Many indicators are now pointing towards a global downturn in the economy, along with paradigm shifts in demand patterns. CEOs need to urgently build resilient business models to survive and prosper in this New Normal world, as I discuss in my 2019 Outlook and video interview with ICIS.
Global recession is the obvious risk as we start 2019. Last year’s hopes for a synchronised global recovery now seem just a distant memory. Instead, they have been replaced by fears of a synchronised global downturn.
Capacity Utilisation in the global chemical industry is the best leading indicator that we have for the global economy. And latest data from the American Chemistry Council confirms that the downtrend is now well-established. It is also clear that key areas for chemical demand and the global economy such as autos, housing and electronics moved into decline during the second half of 2018.
In addition, however, it seems likely that we are now seeing a generational change take place in demand patterns:
- From the 1980s onwards, the demand surge caused by the arrival of the BabyBoomers into the Wealth Creating 25 – 54 cohort led to the rise of globalisation, as companies focused on creating new sources of supply to meet their needs
- At the same time the collapse of fertility rates after 1970 led to the emergence of 2-income families for the first time, as women often chose to go back into the workforce after childbirth. In turn, this helped to create a new and highly profitable mid-market for “affordable luxury”
- Today, however, only the youngest Boomers are still in this critical generation for demand growth. Older Boomers have already moved into the lower-spending, lower-earning 55+ age group, whilst the younger millennials prefer to focus on “experiences” and don’t share their parents’ love of accumulating “stuff”
The real winners over the next few years will therefore be companies who not only survive the coming economic downturn, but also reposition themselves to meet these changing demand patterns. A more service-based chemical industry is likely to emerge as a result, with sustainability and affordability replacing globalisation and affordable luxury as the key drivers for revenue and profit growth.
Please click here to download the 2019 Outlook (no registration necessary) and click here to view the video interview.
Last year it was Bitcoin, in 2016 it was the near-doubling in US 10-year interest rates, and in 2015 was the oil price fall. This year, once again, there is really only one candidate for ‘Chart of the Year’ – it has to be the collapse of China’s shadow banking bubble:
- It averaged around $20bn/month in 2008, a minor addition to official lending
- But then it took off as China’s leaders panicked after the 2008 Crisis
- By 2010, it had shot up to average $80bn/month, and nearly doubled to $140bn in 2013
- President Xi then took office and the bubble stopped expanding
- But with Premier Li still running a Populist economic policy, it was at $80bn again in 2017
At that point, Xi took charge of economic policy, and slammed on the brakes. November’s data shows it averaging just $20bn again.
The impact on the global economy has already been immense, and will likely be even greater in 2019 due to cumulative effects. As we noted in this month’s pH Report:
“Xi no longer wants China to be the manufacturing Capital of the world. Instead his China Dream is based on the country becoming a more service-led economy based on the mobile internet. He clearly has his sights on the longer-term and therefore needs to take the pain of restructuring today.
“Financial deleveraging has been a key policy, with shadow bank lending seeing a $609bn reduction YTD November, and Total Social Financing down by $257bn. The size of these reductions has reverberated around Emerging Markets and more recently the West:
- The housing sector has nose-dived, with China Daily reporting that more than 60% of transactions in Tier 1 and 2 cities saw price drops in the normally peak buying month of October, with Beijing prices for existing homes down 20% in 2018
- It also reported last week under the heading ’Property firms face funding crunch’ that “housing developers are under great capital pressure at the moment”
- China’s auto sales, the key to global market growth since 2009, fell 14% in November and are on course for their first annual fall since 1990
- The deleveraging not only reduced import demand for commodities, but also Chinese citizens’ ability to move money offshore into previous property hotspots
- Real estate agents in prime London, New York and other areas have seen a collapse in offshore buying from Hong Kong and China, with one telling the South China Morning Post that “basically all Chinese investors have disappeared “
GLOBAL STOCK MARKETS ARE NOW FEELING THE PAIN
As I warned here in June (Financial markets party as global trade wars begin), the global stock market bubble is also now deflating – as the chart shows of the US S&P 500. It has been powered by central bank’s stimulus policies, as they came to believe their role was no longer just to manage inflation.
