Two New Dilemmas and One Old

Dilemma I: In December 2023, equity and bond markets had blockbuster rallies on expectations of imminent FOMC rate cuts. On December 1, Federal Chair Powell attempted to discourage expectations of rate cuts, noting that it would be premature to conclude that the Federal Reserve had achieved a sufficiently restrictive stance, or to speculate on when policy might ease. Twelve days later, he completely reversed his position indicating that the tightening of monetary policy is likely over as inflation is falling faster than expected. Consequently, financial conditions dramatically loosened, much more than the Federal Reserve wished. Now FOMC members are doing their utmost to tamper expectations.  We have been cautious in projecting aggressive rate cuts, but some action is more likely than none. Rate cuts should be beneficial for shipping equities, all else being, due to their considerable yields.

Dilemma 2: For shipping investors, more important than interest rates is the current conflict in the Red Sea. Conditions are treacherous.  Ton miles and rates are increasing as ships are routed around the Cape of Good Hope on longer voyages.   We would note despite the disruption that fundamentals still matter.  Dry bulk shipping, which is much less impacted than crude or clean segments, for example, has outperformed them over the last 90 days. That is not to say it won’t change if the current Red Sea situation lingers for months. No one knows how long these conditions will last.  Consequently, it is hard for markets to give credit for higher rates when their duration is unknowable.  Still the order book in tankers, especially VLCC’s, remains low, while the positive fundamentals in dry bulk are not fully captured in their valuations. We continue to focus on what we do know versus speculating on what can happen.

Dilemma 3: At this time of year, we are overwhelmed by predictions for the future.  Investing fundamentally is predicated on looking forward, whether it be six months or six years.  At this point, it is helpful to look back to prior years’ forecasts, none of which were remotely correct:

  • In 2016, the president of Lyft claimed that the majority of Lyft’s trips would be carried out by fully autonomous cars by 2021;
  • In 2020, Gartner projected that at least five countries would issue national cryptocurrencies;
  • In 2021, the CEO of Shell claimed that the pandemic may have already brought a peak in oil, saying: “Demand will take a long time to recover, if it recovers at all;” and
  • In October 2023, Jake Sullivan, President Biden’s national security adviser, noted in a 7,000-word essay for Foreign Affairs magazine, “Although the Middle East remains beset with perennial challenges, the region is quieter than it has been for decades.”

We attempt to be more measured in our forecasts.  We see a continued likelihood of US regional energy crises as demand for electricity increases, while supply is constrained.  In December we saw that ISO-New England said it doesn’t intend to extend its cost-of-service agreement with the 1,413 MW Mystic gas-fired plant in May.  Mystic runs on expensive imported LNG and the loss of the cost-of-service subsidies would force it to close. New England overcomes its lack of pipeline capacity by importing LNG from international markets at 2.0x to 3.0x the cost of US natural gas.  Should Mystic close, there would be no demand for imported LNG, and shipments would stop. Potentially New England would have to increase its reliance on heating oil given a lack of alternatives.  We also project a slower than anticipated transition to EVs in the US due to a lack of infrastructure.  It was reported this month that not a single electric vehicle charging station has been constructed yet through the $7.5 billion Federal Highway Administration’s National Electric Infrastructure program.  Overall, we prefer to focus on supply and demand rather than narrative or sentiment. Many analysts are highlighting the accelerating growth in extremely power-hungry AI applications, but almost none are focused on where the electricity is coming from. Given recent forecasts and pronouncements from CEOs, consultants, Federal Reserve Open Market Committee, and the National Security Council, we are firmly reminded of the line that appeared in Walt Kelly’s Pogo comic strip, “We have met the enemy, and he is us.”