Trump’s trade war should set warning bells ringing for every company and investor

There should be no surprise that President Trump has launched his trade war with China.  The real surprise is that financial markets, and business leaders, are so surprised it is happening.  He was, after all, elected on a platform that called for a trade war, as I noted originally back in November 2016 – and many times since, even just last month.

Nor is it a surprise that China has chosen to target chemicals in its proposed list of products for retaliation. As my colleague John Richardson has noted:

“On Tuesday, China’s reaction to that first round of $50bn US tariffs included proposed tariffs of 25% on US exports of low and linear-low density polyethylene.  The same tariffs could also be levied on US polycarbonate, polyvinyl chloride, plastic products in general, acrylonitrile, catalysts, lubricants, epoxy resin, acrylic polymers, vinyl polymers, polyamides (nylon) and surfactants.”

China, unlike almost everyone else it seems, has used the past 15 months to prepare for Trump’s trade war.  So they are naturally targeting the chemicals industry – which was a great supporter of Trump in the early days, and has also come to depend on China for much of its growth.

They will have seen this December 2016 photo of Dow Chemicals CEO, Andrew Liveris, joining Trump at a victory rally in Michigan.

They will also have read Liveris’ tribute to the new President, when announcing the opening of a new R&D centre in Michigan:

“This decision is because of this man and these policies,” Mr. Liveris said from the stage of the 6,000-seat Deltaplex Arena here, adding, “I tingle with pride listening to you.”

The fact that Liveris stepped down last year as head of Trump’s manufacturing council will also have been noticed in Beijing, but clearly did not change their strategy.

FINANCIAL MARKETS EXPECT THE  FED TO BE A FAIRY GODMOTHER
Industry now has a few weeks left to plan for the inevitable.  But if history is any guide, many business people will fail to take advantage of this narrowing window of opportunity.  Instead, like most investors, they will continue with “business as usual”.  The problem is simple:

  • A whole generation has grown up expecting the central banks to act as a fairy godmother
  • Whenever markets have moved downwards, Fed Chairmen and others have showered them with cash
  • Therefore the winning strategy for the past 20 years and more has been to “buy on the dips”
  • Similarly, industry no longer bothers with genuine scenario analysis, where bad things can and do happen

Another key factor in this developing drama is that not all the actors are equally important.  China seems to have been initially wrong-footed, for example, by placing its trust in Treasury Secretary, Steve Mnuchin, and US Ambassador to China, Terry Branstad, to argue its case.  They might appear on paper to be the right people to lobby, but at the end of the day, they are simply messengers – not the ones deciding policy.

The key people are the US Trade Representative, Robert Lighthizer, and his aide, Peter Navarro.  They are now being joined by arch-hawk John Bolton, who in his role as National Security Advisor can be expected to play a key role – along with newly appointed Secretary of State, Mike Pompeo.   Like everything in the Trump White House, Lighthizer’s power comes from his relationship with the President, as the Wall Street Journal describes:

“To Mr. Trump, Mr. Lighthizer was a kindred spirit on trade—and one who shuns the limelight. The two men, who have a similar chip-on-the-shoulder sense of humor, bonded. Mr. Lighthizer caught rides to his Florida home on Air Force One. Mr. Trump summons Mr. Lighthizer regularly to the Oval Office to discuss trade matters, administration officials say.

THE NEXT 6 MONTHS WILL BE A WAKE-UP CALL FOR MANY
The past 18 months have in many ways been a repeat of the 2007-8 period, when I was told my warnings of a subprime crisis were simply alarmist.  This complacency even lasted into October 2008, after the Lehman collapse, when senior executives were still telling me the problems were “only financial” and wouldn’t impact “the real world”.

Similarly, I have been told since September 2015, when I first began warning of the dangers posed by populism in the US and Europe, that I “didn’t understand”. It was clear, I was told, that Trump could “never” become the Republican candidate and could “never ever” become President – and if he did, then Congress would “never ever ever” allow him to take charge of trade policy.  Similarly, I was being told in March 2016 that the UK would “never” vote for Brexit.