Instead, they have followed the path set out by then Federal Reserve Chairman, Ben Bernanke, in November 2010, believing that:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Now, however, we are coming close to the to the point when it becomes obvious that the Fed cannot possibly control the economic fortunes of 325m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted by central banks in this failed experiment.
The path back to fiscal sanity will be very hard, due to the debt that has been built up by the stimulus policies. The impartial Congressional Budget Office expects US government debt to rise to $1tn.
Japan – the world’s 3rd largest economy – is the Case Study for the problems likely ahead:
- Consumer spending is 55% of Japan’s GDP. It falls by around a third at age 70+ versus peak spend at 55, as older people already own most of what they need, and are living on a pension
- Its gross government debt is now 2.5x the size of its economy, and with its ageing population (median age will be 48 in 2020), there is no possibility that this debt can ever be repaid
- As the Nikkei Asian Review reported in July, the Bank of Japan’s stimulus programme means it is now a Top 10 shareholder in 40% of Nikkei companies: it is currently spending ¥4.2tn/year ($37bn) buying more shares
- Warning signs are already appearing, with the Nikkei 225 down 12% since its October peak. If global stock markets do now head into a bear market, the Bank’s losses will mount very quickly
CHINA MOVE INTO DEFLATION WILL MAKE DEBT IMPOSSIBLE TO REPAY
Since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, Again“, in 2011 with John Richardson, I have argued that the stimulus policies cannot work, as they are effectively trying to print babies. 2019 seems likely to put this view to the test:
- China’s removal of stimulus is being matched by other central banks, who have finally reached the limits of what is possible
- As the chart shows, the end of stimulus has caused China’s Producer Price Inflation to collapse from 7.8% in February 2017
- Analysts Haitong Securities forecast that it will “drop to zero in December and fall further into negative territory in 2019“
China’s stimulus programme was the key driver for the global economy after 2008. Its decision to withdraw stimulus – confirmed by the collapse now underway in housing and auto sales – is already putting pressure on global asset and financial markets:
- China’s lending bubble helped destroy market’s role of price discovery based on supply/demand
- Now the bubble has ended, price discovery – and hence deflation – may now be about to return
- Yet combating deflation was supposed to be the prime purpose of Western central bank stimulus
This is why the collapse in China’s shadow lending is my Chart of the Year.
The chemical industry is easily the best leading indicator for the global economy. And thanks to Kevin Swift and his team at the American Chemistry Council, we already have data showing developments up to October, as the chart shows.
It confirms that consensus hopes for a “synchronised global recovery” at the beginning of the year have again proved wide of the mark. Instead, just as I warned in April (Chemicals flag rising risk of synchronised global slowdown), the key indicator – global chemical industry Capacity Utilisation % – has provided fair warning of the dangers ahead.
It peaked at 86.2%, in November 2017, and has fallen steadily since then. October’s data shows it back to June 2014 levels at 83.6%. And even more worryingly, it has now been falling every month since June. The last time we saw a sustained H2 decline was back in 2012, when the Fed felt forced to announce its QE3 stimulus programme in September. And it can’t do that again this time.
The problem, as I found when warning of subprime risks in 2007-8 (The “Crystal Blog” foresaw the global financial crisis), is that many investors and executives prefer to adopt rose-tinted glasses when the data turns out to be too downbeat for their taste. Whilst understandable, this is an incredibly dangerous attitude to take as it allows external risks to multiply, when timely action would allow them to be managed and mitigated.
It is thus critical that everyone in the industry, and those dependent on the global economy, take urgent action in response to BASF’s second profit warning, released late on Friday, given its forecast of a “considerable decrease of income” in 2018 of “15% – 20%”, after having previously warned of a “slight decline of up to 10%”.
