A dose of global flu: the male variety?

The world has caught a cold, and not just any cold. The constant flow of negative data the world over could be seen to be exacerbating global sentiment. The ‘bear’ retains its grip on world stock markets as investors shy away from the unpredictable volatility; the banking sector drops from bad to worse as more and more institutions announce further losses. Global manufacturing also continues to bear the brunt of this particularly stubborn virus.

The Symptoms…

The Baltic Dry Index (BDIY:IND), which is often seen as the thermometer of global trade, has plummeted from an all time high of 11,793, last may, to 663 last December, a 22 year low, and has now been hovering around 2,000 for the past couple of weeks. To quantify this dramatic decline; the daily rental rate of the largest bulk carriers dropped from $234,000 last summer to less than $3,000 in early December. Although not wholly indicative of container shipping, the index does illustrate the impact the lack of 11,793, last may, to 663 last December, a 22 year low, and has now been hovering around 2,000 for the past couple of weeks. To quantify this dramatic decline; the daily rental rate of the largest bulk carriers dropped from $234,000 last summer to less than $3,000 in early December. Although not wholly indicative of container shipping, the index does illustrate the impact the lack of demand and tight liquidity in credit markets has had on global trade. After all, if raw material is not being moved, supply chains do not appear to require the necessary materials to manufacture goods.

Similarly, global airfreight which accounts for 35% of the value of goods traded internationally is in freefall; down 22.6% in December 2008 (after 9/11, when much of the global fleet was grounded, the decline was only 13.9%). Of this, Asia Pacific accounts for 45% of international cargo and has subsequently seen the biggest decline in airfreight. Clearly the figures are indicative of a lack of demand and a sign of the economic downturn.

Whilst such economic data is enough to give one a headache, there is a silver lining. A reduction in freight costs is good for the “buyers”, who have been able to reduce shipping costs (both sea and air) but also utilise the spare capacity on planes to reduce lead time and maintain lower stock inventory levels, streamlining their supply chain.

Global commodity prices have generally continued to trend downwards over the past six months due to the lack of demand (see graphics below) Such reductions should certainly have begun to work themselves into supplier inventory by now and we would also expect further operational savings to feed through as vendors try to maintain their existing order books in this tough manufacturing environment.

One should also remember, as referred earlier, that it is not only China’s manufacturing sector that is suffering. The number of cars being assembled in America last month was 60% below the same month last year. Industrial production in America, Britain and Germany fell in the last three months 3.6%, 4.4% and 6.8% respectively; Taiwan’s by 21.7% and Japan’s by 12% in the last quarter of last year. Other low cost countries are also being hit hard by the lack of demand and credit finance.

In fact, China has possibly the most potent cure; namely, central Government. Like few others, China’s leaders operate with little opposition and are capable of making quick decisions that are implemented almost immediately. Some commentators argue that the recent stimulus is already beginning to have an effect. Others suggest that China is back on course for the 8% GDP growth that is required to employ the mass of new workers entering the labour pool each year. The 1st quarter GDP figures should be released next month and will give an indication as to whether this is at all a possibility. Conjecture aside, actions speak louder than words and Zhong Shan, Vice-Minister of Commerce for the PRC, recently stated that, ‘Policies implemented so far are a comma, not a full stop’ suggesting that further tax and credit policies will be implemented to cushion the ailing export sector. Notably, from the 1st of February, textile rebates were increased by a percentage point from 14% to 15% and it is anticipated that a further stimulus package will be announced following the National People’s Congress.

The latest figures released by CLSA on China’s Purchasing Manager’s Index may point to a possible bottoming out in the manufacturing sector’s decline, although it is still true that there was a further contraction in February; from 42.2 to 45.1, the third straight month of improvement since it reached a record low of 40.9 in November (below 50 suggests a contraction, above 50 an expansion). At least it suggests that any contraction is slowing and looking at some of the individual indices comprised within the PMI, it can be seen that output, new orders and employment are all on the rise compared with January. Raw materials, fuel and power also fell 5.3% in the Producer Price Index, which overall was down 3.3% year-on-year for January for manufactured goods.

Even though China may be well placed to support its manufacturing sector, there is a heightened risk of protectionism. As soon as the Treasury Secretary, Tim Geithner, was appointed he referred to China’s manipulation of the exchange rate mechanism. The original draft of the US stimulus package included a ‘Buy American’ provision that was subsequently watered down as a result of international protest. Even India has only recently relaxed the import ban on China made toys, which was imposed without any real justification. However, world leaders appear to have learnt from past mistakes (Tariff Act of 1930 which only exacerbated the Great Depression) and are aware of the implications a trade war would have on the current global economy. In this context, we do not believe that China’s export sector will suffer any additional burden in the short to medium term.

Not Such a Bitter Pill…

There is no denying that trading conditions are tough. Retailers, wholesalers and suppliers – the whole supply chain – is being disrupted by bankruptcies, lack of demand, low stock turnover and a lack of credit finance. However, ironically, from a sourcing perspective these conditions have led to an environment that heavily favours the ‘Buyer’, whether negotiating on prices, volumes or freight rates. As long as vendors are managed appropriately there are opportunities to reduce both risk and prices going into 2009. A complete understanding of your vendors is more important than ever. Their financial position, subsidiaries, reliance on your orders should all be understand in addition to the usual due diligence that is conducted. It is also essential to have a wide supplier base to make sure that you have options should part of your supply chain be disrupted. The world has certainly caught a cold, but there are still opportunities to deliver value through your purchasing channels; it is just a question of blowing one’s nose and sniffing them out.

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