I also understand why so many friends and colleagues have been blindsided by these developments, as I discussed in the same September 2015 post:

“The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat. People no longer needed to argue over “who got what” as there seemed to be plenty for everyone. But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels.

“Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.”

TIME TO DEVELOP PROPER SCENARIOS ANALYSIS
Nobody can forecast everything in detail over the next 6 months, let alone the next few years.  And it is very easy to mock if one detail of the scenario analysis turns out to be wrong.  But the point of scenario analysis is not to try and forecast every detail.  It is instead to give you time to prepare, and to think of alternative strategies.

Just imagine, for example, if you had taken seriously my September 2015 warning about the rise of populism:

  • Think about all the decisions you wouldn’t have made, if you had really believed that Trump could become President and Brexit could happen in the UK?
  • Think of all the decisions you would have made instead, to create options in case these developments occurred?

I understand that you may worry about being mocked for being “stupid” and “alarmist”.  But you should simply remind the mockers of the lesson learnt by insurer Aetna’s CEO, from his failure to undertake proper scenario analysis, as he described in November 2016:

“When Aetna ran through post-election expectations, the idea that Donald J. Trump would win the presidency and that Republicans would control both chambers of Congress seemed so implausible that it was not even in play.  We started with a fresh piece of paper yesterday — we had no idea how to approach it. What we would have spent months doing if we thought it was even remotely possible, we had to do in a day.” 

There is no doubt that he was the one feeling stupid, then.

 

 

The post Trump’s trade war should set warning bells ringing for every company and investor appeared first on Chemicals & The Economy.

Trump policies to impact global supply chains, US stock markets

Shiller Jan17

Wall Street’s post-election rally suggests that many investors currently have the wrong idea about Donald Trump. They have decided he is a new Ronald Reagan, with policies that will deliver a major bull market.

But those promoting this narrative have forgotten their history. Both men certainly share a link with the entertainment industry. But Reagan took office towards the end of one of the worst recessions in the 20th century. By contrast, Trump takes office at the end of an 8-year bull market.

Prof Robert Shiller’s CAPE Index (based on average inflation-adjusted earnings for the past 10 years), provides the best long-term view of the US stock market, going back over a century to 1881.  As the chart shows:

   Ronald Reagan took office in January 1980, when the CAPE Index was 9.4
   It fell to 6.6 in July/August 1981 at the bottom of the recession, when the S&P 500 was just 109
   At the end of Reagan’s Presidency it was still only at 14.7, and the S&P 500 was at just 277
   Today, Donald Trump takes office with the CAPE ratio at 28.5 and the S&P at 2271, after an 8-year rally

Is it really credible as a Base Case that the rally could continue for another 8 years?  After all, Trump himself claimed back in September that the US Federal Reserve was being “highly political” in refusing to raise interest rates:

They’re keeping the rates down so that everything else doesn’t go down. We have a very false economy. At some point the rates are going to have to change. The only thing that is strong is the artificial stock market.”

Common sense would also tell us that Trump is about to make sweeping changes in economic and trade policy.  He made his position very clear in October with his Gettysburg speech.  And his Inauguration Speech on Friday explicitly broke with the key thrust of post-War American foreign policy:

We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.

Change on this scale is never easy to achieve, and usually starts by creating major disruption.  The expected benefits take much longer to appear.  This, of course, is why “business as usual” is such a popular strategy.  But it is clear that Trump is perfectly prepared to take this risk.  As he said at the start of the speech:

“We will face challenges. We will confront hardships. But we will get the job done.

Many companies and investors are still hoping nothing will change.  But CEOs such as Andrew Liveris at Dow Chemical and Mark Fields at Ford have already realised we are entering a New Normal world:

   Liveris told a Trump rally last month that jobs would be “repatriated” from outside the USA when Dow’s new R&D centre opened, adding as the Wall Street Journal reported “This decision is because of this man and these policies,” Mr. Liveris said from the stage of the 6,000-seat Deltaplex Arena here, adding, “I tingle with pride listening to you.”
  Fields personally told Trump of their decision to cancel the Mexican plant and invest in Michigan, sayingOur view is that we see a more positive U.S. manufacturing business environment under President-elect Trump and the pro-growth policies and proposals that he’s talking about”.