I have long had enormous respect for BASF and its management. It is therefore deeply worrying that the company has had to issue an Adjustment of outlook for the fiscal year 2018 so late in the year, and less than 3 weeks after holding an upbeat Capital Markets Day at which it announced ambitious targets for improved earnings in the next few years.
The company statement also confirmed that whilst some problems were temporary, most of the issues are structural:
- The impact of low water on the Rhine has proved greater than could have been earlier expected
- But the continuing downturn in isocyanate margins has been ongoing for TDI since European contract prices peaked at €3450/t in May — since when they had fallen to €2400/t in October and €2050/t in November according to ICIS, who also reported on Friday that
“Supply is still lengthy at year end in spite of difficulties at German sellers BASF and Covestro following low Rhine water levels”
- The decline is therefore a very worrying insight into the state of consumer demand, given that TDI’s main applications are in furniture, bedding and carpet underlay as well as packaging applications.
- Even more worrying is the statement that:
“BASF’s business with the automotive industry has continued to decline since the third quarter of 2018; in particular, demand from customers in China slowed significantly. The trade conflict between the United States and China contributed to this slowdown.”
This confirms the warnings that I have been giving here since August when reviewing H1 auto sales (Trump’s auto trade war adds to US demographic and debt headwinds).
I noted then that President Trump’s auto trade tariffs were bad news for the US and global auto industry, given that markets had become dangerously dependent on China for their continued growth:
- H1 sales in China had risen nearly 4x since 2007 from 3.1m to 11.8m this year
- Sales in the other 6 major markets were almost unchanged at 23m versus 22.1m in 2007
Next year may well prove even more challenging if the current “truce” over German car exports to the USA breaks down,
INVESTORS HAVE WANTED TO BELIEVE THAT INTEREST RATES CAN DOMINATE DEMOGRAPHICS
The recent storms in financial markets are a clear sign that investors are finally waking up to reality, as Friday night’s chart from the Wall Street Journal confirms:
“In a sign of the breadth of the global selloff in stocks, Germany’s main stock index fell into a bear market Thursday, the latest benchmark to have tumbled 20% or more from its recent peak….Other markets already in bear territory are home to companies exposed to recent trade fights between the U.S. and China.”
The problem, as I have argued since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, again“, in 2011 with John Richardson, is that the economic SuperCycle created by the dramatic rise in the number of post-War BabyBoomers is now over.
I highlighted the key risks is my annual Budget Outlook in October, Budgeting for the end of “Business as Usual”. I argued then that 2019 – 2021 Budgets needed to focus on the key risks to the business, and not simply assume that the external environment would continue to be stable. Since then, others have made the same point, including the president of the Council on Foreign Relations, Richard Haas, who warned on Friday:
“In an instant Europe has gone from being the most stable region in the world to anything but. Paris is burning, the Merkel era is ending, Italy is playing a dangerous game of chicken with the EU, Russia is carving up Ukraine, and the UK is consumed by Brexit. History is resuming.”
It is not too late to change course, and focus on the risks that are emerging. Please at least read my Budget Outlook and consider how it might apply to your business or investments. And please, do it now.
You can also click here to download and review a copy of all my Budget Outlooks 2007 – 2018.
Companies and investors are starting to finalise their plans for the coming year. Many are assuming that the global economy will grow by 3% – 3.5%, and are setting targets on the basis of “business as usual”. This has been a reasonable assumption for the past 25 years, as the chart confirms for the US economy:
- US GDP has been recorded since 1929, and the pink shading shows periods of recession
- Until the early 1980’s, recessions used to occur about once every 4 – 5 years
- But then the BabyBoomer-led economic SuperCycle began in 1983, as the average Western Boomer moved into the Wealth Creator 25 – 54 age group that drives economic growth
- Between 1983 – 2000, there was one, very short, recession of 8 months. And that was only due to the first Gulf War, when Iraq invaded Kuwait.
