Download The Dust Bowl: action and reaction between

The Dust Bowl: action and reaction
between ecosystem and economy
Alejandro Vidal Crespo
Service Director, Market Strategies
MONTHLY STRATEGY REPORT
November 2014
Monthly Strategy Report. November 2014
The Dust Bowl: action and reaction
between ecosystem and economy
“In light of increasing concerns about environmental issues, we put into historical perspective
the colonisation of America’s Great Plains, when crops replaced native vegetation, and a
period of drought – compounded by the onset of the Great Depression in 1929 – triggered
human displacement and massive dust storms. The government took the helm to mitigate
the effects on the population and the rains returned, but major changes occurred along the
way…”
In the second half of the nineteenth century, Americans migrated en masse to the country’s vast
central plains. Waves of settlers uprooted from the east coast to the country´s heartland, where the
government offered land grants in exchange for five years of continuous residence on the property,
cultivating the land and building a house on it.
The territory was originally inhabited by Native Americans, who – in the best scenarios – agreed to
“transfer” the land to the settlers. Often, clashes ensued between the authorities and the indigenous
population, resulting in outright wars and the destruction of their livelihood. For example, of the vast
herds of bison that roamed the prairies, an estimated 25 million were slaughtered in 1872-1873.
Subsequently, in the decades to follow, the appearance of the Great Plains changed dramatically. A
wild, drought-resistant ecosystem teeming with native flora and millions of large animals that tilled
the soil beneath their feet became vast farmlands, particularly after the introduction of steel ploughs,
a more efficient alternative than iron on this type of terrain.
Farmers focused on cultivating wheat, a crop that was less-drought resistant with lower soil retention
than the region’s native grasses.
Nevertheless, in the early 1930s, a cold front
from the tropical region of the eastern Pacific
(known as La Niña) combined with abnormally
high temperatures in the North Atlantic,
triggered a period of prolonged drought (19301938) in the Great Plains of North America.
Large wheat plantations yielded little or
no crops. Degraded topsoil, coupled with
desiccation and the effects of mechanised
farming techniques, stripped the superficial
layers of organic nutrients, and left the soil
exposed to wind erosion. An estimated annual 369 million net tonnes of dust was lifted into the
atmosphere, creating terrible dust storms over 400,000 km2 in scale (twice the size of Great Britain),
that swept through the central and south-western states of Colorado, Texas, Oklahoma and Kansas,
on its way to the Atlantic.
For the population, the ramifications could not have come at a worse time. The onset of the drought
and the subsequent Dust Bowl phenomenon coincided with the outbreak of the Great Depression in
the United States, in October of 1929. Crop failures, followed by unbearable dust storms that buried
farms, were compounded by unemployment rates that reached 25% at the height of the Depression,
a crisis exacerbated by the Dust Bowl. It is important to note that in the years preceding the Great
Monthly Strategy Report. November 2014
Depression, crops were bountiful and farmers enjoyed several seasons of high yields, the profits of
which were often consigned to financial investments and bank deposits that disappeared over night.
The combination of both phenomena resulted
in a mass exodus from the central states. More
than three million people abandoned their farms
and headed to cities, where the situation was not
much better and their arrival only exacerbated
supply problems by reducing the ratio of food
producers to consumers.
The phenomenon also coincided with a shift in the
economic focus of the United States implemented
by President Roosevelt, known as the New Deal.
One of its programmes, the Soil Erosion Service,
promoted improved farming practices such as legume planting and the creation of pasturelands on
which to rear livestock, whose prices were in turn subsidised by another government body to ensure
the supply of quality meat products to cities.
Millions of heads of livestock that could not be maintained by farmers were purchased by the
government at above-market rates and, in many cases, slaughtered in order to stabilise falling prices
as demand plummeted due to the crisis and the poor quality of meat products derived from animals
living in substandard conditions. The restoration of market conditions meant salvation for many small
farming communities, saving jobs and securing the rural population.
