still remains profitable to remain operative. Commodity businesses in emerging and frontier markets with operating leverage will be devastated. However, this effect will not be felt immediately.
The timing behind such a process gets difficult in a global context. It is a combination of order processing and price points that are unclear to those outside of the business under scrutiny. Some may argue that the 'bullwhip effect' has done its course, others argue that emerging markets have yet to fully price the risk. We tend to be on the latter side of the argument. Surely though, time will tell whether the massive decline in commodities is sustainable, but in our opinion, pre-FOMC rate hike is not the time to be gambling on a bottom.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.