Since then, the central banks have taken over from the Boomers as the engine of growth. They cut interest rates after the 2001 recession, deliberately pumping up the housing and auto markets to stimulate growth. And since the 2008 financial crisis, they have focused on supporting stock markets, believing this will return the economy to stable growth:
- The above chart of the S&P 500 highlights the extraordinary nature of its post-2008 rally
- Every time it has looked like falling, the Federal Reserve has rushed to its support
- First there was co-ordinated G20 support in the form of low interest rates and easy credit
- This initial Quantitative Easing (QE) was followed by QE2 and Operation Twist
- Then there was QE3, otherwise known as QE Infinity, followed by President Trump’s tax cuts
In total, the Fed has added $3.8tn to its balance sheet since 2009, whilst China, the European Central Bank and the Bank of Japan added nearly $30tn of their own stimulus. Effectively, they ensured that credit was freely available to anyone with a pulse, and that the cost of borrowing was very close to zero. As a result, debt has soared and credit quality collapsed. One statistic tells the story:
“83% of U.S. companies going public in the first nine months of this year lost money in the 12 months leading up to the IPO, according to data compiled by University of Florida finance professor Jay Ritter. Ritter, whose data goes back to 1980, said this is the highest proportion on record. The previous highest rate of money-losing companies going public had been 81% in 2000, at the height of the dot-com bubble.”
And more than 10% of all US/EU companies are “zombies” according to the Bank of International Settlements (the central banks’ bank), as they:
“Rely on rolling over loans as their interest bill exceeds their EBIT (Earnings before Interest and Taxes). They are most likely to fail as liquidity starts to dry up”.
2019 – 2021 BUDGETS NEED TO FOCUS ON KEY RISKS TO THE BUSINESS
For the past 25 years, the Budget process has tended to assume that the external environment will be stable. 2008 was a shock at the time, of course, but time has blunted memories of the near-collapse that occurred. The issue, however, as I noted here in September 2008 is that:
“A long period of stability, such as that experienced over the past decade, eventually leads to major instability.
“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.”
This is the great Hyman Minsky’s explanation for financial crises and panics. Essentially, it describes how confidence eventually leads to complacency in the face of mounting risks. And it is clear that today, most of the lessons from 2008 have been forgotten. Sadly, it therefore seems only a matter of “when”, not “if”, a new financial crisis will occur.
So prudent companies will prepare for it now, whilst there is still time. You will not be able to avoid all the risks, but at least you won’t suddenly wake up one morning to find panic all around you.
The chart gives my version of the key risks – you may well have your own list:
- Global auto and housing markets already seem to be in decline; world trade rose just 0.2% in August
- Global liquidity is clearly declining, and Western political debate is ever-more polarised
- Uncertainty means that the US$ is rising, and geopolitical risks are becoming more obvious
- Stock markets have seen sudden and “unexpected” falls, causing investors to worry about “return of capital”
- The risks of a major recession are therefore rising, along with the potential for a rise in bankruptcies
Of course, wise and far-sighted leaders may decide to implement policies that will mitigate these risks, and steer the global economy into calmer waters. Then again, maybe our leaders will decide they are “fake news” and ignore them.
Either way, prudent companies and investors may want to face up to these potential risks ahead of time. That is why I have titled this year’s Outlook, ‘Budgeting for the end of “Business as Usual“. As always, please contact me at email@example.com if you would like to discuss these issues in more depth.
Please click here to download a copy of all my Budget Outlooks 2007 – 2018.
300,000 homes and half a million cars have been destroyed by Hurricane Harvey. And in terms of business, it is often forgotten that Houston is home to more Fortune 500 companies than any other metro area than New York. The damage will take years to repair, as families have to regroup and re-establish their lives – as I describe in my new feature article for ICIS Chemical Business, and in the above video interview with ICB Deputy Editor, Will Beacham.
The hurricanes are also likely to have a longer-term impact on the chemicals industry. Regulatory concerns may well be increased, given the prominent reporting of the potential for toxic run-off from the two dozen Superfund sites in the area. There will also be increased pressure on the industry to rethink its basic business model and increase the priority given to sustainability.