Under the Soil Conservation and Domestic Allotment Act of 1936, more than 200 million trees were
planted from Canada to Texas, which not only alleviated the problem of soil erosion, but created jobs
for many unemployed labourers in the United States. Millions of acres of farmland transferred into
government custody and were subsequently allocated to other uses in an effort to reduce the effects
of soil degradation.
The return of the rains, together with measures designed to mitigate erosion helped alleviate the
problem in the years that followed. Nevertheless, the impact of the sudden changes to the ecosystem
and the mass elimination of native species in favour of more productive but less resilient crops caused
a natural disaster with mammoth implications for the human population, as well as for the economy
and the supply of basic resources in the medium term.
A month of market fluctuations
Banca March Market Strategy Team:
Miguel Ángel García, Director of Market Strategy
Rose Marie Boudeguer, Director of Research Department
Pedro Sastre, Head of Market Strategy
Alejandro Vidal, Head of Market Strategy
Paulo Gonçalves, Head of Research Department
MONTHLY STRATEGY REPORT
November 2014
Monthly Strategy Report. November 2014
A month of market fluctuations
Volatility returns to the markets.
There was a sharp increase in market volatility throughout the month. Concerns about global
growth, fears of a recession in the Eurozone, the discontinuation of monetary stimulus measures
in the U.S., compounded by a complex geopolitical scenario, affected investor confidence. These
factors prompted a retreat toward quality with sharp declines in stocks in the first half of
October that recovered as the month progressed.
An agreement was reached to ensure the supply of Russian gas to Europe.
On the geopolitical front, in the Ukraine, despite ongoing unrest, an agreement was reached
between Ukraine, Russia and the European Commission that will ensure the supply of Russian gas
to Europe, on condition that the Ukraine first honour its outstanding debts (totalling some USD
3.1 billion). Meanwhile, the pro-European parties swept the country’s parliamentary elections,
though pro-Russian separatists did not allow voting in the territories they hold (Donetsk and
Lugansk).
The IMF cut its global growth forecast…
The IMF cut its global growth forecast for the year by one-tenth of a percentage point to 3.3%,
and two-tenths for 2015 to 3.8%. It also downgraded expected growth in the Eurozone to 0.8%
in 2014 (three-tenths less) and to 1.3% for next year (vs. 1.5% previously), and issued an alert
about increased risks in the region, indicating the 30%-40% likelihood of another recession or
deflation.
…and issued an alert about the risk of recession in the Eurozone.
Expectations for the Spanish economy were more positive, with GDP up one-tenth of a percentage
point to +1.3%, and +1.7% in 2015. Spain is the only major Eurozone economy expected to
improve. Nevertheless, the IMF does not foresee a significant drop in unemployment rates,
which would close 2015 at 23.5%.
Nevertheless, more growth is expected in Spain and the U.S.
The organisation also highlighted a favourable forecast for the United States, with an upward
revision in growth to 2.2% that could accelerate in 2015 to 3.1%. Finally, it estimates lower
growth for emerging economies: 4.4% this year (vs. 4.5% previously), and 5% in 2015 (vs. 5.2%),
with a larger spread between the major economies: China with an increase of 7.4%, and Brazil
with a 1 p.p. drop in growth, to 0.3% in 2014.
ECB stress tests reveal no systemic problems in European banking.
In Europe, the results of the stress tests were announced, revealing capital needs that do not pose
a systemic risk. Of the 130 institutions analysed, 25 were identified as being undercapitalised,
but of these, only 13 will have to apply recapitalisation plans amounting to EUR 9 billion. The
audits identified Italian and Greek banks as those with the greatest needs. Meanwhile, the
Spanish institutions analysed passed the ECB tests and only Liberbank was shown to have a
capital deficit (EUR 32 million) that has already been covered.
Nevertheless, doubts persisted in the markets, particularly regarding the health of the Greek
financial sector. Moreover, the instability of the current government could lead to early elections
where, according to the latest polls, the Syriza party would emerge victorious (against European
Monthly Strategy Report. November 2014
austerity programmes).
