Michael Wilson doesn’t have many doubts about who’s scared Santa Claus away this Christmas
Is it me, or has the world gone rather wobbly for this time of year? Normally we’d be well into the Santa Claus rally by now, with the usual index-matching rampage calling the shots as traders square up their accounts in readiness for the annual bonus bell to ring.
And normally we’d expect this essentially positive trend to continue until around 5th January, when the arrival of Twelfth Night usually puts a well-overdue end to the festivities and the Christmas tree lights go out. All very predictable, and for predictable reasons too.
But not this year. The hour-by-hour volatility of recent weeks is just one thing. More importantly, the October rally in London and the eurozone is now a busted flush, completely cancelled out by an attack of cold-war nerves. The S&P 500 hasn’t lost all its October gains yet, but at this rate it won’t be very long in coming, and already the S&P is back down to June levels. Funny, not a lot of people seem to have noticed that….
Even the Nikkei 225, which has had a pretty decent run this autumn, is buckling fast despite the successful outcome of Sunday’s election which gave the Japanese government the mandate it wanted to relaunch its tax proposals. Indeed, for proper cheer you’ve got to turn to China, where the Xinhua 200 has gained 25% in the last 30 days. Very probably on the lower world prices for fuel and raw materials, and the probable impact on energy-hungry industrial manufacturers. Which is bad news for everybody else, of course.
Worse Than 1998?
Especially for Russia, which is now on the brink of a very terrible crisis – worse than 1998, according to some o
bservers, and with the potential to smash into all our hopes of a peaceful new year. Forget about Pakistan and Islamic State, if you can, and the Greek debt problems and the Italian problems, even though they’re all important contributors. And focus instead on an intractable situation in Russia which is getting worse in ways that we can’t even begin to quantify. And which shows very few opportunities for a quick resolution.
Actually, it would be bad enough if this were merely a financial crisis – the same debt defaults as in 1998, the usual rout of Russian companies that can’t service their obligations, and the same old political shouting. But the additional feature this year is that Vladimir Putin is painting himself into a lonely corner, economically isolated and totally reliant on his country’s hero-worshipping media as he weighs up the domestic PR advantages of attacking somebody militarily. One way and another, President Putin is starting to look more and more like Kim Jong Un. And that’s not a very flattering comparison.
Where the Saudis Fit The Picture
You think it’s exaggerated? Of course you do, and let’s remember that it’s part of the media’s job to provoke you with the occasional scare story. But let’s take this in stages.
Ask yourself, for instance, exactly why the low oil price is sending the markets into such a vortex of despair at the moment? Didn’t we used to fret that high oil prices were going to smash economic growth? And isn’t Brent crude at $60 still above the levels of 2008?
Of course it is. But something’s changed this time. Not only have shale oil and gas changed the pricing structure of non-OPEC oil over the last three years. We’ve also got the fact that Saudi Arabia, OPEC’s traditional ‘swing producer’, has changed tack. Not necessarily to Russia’s advantage.
Until recently, Riyadh would use its role as the world’s biggest oil producer to regulate oil prices, mainly by cutting back its production when prices were low (to create a supply squeeze) and raising it when oil got expensive enough to permit a little profit-taking. That’s changed. Recently the Saudis have been trying to drive the US shale producers out of business by denying them the $70-80 a barrel that they need to make a profit. And Russia, which needs $100 a barrel to balance its budget, is a collateral casualty.
We don’t need reminding that oil and gas provide half of Russia’s gross domestic product, of course. And that, apart from some rather nifty aerospace and a rare talent for seamless pipe welding equipment, Russia doesn’t have much else in the way of unique products that can easily be sold abroad.
Let’s put that more strongly. Moscow’s failure to diversify its economy during the good years for oil is a key and signal sign of its inability to think ahead. It’s also why Mikhail Gorbachev was very wrong when he said recently, on the 25th anniversary of the Berlin Wall coming down, that the West bore the sole responsibility for Russia’s current economic malaise. It doesn’t.
But then, if we’re allowed a few overstatements, then I suppose so is Mr Gorbachev. There’s little doubt that the western sanctions announced in July and August have had a cripplingly tightening effect on Russia’s situation. And in a particularly pervasive way.