Even before the hurricanes, consumer concern was mounting over the impact of plastic waste on the oceans and the environment. Now, the devastation they have caused will likely turbo-charge the move towards renewables and the circular economy. Fear is a strong motivator, and millions will take another look at climate change.
This development will, of course, create opportunities as well as challenges for farsighted companies. It is never easy to move away from a “business as usual” mind-set. But the increased need to adopt key elements of the circular economy agenda creates an opportunity to develop major new sources of revenue and profit for the future.
In a decade’s time, therefore, we will not simply remember today’s devastation. We will likely also recognise that it marked the moment when sustainability stopped being simply an item in the Annual Report, and instead opened the door to a new era for the industry and those who work and invest in it.
Please click here to download the feature article for ICIS Chemical Business, and click here to view the video interview.
“By Monday, the third straight day of flooding, the aftermath of Hurricane Harvey had left much of the region underwater, and the city of Houston looked like a sea dotted by small islands. ’This event is unprecedented,’ the National Weather Service tweeted. ‘All impacts are unknown and beyond anything experienced.’”
This summary from the New York Times gives some idea of the immensity of the storm that struck large parts of Texas/Louisiana last week, including the 4th largest city in the US. And this was before the second stage of the storm.
I worked in Houston for 2 years, living alongside the Buffalo Bayou which flooded so spectacularly last week. The photo above from the Houston Chronicle shows the area around our former home on Saturday, still surrounded by water. Today, as the rest of America celebrates the Labor Day holiday, the devastated areas in Texas and Louisiana will be starting to count the cost of rebuilding their lives and starting out anew:
Some parts of the Houston economy will recover remarkably quickly. It is a place where people aim to get things done, and don’t just sit around waiting for others to do the heavy lifting
But as Texas Governor Abbott has warned, Harvey is “one of the largest disasters America has ever faced. We need to recognize it will be a new normal, a new and different normal for this entire region.”
The key issue is that the Houston metro area alone is larger in size than the economies of Sweden or Poland. And as Harris County Flood Control District meteorologist Jeff Lindner tweeted:
“An estimated 70% of the 1,800-square-mile county (2700 sq km), which includes Houston, was covered with 1½ feet (46cm) of water”
Already the costs are mounting. Abbott’s current estimate is that Federal funding needs alone will be “far in excess of $125bn“, easily topping the costs of 2005′s Hurricane Katrina in New Orleans. And, of course, that does not include the cost, and pain, suffered by the majority of homeowners – who have no flood insurance – or the one-third of auto owners who don’t have comprehensive insurance. They will likely receive nothing towards the costs of cleaning up.
SOME PARTS OF THE ECONOMY HAVE THE POTENTIAL FOR A QUICK RECOVERY
Companies owning the large refineries and petrochemical plants in the affected region have all invested in the maximum amount of flood protection following Katrina, when some were offline for 18 months
Oil platforms in the Gulf of Mexico are used to hurricanes and are already coming back – Reuters reports that only around 6% of production is still offline, down from a peak of 25% at the height of the storm
It is hard currently to estimate the impact on shale oil/gas output in the Eagle Ford basin, but the Oil & Gas Journal reports that 300 – 500 kb/d of oil production is shut-in, and 3bcf/d of gas production
ExxonMobil is now restarting the country’s second-biggest refinery at Baytown, and Phillips 66 and Valero are also restarting some operations, whilst ICIS reports that a number of major petrochemical plants are now being inspected in the expectation that they can soon be restarted
Encouragingly also, it seems that insurance companies are planning to speed up inspections of flooded properties by using drone technology, which should help to process claims more quickly. Loss adjusters using drones can inspect 3 homes an hour, compared to the hour taken to inspect on roof manually. But even Farmers Insurance, one of the top Texas insurers, only has 7 drones available – and has already received over 14000 claims.