The U.S. economy shows robust growth…
In terms of activity data, the U.S. economy maintained a steady growth rate, which, in Q3,
stood at 3.5% quarter-on-quarter annualised. The labour market improved with the creation of
248,000 jobs in September and a two-tenths drop in the unemployment rate to 5.9%. Consumer
confidence also improved, with an increase in the Conference Board index to 94.5, its highest
level since 2007. Real estate sector results were mixed, with a spike in previously-owned homes
sales (+2.4% monthly), while new-home sales stagnated.
…enabling the FED to end its bond-buying programme.
Against this backdrop of improved activity, the FED ended its bond-buying programme, though it
will continue to reinvest the proceeds from the securities, meaning the balance sheet will remain
intact for the time being. Official rates were kept at a minimum (between 0%-0.25%) where
they will remain for a considerable period of time. The FED also reaffirmed its commitment to
support growth.
Activity data declines in the Eurozone…
In Europe, activity data weakened amid concerns about low inflation. Industrial production fell
1.9% year-on-year in August, while the unemployment rate remained high (11.5% in September).
The CPI rebounded by one-tenth of a percentage point to 0.4% year-on-year, but the underlying
rate fell to its lowest level (0.7%) in October. On a positive note, business confidence indicators
stabilised: the composite PMI rebounded two-tenths of a percentage point to 52.2, to remain in
growth territory.
…and the ECB does not specify the scale of its asset-purchase programme.
The ECB continued its expansionary monetary policy, with minimal official rates (0.05%) and
announced the go-ahead to its asset-buying programme, beginning with mortgage bonds.
However, given the lack of detail about the magnitude of these purchases, concerns persist
about how to strengthen the balance sheet and avoid the risk of deflation.
In Spain, growth accelerates as employment rates improve.
The Spanish economy managed to maintain steady growth rates in Q3 as GDP expanded 1.6%
year-on-year, in comparison to 1.2% previously. The unemployment rate fell, closing the quarter
at 23.7% (vs. 24.5% previously), the lowest level since 2011, confirming an upsurge in job
occupation (increasing by 291,000 people throughout the year, +1.6% year-on-year). Inflation
remains in negative territory, with moderate declines: in October, the CPI dropped 0.1% yearon-year.
The Bank of England postpones policy changes…
The United Kingdom reported Q3 growth of 3% year-on-year, two-tenths less than the previous
quarter. Inflation is contained: +1.2% year-on-year (vs. 1.5% previously). The Bank of England left
its monetary policy unchanged with official rates at 0.5% and the amount of assets purchased
at GBP 375 billion.
…while the Bank of Japan expands asset purchases.
In Japan, the Central Bank extended stimulus measures and will raise the ceiling of its annual
bond purchase to JPY 80 billon (compared to JPY 60-70 billion previously) and invest in various
assets, primarily public debt, exchange-traded funds (ETFs), and Japanese real estate investment
trusts (J-REITs). Activity showed signs of slight improvement in the data from September with
Monthly Strategy Report. November 2014
retail sales up 2.3%. Similarly, industrial production stopped contracting and grew 0.6% yearon-year.
China slows but remains within government targets.
In China, the economy slowed but growth remained consistent with the government’s objectives:
in Q3, GDP grew 7.3% year-on-year (vs. 7.5% previously). This growth was accompanied by an
easing of inflation in September, which stood at 1.6% year-on-year (vs. 2% previously). Foreign
sector figures were more encouraging, with exports up 15.3% and imports up 7% year-on-year.
Following elections, Brazil’s challenge is to restore growth and confidence.
In Brazil, attention focused on the presidential elections, in which Dilma Rouseff was re-elected
for a second term by a narrow margin. The president must now institute a reform programme
to restore growth and confidence in the Brazilian economy. In addition to sluggish growth,
inflation rose in September to 6.75% year-on-year. The Central Bank showed concern about
future price trends and the effects of a further-weakened currency, which prompted a 25-b.p.
increase in official rates to 11.25%.
Stocks are supported by business results and improved activity in the U.S.
Stocks plummeted but managed to recover and the global index (MSCI World) closed up 0.6%.
The results of Q3’s earnings calls have been positive, particularly in the United States. As of late
October, 73% of S&P500 companies had reported, of which 81% exceeded profit expectations,
driving the S&P500 up 2.3%.
