Main topic of this week:
- Airlines and shipping containers, can they get any bigger?
Equity markets recovered from last week’s Thursday & Friday asset-wide losses post-Brexit decision as exchanges executed bets & hedges made prior.
- UK’s FTSE 100 index led the charge as it recovered 7.15% to close at 6,578, the highest close since August last year. This could be a result of increased investment demand as the Pound reaches a near 30-year low;
- US S&P 500 gained 3.22% to close at 2,103 or 93% above 52w lows, a position which will test FOMC policy makers on whether to continue with its coming two Funds Rate hikes;
- Japan’s Nikkei 225 gained 4.89% to close at 15,682.5; however, the Nikkei 225 index remains in a YTD low territory as it started the year at nearly 19,000 and dropped 8% last Friday (16,238 => 14,952) post-Brexit;
- Hong Kong’s Hang Seng index closed 2.64% higher this week at 20,794 (on Thursday as markets were closed on July 1st), a position around 10% lower than a 22,000 index close analysts are forecasting; and
- China’s CSI 300 closed 2.50% higher at 3,154 as the CSI 300 index looks to continue recovery from its Dec-15 to Jan-16 sell-off.
Government Bond Yields
Government bond yields continue their path into new horizons as outdated pension fund mandates drive bond yields stronger into negative territory with the help from ECB and BoJ large-scale asset repurchase programme.
In fact, the capital return on government bonds YTD have been the best performing asset class as 30-year government bonds have generated double-digit gains:
- US 10-year yields closed at 1.44%, down 8% this week from 1.56% last Friday;
- CAD 10-year yields closed 1.05%, down 10% this week from 1.16% last Friday;
- UK 10-year yields closed at 0.86%, down 21% this week from 1.08% last Friday;
- GER 10-year yields closed at -0.13%, down 165% this week from -0.05% last Friday; and
- JPY 10-year yields closed at -0.27%, with a yield curve compared to GER 10-year bunds looking like this:
From the above graph, Germany 2- & 5-year government bond yields are suppressed further than the equivalent Japan government bond yields, while Japanese 10- & 30-year government bond yields are flatter than Germany’s – a function most likely the result of Japan’s banking framework previously covered here and here.
And as previously highlighted, risk-free rates have come are becoming riskier as they push towards a long-term trend in negative territory:
The above graph depicts the 5-year decline in risk-free rates of the US (white line), UK (purple line), Germany (green line), and Japan (yellow line).
Free-floating currencies were much less volatile this week as institutional and stay-at-home FX traders continue to chart what the latter half of 2016 will have in store regarding interest rate decisions and economic forecasts.
The following currencies quoted against the US dollar:
- Chinese Yuan: 6.6422
- Japanese Yen: 102.52
- Canadian dollar: 1.2915
- Australian dollar: 0.7491
- British Pound: 1.3272
- Euro: 1.1139
Is Bigger Better?
The shipping industry has doubled in size several times since 1955 as a result of globalization and financial interconnectedness. In fact, healthy shipping volumes have spurred ship manufacturers to double capacity every 20 years in the last half century, a trend which has evaded the radar of climate change agreements.
During healthy economic growth and demand, large ships translated to economies of scale and thus more competitive freight prices, which in turn spurred greater export/import trade. However, growth in the shipping industry appears to have slowed down post-financial crisis as global trade volumes squeeze. This leads to a negative effect on cargo revenues:
Slowing growth in global trade volumes should see the growth in shipping capacity similarly curtail, but the opposite has occurred. Despite a curtail in shipping volumes, the number of orders for larger ships has continued to grow as industry experts insist volume and capacity will trump, seizing the economies of scale.
The most obvious argument against the need for ever-larger ships still holds: destination ports, and whether these can modify their facilities to accommodate the arrival of ever-larger ships. These ports require new infrastructure, such as new cranes, taller bridges, environmentally perilous dredging, reconfiguration of container yards – costly disruptions when global import demand curtails.
While vessel-sharing partnerships (similar to airline code-sharing arrangements) aren’t original, consolidation of the shipping industry has resulted from cost cutting measures, by boosting ship capacity synergies, and economies of scale; however, this could have a negative impact on the industry’s prospective growth: consolidation leads to a lack of competition.
It appears that, at least in the long-term, (relatively) smaller and more fuel-efficient ships will pave the new path forward as large ships become targets of pirates and terrorists looking to exploit a ransom against the value of cargo aboard.
The pace at which shipping capacity outstrips demand is worrying – shipping capacity is expected to increase by 4.5% in 2016 and 5.6% in 2017, whilst global demand is expected to grow by just 1%. In fact, the newest and biggest shipping containers now carry ca. 18,000 twenty-foot-equivalent units with plans to expand capacity to 22,000-TEU by 2018, then 24,000-TEU soon thereafter.
The idea is that shipping costs can be lowered so long as these new ever-larger TEU ships are operating with full capacity. While engineering has yet the opportunity to test larger, longer ship sizes, structural risks springing and whipping are concerns, perhaps less material than a concern over capacity.
The airline industry stands as an interesting comparison to the shipping problem as both industries forecast a positive growth in capacity while curtailing demand are dangerous to tight margins. Both the airline and shipping industry are mature markets with developed infrastructure – the number of new orders for planes and ships gives a good indication on sentiment of future growth:
It has become clear that “the future of aviation lies in smaller, quitter and more fuel-efficient planes that can carry fewer passengers at greater frequencies between more destinations,” according to Bloomberg Gadfly. In fact, airport pairing and frequency growth of airlines could lead towards the average size of planes going down.
It is obvious that at current oil prices, airlines have the flexibility of pondering whether to go big or go home, just not for long.