RECOVERY FOR MOST PEOPLE AND BUSINESSES WILL TAKE MUCH LONGER
For the 45 or more people who have died in the floods, there will be no recovery.
Among the living, 1 million people have been displaced and up to 500k cars destroyed. 481k people have so far requested housing assistance and 25% of Houston’s schools have suffered severe or extensive flood damage.
These alarming statistics highlight why clean-up after Harvey will take a long time. Basic services such as water and sewage are massively contaminated, with residents being told to boil water in many areas. The “hundreds of thousands of people across the 38 Texas counties affected by Harvey” using their own wells are particularly at risk.
And as the New York Times adds:
“Flooded sewers are stoking fears of cholera, typhoid and other infectious diseases. Runoff from the city’s sprawling petroleum and chemicals complex contains any number of hazardous compounds. Lead, arsenic and other toxic and carcinogenic elements may be leaching from some two dozen Superfund sites in the Houston area”
FEW IN HOUSTON HAVE FLOOD INSURANCE
Then there is the issue that, as the chart from the New York Times shows, most of those affected by Harvey don’t have home insurance policies that cover flood damage. Similarly, a survey in April by insurer Aon found that:
“Less than one-sixth of homes in Harris County, Texas, whose county seat is Houston, currently have active National Flood Insurance Program policies. The county has about 1.8 million housing units.”
As the Associated Press adds:
“Experts say another reason for lack of coverage in the Houston area was that the last big storm, Tropical Storm Allison, was 16 years ago. As a result, people had stopped worrying and decided to use money they would have spent for insurance premiums on other items.”
Even those with insurance will get hit by the low levels of coverage – just $250k for a house and $100k for contents. Businesses carrying insurance also face problems, according to the Wall Street Journal, as they depend on the same Federal insurance scheme, which:
“Was primarily designed for homeowners and has had few updates since the 1970s. Standard protections for small businesses, including costs of business interruption and significant disaster preparation, aren’t covered, and maximum payouts for damages haven’t risen since 1994.
The maximum coverage for business property is $500k, and the same cap applies to equipment and other contents, far below many businesses’ needs. And even those with insurance find it difficult to claim, according to a study by the University of Pennsylvania and the Federal Reserve Bank of New York after Hurricane Sandy in 2012:
“More than half of small businesses in New York, New Jersey and Connecticut that had flood insurance and suffered damages received no insurance payout. Another 31% recouped only some of their losses.”
Auto insurance is a similar story. Only those with comprehensive auto insurance are likely to be covered for their loss – and even then, people will still suffer deductions for depreciation. According to the Insurance Council of Texas:
“15% of motorists have no car insurance, and of those who do, (only) 75% have comprehensive insurance. That leaves a lot of car owners without any protection.”
In other words, around 1/3rd of car owners probably have no insurance cover against which to claim for flood damage.
HARVEY’S IMPACT WILL BE LONG-TERM
It is clearly too early, with flood waters still rising in some areas, to be definitive about the implications of Hurricane Harvey for Houston and the affected areas in Texas and Louisiana.
Of course there are supply shortages today, and the task of replacement will created new demand for housing and autos. But over the medium to longer term, 3 key impacts seem likely to occur:
It will take time for the supply of oil, gas, gasoline and other refinery products, petrochemicals and polymers to fully recover. There will inevitably also be some short-term shortages in some value chains. But within 1 – 3 months, most if not all of the major plants will probably be back online
It will take a lot longer for most people affected by Harvey to recover their losses. Some may never be able to do this, especially if they have no insurance to cover their flooded house or car. And those working in the gig economy have little fall-back when their employers have no need for their services
The US economy will also be impacted, as Slate magazine warned a week ago, even before the full magnitude of the catastrophe became apparent:
“For the U.S. economy to lose Houston for a couple of weeks is a human disaster—and an economic disaster, too….Given that supply chains rely on a huge number of shipments making their connections with precision, the disruption to the region’s shipping, trucking, and rail infrastructure will have far-reaching effects.”