In Europe, stocks closed lower on concerns about a recession and less compelling earnings
reports (the ratio of positive earnings surprises stands at 62%). Specifically, the EuroStoxx50
fell 3.5%, while the Ibex35 dropped 3.2%. Emerging stocks rebounded with the MSCI Emerging
Market Index up 1% on improved performance from Asian markets, which rose 1.7%, while Brazil
and Russia reported declines stemming from political uncertainties.
It was a good month for bonds, given the absence of inflation.
In equity, the absence of inflation and an expansionary monetary policy pushed down sovereign
curve rates. In the U.S., although the FED has phased-out its bond-buying programme, a hike in
official rates is not expected in the short term. In the meantime, the ECB and the Bank of Japan
will inject more liquidity. Ten-year rates on U.S. debt fell 15 b.p. to 2.34% and in Germany to
0.84% (-11 b.p.). It is worth noting that 10-year rates in Spain dropped 6 b.p. to 2.1%. The decline
of base rates favoured the credit market, which showed overall gains of nearly 1%.
The dollar gains strength, driven by economic growth and the FED.
The dollar continued to rise in value, buoyed by improved activity and changes to the FED’s
monetary policy. The greenback appreciated 0.8% relative to the euro and the crossover ended
at 1.25 EUR/USD. The pound lost some ground against the euro, after the deferral of expected rate
hikes. The yen, meanwhile, reported sharp declines following the Bank of Japan’s announcement
to expand stimulus measures, depreciating 1.6% relative to the euro and surpassing 140 EUR/
YEN.
Lower demand and greater supply put pressure on oil prices.
Reductions in global demand estimates coupled with OPEC’s refusal to cut production because
key members (Saudi Arabia and Kuwait) are comfortable lowering prices to discourage
investment in energy alternatives (“fracking,” among others), led to a sharp drop in oil prices.
Brent crude fell 9% to USD 86 per barrel. Gold also declined, closing at USD 1.172 /ounce (-3%).
Monthly Strategy Report. November 2014
Strategy for November 2014
Monetary
Difference
Neutral
Bonds
Recommended
Equities
-10
0
10
20
30
40
50
Geopolitical risks persist…
Despite progress in recent days, the situation in the Ukraine remains unresolved and could
continue to be a geopolitical hotspot in Europe. The impact of the mutual sanctions between
Russia and western countries is affecting the growth of both parties. A lifting of these sanctions
would have a positive effect on economies.
The rise of the Sunni militia in Syria and Iraq (IS) has yet to affect the price of crude, though it
does pose a humanitarian crisis that would clearly destabilise the region.
...though global growth remains momentarily unaffected.
Globally, growth continues to be led by the United States and the Asia-Pacific region. In the U.S.,
we expect a continuation of the positive GDP growth data reported in the last quarter, despite
the completion of the monetary stimulus programme applied by the Federal Reserve since
2008, as early consumer- and business-confidence indicators show.
In the Eurozone, the possibility of a stand-off between the French and Italian governments with
the European Commission over disagreements in the State Budgets seems to have dissipated
with the adoption of austerity measures by both countries, though spending cuts are minimal.
Concerns about growth in emerging economies lessen, but persist.
Economic growth in the Eurozone remains very low and the risk of a third recession or deflation
persists. Given this context, the lifting of mutual sanctions with Russia and the initial effects
of the ECB’s action in the markets would be key to restoring the road to growth and inflation.
In Asia, the risk of a sharp economic slowdown continues to dissipate; China’s growth, albeit
minimal, is still considered strong, although inflation figures remain a concern for markets. In
Brazil, electoral doubts were dispelled with a win for the incumbent, and markets will await
economic measures undertaken to revive the country’s economy.
Central Banks will continue to support the economy and the market…
We expect global growth data to remain stable or increase slightly, though still below potential;
inflation figures will stabilise at current levels in the short term, though market intervention on
the part of the Central Banks in the Eurozone and Japan should begin to raise expectations in
the medium-term.