The reversal of US trade policies will impact companies all around the world.  The White House website has already confirmed the planned withdrawal from the TransPacific Partnership – and from NAFTA, if Mexico and Canada refuse to negotiate a new deal.  China is certain to be targeted as well. Protectionism will start to replace globalisation.

This means that today’s global supply chains are set for major disruption.  This will directly impact anyone currently selling to the US, and US companies currently selling overseas.  It will also impact every supply chain that involves a final sale either to or from the US.  The Great Reckoning for the policy failures since 2009 is now well underway:

   The Dow Jones Industrial Average’s repeated failure to break the 20,000 level may well be a warning sign
   Japan’s Nikkei Index was also poised to hit 40,000 when closing at 38,916 on 29 December 1989 – but never did

Sometimes, as US writer Mark Twain noted, “History doesn’t repeat itself, but it often rhymes”.

2016′s Word of the Year: “Impossible”

Trump Dec16Nobody likes change, particularly on the scale that is taking place all around us today.  Understandably, we prefer to live in a state of Denial.  This is why “Impossible” is my Word of the Year for 2016.

The main feature of the word is that it is a statement, and a very clear statement.  People who describe something as being “Impossible” aren’t looking for a discussion.  They are wanting to close down the topic and move on.  I saw this first between 2006-8 over my warnings about the potential for a subprime crisis.  And then the same reaction occurred with increasing frequency from September last year, in response to my warning that:

“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….Companies and investors have had little experience of how such debates can impact them in recent decades.  They now need to move quickly up the learning curve.  Political risk is becoming a major issue, as it was before the 1990s.”

The word “Impossible” then became a more-or-less routine response after my February and March posts, warning that Brexit poll creates UK, euro, interest rate rise risk and Brexit vote will hit UK, Eurozone and global economies.  Brexit was simply “Impossible”, I was told, as were major rises in interest rates.  Yet benchmark UK and euro 10-year interest rates are already higher today than when I wrote 9 months ago, and will likely rise much further in 2017.

There is no denying the pain created by today’s paradigm shift.  Yesterday’s successful strategies are now becoming irrelevant, and will have to be completely rethought.  Understandably, companies and investors instead found it much easier to follow the consensus and insist such a shift was “Impossible”.

The past few weeks saw this pattern of Denial reach its peak, as I highlighted in early October when noting that Markets struggle with political risk as populist momentum gains:

“Companies and investors therefore need to prepare very carefully for every possible outcome – even if these seem unlikely today.  For example, most investors today assume that the Federal Reserve will always support US stock markets. But if Trump were to win next month, it is likely that this policy would change very quickly.”

Sure enough, Fed policy has indeed now begun to “change very quickly”, as we saw last week.  Fed Chair, Janet Yellen, has taken the obvious way out: by declaring “victory” for the stimulus policy, she was then able to abandon it:

  The Fed not only raised the short-term rate, but also announced a rapid programme of rises for next year
  Given Trump’s known views on stimulus, it would be no surprise to see monthly rate rises taking place later in 2017

Of course, the consensus will respond that such a return to pre-SuperCycle rate moves is “Impossible”.  But it is already becoming clear that Yellen’s term as Chair is unlikely to renewed in 2018.  Trump has consistently termed her policies “highly political” in refusing to raise interest rates, as he confirmed in a September interview:

“They’re keeping the rates down so that everything else doesn’t go down. We have a very false economy. At some point the rates are going to have to change. The only thing that is strong is the artificial stock market.”

Developments in the benchmark 10-year rate, where the yield has almost doubled since the summer to 2.6%, confirm that the Fed is now well behind the market.  Rates for mortgages, auto loans and student loans are already climbing, as the Wall Street Journal has highlighted:

“Experts warn homeowners of sticker shock ahead, as interest rates on adjustable-rate mortgages and home equity lines of credit are expected to creep up”

All those who hid behind the use of the word “Impossible” will now have to reverse course very quickly indeed.

THE “IMPOSSIBLE” IS NOW BECOMING INEVITABLE
Even today, too many people still believe that Trump will abandon his policies now he has been elected.  But common sense tells us this really is “Impossible”. He would risk becoming a lame-duck President if he fails to carry out the “contract between myself and the American voter” set out in his 100-day plan.

