The following issues provide the foundation of our view:

• Declining rates of growth in manufacturing and tariff induced demand destruction
• Increased domestic production capacity
• Weakening global economics
• Crude oil price falling sharply
• Higher interest rates
• Strengthening U.S. dollar
• Falling global flat rolled prices
• Tariff resolution potential

While last month’s economic data was mixed leaving some uncertainty about how Q1 would start for the steel industry, the price action and latest data have clarified that flat rolled prices have moved into a bear market.  Some define a bear market as one that is simply down 20% from its highs.  A more nuanced definition includes the following description:

• Price action makes lower lows and lower highs in a downtrend
• Volatility sharply increases including relatively large moves to both the up and downside
• The majority of market participants are deleveraging
• Liquidity tightens, especially on the buy side, making it more difficult to transact

As you will see below, our caution is no longer in question, after prices have fallen over $100 since Thanskgiving.  Now, the focus turns to how the following weeks and months unfold.

The reason for the sharp mid-year turnaround and subsequent collapse in price and demand could be due to any number of factors such as increased supply, demand destruction, slowing growth, the downside of the business cycle, the Federal Reserve’s monetary tightening policy/higher interest rates and President Trump’s disruptive trade policy.  While we won’t fully know the “why” for months to come, we do know steel fundamentals have turned precipitously worse.

There is a common pattern across a broad based group of commodity prices and economic indicators breaking sharply below their long-term multi-year uptrends.

This is of concern not only because it indicates weaker economic demand and inflation, but also forecasts a sharp drop in rig counts in the coming months, which will translate into weak demand for energy related steel products.  As you can see in the chart below, the rig count has a strong lagged correlation with the oil price.

This chart of U.S. new home sales is another example of the above-mentioned pattern forcibly breaking below its almost eight-year uptrend.

Economies had been growing in unison since the bottom in 2016 gaining momentum throughout 2017. However, that peaked at the turn of 2018 and the global manufacturing PMIs have been trending lower ever since.

The most recent manufacturing PMI’s showed the majority of countries took continued lower in December including seven countries now with a PMI in contraction territory below 50.   This table shows a number of countries with a sharp YoY drop in their manufacturing PMI.

The U.S. ten-year treasury yield is yet another example of this pattern indicating a reversal of the animal spirits unleashed following the election has occured.  Risk aversion has spread across financial markets with undertones of deflationary pressures starting to percolate best evidenced by the Japanese 10-year treasury yield now in negative territory.

The following six regional manufacturing reports precede the ISM PMI. All six were lower, with the bottom four surprisingly weak.  All of them are lower YoY, four of them moved much lower.

FGM has been closely following these regional manufacturing indexes throughout December; forecasting a downside surprise in the ISM Manufacturing PMI on my twitter account @TheFeldstein.  However, the ISM exceeded even my most bearish expectations falling 5.2 points to 54.1.  A deep dive into the ISM PMI is below, but the sharp drop in the PMI is yet another example of a sharp break below a long term uptrend.  Charts patterns are indicators at best and can be unreliable, but when you see sharp moves like this and this pattern repeated across multiple industries, it becomes much more meaningful.  If the uptrend is over, then it is a downtrend.

The next two charts are further examples of this pattern, the first being the 2^nd month Chinese HRC future and the second the Chinese HRC spot price.

Finally, we see the pattern in the 2^nd and 3^rd month CME HRC futures.

The last chart to go is the Platts TSI Midwest HRC index.  Late last week, the index fell 14 points to 726 closing in on the uptrend line.  Keep an eye on the $715 level.

While the drop from $900 to $700 has been huge, these charts indicate HRC prices failed to find support in the low $700s and are closer to the second stage of the sell-off than to finding a short-term bottom.  Typically, when prices break below a support level, they have to fall significantly to a level buyers see the value being attractive enough to assuage their fears while those enduring losses panic and overshoot “rational” values.

“The market can stay irrational longer than you can stay solvent”

“The cure for low prices is low prices.”