Monthly Strategy Report. November 2014
Regarding monetary policy, the conclusion of the stimulus programme in the United States will
shift the focus of the debate toward the timing and intensity of an inevitable interest-rate hike
by the FED. We believe it will be done carefully and gradually so as not to affect the markets or
the economy, particularly while inflation forecasts remain at current levels.
In the Eurozone, following the ECB’s initial purchase of covered bonds, we would wait to see
how the monetary stimulus programme – designed to increase the Central Bank’s balance sheet
by one billion euros – takes shape and gathers momentum. It remains to be seen whether or
not the ECB will buy public debt given the impact it would have on government bonds with risk
premia.
… affecting the forex.
In this climate, we remain committed to the depreciation of the euro against the U.S. dollar
and the British pound, given the divergent monetary policy and higher economic growth of the
United States and the United Kingdom. In the coming months, the rates of exchange against the
euro should lead to levels closer to 1.20 USD/EUR.
Monetary asset rates remain at zero…
The rates offered by monetary assets will remain near zero for another month, regardless of the
issuer in the majority of cases. Debt instruments issued with less than 12 months to maturity
in the United States, United Kingdom, and practically the entire Eurozone, will move to zero
profitability, while official rates hover at 0% and inflation looms. Commercial paper and bank
deposits may yield some tenths of profitability, though they are not very attractive in nominal
terms, and only the absence of inflation and the fact that they do not depreciate keep us
invested in these types of instruments.
… and long-term rates show little potential.
In medium- and long-term equity, it is increasingly difficult to find attractive returns, and even
the profitability of bonds issued by the euro’s peripheral economies has slowed considerably.
Only an intervention from the European Central Bank, by buying government debt, could
generate further hikes in the price of these instruments, though this scenario appears unlikely
in the coming weeks. The rates offered on U.S. bonds and those issued by the central Euro
economies remain outside our recommendation.
Opportunities in corporate debt are also negligible.
The rates on corporate bonds are also very low, following a rally in recent years. We would only
maintain positions in companies with moderate or moderate/low credit ratings for the shortest
terms to diversify cash-flows. We remain optimistic about convertible bonds linked to equity.
In stocks, we expect a calm after the storm…
Following the volatility in recent weeks, we expect equity markets will stabilise, providing
corporate results remain positive and justify current share valuations. A revival of economic
growth in Europe and the resolution of the conflict in the Ukraine could trigger a surge of some
magnitude in the last two months of the year, particularly in the Eurozone.
…with higher returns in Europe vs. U.S. security.
By geographic region, we believe that in the short term, European markets are more attractive
than American markets because they have yet to recover from October declines, and could
rebound strongly in the event that i) the ECB takes greater action in markets, ii) mutual sanctions
with Russia are lifted, or iii) concerns about a Eurozone recession dissipate. However, these
Monthly Strategy Report. November 2014
same factors could pose a risk should they flare up.
In this scenario, U.S. stocks will continue to serve as a refuge in times of turbulence, providing
good risk/return ratios. Emerging stocks remain contingent upon U.S. rates and economic
activity, thus lower expectations of increases would benefit these markets.
On the commodities market, despite the price of crude falling to USD 85 per barrel, we think
that the point of equilibrium between producers and consumers will shift to the range of USD
90-100 per barrel, so we expect the price of black gold to escalate in the coming weeks, but
expectations of economic recovery and global demand will dictate the speed of the rebound.
We expect to see spikes in crude and caution in the price of gold.
Gold will continue to be adversely affected if assumptions about the appreciation of the dollar
and increased interest rates materialise in the world’s largest economy. Another major factor
affecting the price of gold will be the outcome of the Swiss referendum, which will determine
whether the Central Bank will be forced to build up its bullion position in order to strengthen
reserves.
Monthly Strategy Report. November 2014
Euribor
Euribor 12 months (3 years)
Currencies
Government Bonds
EUR/USD (3 years)
10 years government yields
Corporate Bonds (1 year spread)
Commodities
Equity Indices
Data: Bloomberg
IBEX35 (3 years)
Monthly Strategy Report. November 2014
Equity Indices performance (3 years)
Monthly Strategy Report. November 2014
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