Trump knows this, as the sign pictured above from his Tweet after his Florida rally at the weekend confirmed:

“Thank you Florida. My Administration will follow two simple rules: BUY AMERICAN and HIRE AMERICAN!”

Major companies are, of course, already going up the learning curve.  Thus Dow Chemical CEO, Andrew Liveris, told a recent Trump rally that Dow planned to open a new R&D centre in Michigan, where half of the 200 jobs created would be “repatriated” from outside the USA.  Liveris also added, as the Wall Street Journal reported:

This decision is because of this man and these policies,” Mr. Liveris said from the stage of the 6,000-seat Deltaplex Arena here, adding, “I tingle with pride listening to you.”

The President-elect then announced Mr Liveris’s appointment as chairman of his American Manufacturing Council.

Yesterday’s “Impossible” is now becoming today’s New Normal. But in 2016, “Impossible” was the Word of the Year.

Dow’s CEO says “pre-2008 economy was a bubble”

Now its official.  Andrew Liveris, Dow CEO, told CNBC last week that the “pre-2008 economy was a bubble“.  And exactly mirroring the analysis of Boom, Gloom and the New NoDow rightrmal, he went on to add that “for a couple of years after 2008, we had a head-fake that the growth might have returned, but it didn’t.”

So there we are.  After 5 years, the New Normal analysis has become the consensus.  Liveris didn’t actually highlight changing demographics as the cause of the dramatic change over the past 5 years.  But that moment is surely not far away.

The key point is that Liveris was very clear about recent developments:

Most of us should now just dismiss the pre-2008 economy as a vestige of history, that was a bubble.  .. We’re living in a slow growth world. Its still a world economy that’s very spotty.  You have to have targeted growth.  

“This post 2008, 2009 period – for a couple of years we had a head-fake that the growth might have returned, but it didn’t.  We’re having world event after world event. We have this very uneven global economy.  The 5% world economy, I think, is very much in the past. If we’ve got a 3%, 3.5% world economy, we’ll all be very happy.”

Liveris was also very clear about the growth potential of the US economy, despite his belief that Dow’s home market has the best prospects:

The US is the economy I feel best about,” said Liveris. “But its still 1.5%, 2%, 2.5% growth – it’s still not strong enough for all of us. 

As a result, he noted that Dow has “had to readjust our operating template.  If you don’t focus in on cost, capital and cash in this economy, you won’t grow margins now, no matter what your innovation agenda.  You’ve got to do both.  And that’s a very hard act to pull off.”

This is exactly the message that the blog has been presenting, along with co-author John Richardson.

And as Liveris went on to add, in response to a question about developments with the self-styled activist investor, Third Point, “You have to run the company for those investors who are staying, not for those who are leaving.  That’s the balance, how to actually release value this moment, versus release value in 5 years time.”

This dual-focus on today and tomorrow is not optional.  Companies who don’t invest in new products and services for the future, to meet the radically different needs of the New Normal, probably won’t have a future.

Sadly, an upcoming study in the Harvard Business Review suggests companies in the US S&P 500 instead paid out 91% of their earnings in share buybacks and dividends between 2003 – 2012 (54% in buybacks, 37% in dividends).  And it concludes:

That left them with little potential patient capital (for investing in the future) and even much of that was held, tax-sheltered, abroad“.

 

WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
US$: yen, down 3%
Brent crude oil, down 2%
PTA China, flat.  “Due to prevailing weak downstream demand in the polyester markets, end-users showed strong resistance, as they cited difficulties in passing down such additional costs to their end-markets”
Naphtha Europe, up 3%.  “Supply pressures coming from falling US gasoline blending demand and sluggish domestic petrochemical markets”
HDPE US export, up 7%. “Most US prices are too high to generate much interest from global buyers, with traders saying that Asian and Middle Eastern material is supplying Latin American markets.”
Benzene, Europe, up 8%. “Strong resistance to continued price increases ahead of August, which is traditionally a slow month owing to the summer holidays”
S&P 500 stock market index, up 8%