Financial Sanctions – The Time Bomb
Yes, we’re unsurprised by the fact that Russian consumers don’t appreciate note having our food products and our high-tech manufactured goods. That’s been a fully-intended consequence of the EU’s action to suspend both imports and exports of Russian products, in protest at what seems to be a palpably obvious military intervention in Eastern Ukraine. (Moscow is still formally disputing that the uniformed Russian soldiers seen behind Ukrainian rebel lines are anything but irregulars; but its tanks have been spotted by satellites too often to allow any denials that it is at least providing supplies are arms to the rebels.)
But what we tend to overlook is that the West didn’t just blockade Russian goods this autumn. We also banned ourselves from offering Russia any financial assistance, especially to Russian corporations. And that’s where it’s going to get messy in the next six months.
Why Bonds Will Explode
You see, all large Russian companies need to access Western cash from time to time. And nowhere so much as when they need to roll over their corporate bond debts. Any bond that reaches maturity needs to be replaced immediately with a new bond, unless of course the issuer has a way of paying it off with cash. (Not likely.) And, given the lack of liquidity in Russia’s own market – not to mention the fact that the Russian Central Bank is right out of cash right now – it’s inevitable that they’ll reach for Western investors’ money.
That’s the way it’s been for many years now. And okay, you’d have to be a supremely confident gambler to want to think about taking on any Russian debt at the moment, but let’s leave that aside for the moment. But consider this. The Economist magazine recently reported that the flow of international dollar loans from foreign banks had fallen to just $7.9 billion in the first half of 2014, from $25 billion in the same period of last year. So what will happen now that the West has completely blacklisted this financing route?
The first thing that will happen is that large Russian enterprises will be forced into some sort of default. Although that probably won’t be the word they’ll use. Their share prices will take a hit, and the Micex stock index will make the last week’s month’s 13% crash look like beginner’s stuff. The oil and gas majors who currently comprise 70% of the Micex will be especially badly hit.
And who’ll suffer? According to the Russian media, it’s foreigners who currently own 70% of the Russian stock market, not Russians. Have we built that prospect into our assumptions? No, I fear we haven’t.
What comes next might be even more difficult. Russia’s biggest commercial banks have tens of billions of dollars’ worth of bonds denominated in dollars, euros and Swiss francs that they’ll need to roll over during the next three years. If they can’t raise that money, their creditworthiness may come into doubt. And if Russia’s bank system collapses – even just to the extent of becoming non-viable under BIS rules – then all bets are off as to what may happen next. But either way, it seems clear that what we’re doing to Russia is not going to be without repercussions for us as well.
Compared with structural concerns like these, the recent plunge in the rouble is almost a trifle. The Russian currency is essentially free-floating, which is a good thing insofar as it will be free to find its correct level when the time comes. And, although it seems clear that the Moscow Central Bank is now out of cash and out of elbow-room, this week’s interest rate hike from 10.5% to 17% should at least focus Russia’s attention on the implications of what it’s doing.
We will have more reason to be concerned if the West doesn’t find a way of helping to restore this situation. Oh sure, Russian companies can cope with 17% interest rates for a while, just as British householders did in the late 1970s when their mortgage rates also hit 17% – but in the long term it’ll weaken them, devalue them and scupper their chances of getting back into growth.
And So Back to Putin
The question is, can we take up discussions with President Putin on any level at all? At the moment it doesn’t look promising. Having just been voted Man of the Year for the umpteenth year in succession, he has everything to lose by inviting a bunch of foreigners to help him resolve his problems. Especially if they’re also wagging their fingers at him about eastern Ukraine.
So what’s a poor despot to do? Turn up the volume on the mass media, blame everything on the foreigners, and make more threatening noises. Hmmm, Kim Jong Un could probably give him some useful pointers on that score.
So forgive us if we seem less than festive in this run-up to the season of goodwill. And if our Burning Issues pundits have recently been pouring cold water on the idea of an easy escape from fearful volatility in 2015.
Up in the Baltics, Santa’s reindeer are now sporting laser guidance systems and Rudolph’s red nose has been tasked with detecting incoming Russian traffic with its transponders switched off. It’s not a great way to end what’s been a mightily indecisive year for the markets. And the halving of the oil price has taken every analyst by surprise. Proof, not for the first time, that anyone who believes in an efficient and halfway predictable market is fooling himself.