Shipping's Long Game

Summary

• At the heart of the cyclical mechanism is the long-term cycle.
• Several short-term cycles have defined the market over the past years but these fit into the much larger picture.
• A new market dynamic is set to unfold over the coming years.

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Overview

Over the past decade we have been engulfed in a long-term bearish cycle in practically all of shipping. Yes, there have been brief instances of bullish cycles in the short-run, but in the end the bearish market fundamentals asserted their dominance.

However, as those who study shipping know, this is a highly reactive industry with collective current actions setting the tone for several years out.

It's also well established, therefore, that the greater the volatility the greater the consequent response from shipowners.

We saw this leading up to the Great Recession where shipowners piled up newbuild orders as the demand for shipping mirrored China's monumental growth and global GDP.

This brought the pendulum to a starting point and set the stage for a massive market swings that would unfold over the coming years and decades.

Understanding The Market

Owners have zero control over the demand for their ships. The only thing they do exercise control over, collectively, is the supply side - the ordering and retirement of ships.

Since owners are reactionary we see supply side action directly correlated to current market conditions. Low rates inspire greater demolitions and fewer orders, while higher rates do the opposite.

Historically, the supply side has the most profound impact on the market, which makes it kind of a "Catch 22". Owners collectively engage in action which inspires a certain market response, they then adjust their actions which inspires the opposite reaction, and the cycle goes on.

The peaks and troughs have a direct impact on the upcoming cyclical response, specifically with how owners react and consequently adjust the supply side. This cannot be overstated.

Some cycles can be considered very short term and minor in nature, lasting months or even a year or so. However, there are longer cycles and those dictate the overall market trend at large.

From 2009-2018 we found ourselves in a bearish market, looking for bullish short cycles to capitalize. But things are changing.

Where are we now?

Supply is by far the greatest indicator for these longer term cycles and since these vessels are expensive and take some time to construct it is slow moving by nature.

Smaller trends do emerge, but the larger trend often takes years, or decades even, to fully play out.

So where are we now? One picture says it all for shipping as a whole.

Source: Clarksons SIN

The chart above points out not only how we arrived at the 09-2018 bear market, but how the orderbook is setting up for the exact opposite move.

To drive this point home let's look at a couple charts showing how this relationship works.  Since tankers are a particular favorite of mine for this upcoming long cycle, let's focus in on those. 

Source: Clarksons SIN

The chart above shows a full cycle using Suezmaxes. We start with a low orderbook which precedes tighter supply ahead. This tighter supply leads to higher rates and after the second hand market is exhausted owners turn to shipyards.

However, macro moves slowly. Therefore, in this tight market under supply can only be alleviated through massive investment and years of newbuilding. Eventually vessel supply exceeds demand, a peak in rates is reached and the decline starts. But thick orderbooks which now span years out will keep the market oversupplied in the short run, leaving the medium-run to the chore of absorbing this tonnage as newbuilds slow. Once again, macro moves slowly.

On a side note: Remember, the bull or bear part of the cycle sees a consequential opposite response of corresponding magnitude. Therefore, many will properly note that the demand side was aided by rapid global economic expansion at the time, which was unsustainable. However, orders for ships at that time kept pace with this unsustainable demand, furthering this drastic market divergence from natural equilibrium. This led to the historic shipping bear market of the 2010 decade.

This means that if the premise of corresponding magnitudes holds (pendulum effect), even to a slight degree, the bull side ahead could be quite strong. We are already seeing signs of rates beginning to break away from an orderbook which is still around multi-decade lows.

Source: Clarksons SIN

Figure 3 looks at the product tanker market which shows a similar long-cycle supply pattern but with average weighted earnings per day as opposed to one year time charters. Notice the rate spikes. These spikes in rates here became more prevalent starting in 2000 when tight supply saw spot rates responding more profoundly to instances of increased market demand.

These spikes are once again resurfacing indicating this market tightness. Yes, similar shocks occurred over the bearish decade, however, ample vessel supply muted the impacts keeping rates low.

Conclusion

There are a myriad of other issues serving to complicate this thesis. Yes, I do address them. Everything from IMO 2030, credit access, risk appetite, ample S&P prospects, etc. has been and will continue to be discussed over at Value Investor's Edge.

This brief blog was intended to only to heighten your interest and inform about where we are now in this highly cyclical industry.

Over at Value Investor's Edge we cover over 50 companies across a multitude of shipping segments, offering a variety of opportunity as we embark on this cyclical shift.

Currently we are suffering from an economic crisis, but this relatively short term shock will eventually give way to normalization and when it does market fundamentals will again dominate. Looking ahead, the longer term outlook for shipping holds the most promise in two decades.

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