From subprime to stimulus…and now social division

The blog has now been running for 12 years since the first post was written from Thailand at the end of June 2007. A lot has happened since then:

Sadly, although central banks and commentators have since begun to reference the impact of demographics on the economy, they refused to accept the fundamental issue – namely that economic growth is primarily driven by the needs of the Wealth Creator 25-54 age group:

  • Their numbers are reducing because Western fertility rates have been below replacement level (2.1 babies/woman) for nearly 50 years
  • Central bank attempts to effectively “print babies” via stimulus policies have therefore only increased debt to record levels

As a result, the world has become a much more complex and dangerous place. None of us can be sure what will happen over the next 12 months, as I noted last week.  But clearly, the risks are rising, as UK Justice minister, David Gauke, has highlighted:

“A willingness by politicians to say what they think the public want to hear, and a willingness by large parts of the public to believe what they are told by populist politicians, has led to a deterioration in our public discourse.  This has contributed to a growing distrust of our institutions – whether that be parliament, the civil service, the mainstream media or the judiciary.

“A dangerous gulf is emerging, between the people and the institutions that serve them. Such institutions – including the legal system and the judiciary – provide the kind of confidence and predictability that underpins our success as a society. 

“Rather than recognising the challenges of a fast-changing society require sometimes complex responses, that we live in a world of trade-offs, that easy answers are usually false answers, we have seen the rise of the simplifiers. 

“Those grappling with complex problems are not viewed as public servants but as engaged in a conspiracy to seek to frustrate the will of the public. They are ‘enemies of the people’.”

THANK YOU FOR YOUR SUPPORT OVER THE PAST 12 YEARS
It is a great privilege to write the blog, and to be able to meet many readers in workshops and conferences around the world. Thank you for all your support.

CEOs need new business models amid downturn

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.

BASF’s second profit warning highlights scale of the downturn now underway

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.

Global smartphone recession confirms consumer downturn


Q3 smartphone sales data show the global market in recession, as Strategy Analytics confirmed:

The global smartphone market has now declined for four consecutive quarters and is effectively in a recession.

The warning signs began in Q1, when the market plateaued for the first time, as discussed here in May:

“The global smartphone market has finally gone ex-growth as China’s slowdown continues. In turn, the market is starting to polarise – with Apple pushing further up-market whilst Chinese brands such as Xiaomi focus on volume. Samsung’s middle market positioning looks increasingly under threat.”

The chart highlights the key issues:

  • Samsung’s market share has declined from a third in 2013 to a fifth today, as its mid-market positioning leaves it without a clear value proposition for consumers
  • China’s Top 3 players have meanwhile soared from just a 12% market share to 29% today, powered by their low-cost positioning
  • Apple’s market share has remained very stable, as it has focused on the top end of the market, prioritising price over volume
  • “Others”, also usually without a clear value proposition, have seen their share drop to just 36% from a peak of 46% in Q3 2016


China remains the world’s largest smartphone market, with 103 million phones sold in Q3. But its volume was down 8% compared to Q3 2017, as the stimulus programmes continue to slow. As the Counterpoint chart shows, the market is now consolidating around a few winners:

  • Huawei are emerging as the market leader with a 23% share
  • Vivo and Oppo remain key challengers at 21%
  • But “Others” have dropped to 13%, and Samsung has almost disappeared at just 1%

As Counterpoint note, the top 5 brands now hold 86% of the market:

“The Chinese smartphone market is saturated with accelerated market consolidation. The competition in 2018 is almost a zero-sum game for the top five players. It is challenging however, even for the leading brands to create clear product differentiation. In Q3, only Huawei and vivo managed to achieve positive YoY growth among the top 5 brands.”

Meanwhile, of course, Apple continue to dominate the premium segment after the launch of the new iPhones in September.

This divergence between low-cost and premium will no doubt spread across the rest of the global market as the downturn continues.  And the main growth is likely to be in the low-cost area.

India, for example, saw volume grew 5% versus Q3 2017.  But with average per capita income less than $2000, price is all-important.  Reliance Jio’s ultra-low pricing strategy has been critical in making bandwidth affordable, and there are now over 400 million smartphone users in the country.

But iPhone sales are actually falling, and will be down by a third to just 2 million this year.  Functional phones in the $150-$250 price segment are driving sales growth, via online sales.  Q4 is expected to see these grow 65% to reach 50 million, due to their 50%-60% discounts.


The smartphone market thus continues to confirm that the BabyBoomer-led SuperCycle is over. As the chart shows, this created a new and highly profitable mid-market from the mid-1980s:

  • Before then, companies had competed on the basis of price or perceived value
  • But from the mid-1980s onwards, the mid-market became the most profitable sector
  • Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again

Instead, the market is segmenting again on the basis of price or perceived value. Chinese players compete on price, while Apple focuses on profit and is moving up-market. this means that previously profitable market leaders such as Samsung are slowly disappearing along with the mid-market segment that they supplied.

These very different strategies highlight the new world ahead for consumer markets and those who supply them.

Chemicals flag rising risk of synchronised global slowdown

Chemicals are easily the best leading indicator for the global economy.  And if the global economy was really in recovery mode, as policymakers believe, then the chemical industry would be the first to know – because of its early position in the value chain. Instead, it has a different message as the chart confirms:

  • It shows changes in global production and key sectors, based on American Chemistry Council (ACC) data
  • It highlights the rapid inventory build in H2 as oil and commodity prices soared
  • But since then, all the major sectors have moved into a slowdown, and agchems into decline

As the ACC note:

“The global chemical industry ended the first quarter on a soft note.  Global chemicals production fell 0.3% in March after a 1.0% drop in February, and a 0.6% decline in January. The last gain was 0.3% in December.

This, of course, is the opposite of consensus thinking at New Year, when most commentators were confident that a “synchronised global recovery” was underway. It is therefore becoming more and more likely, as I warned in January, that policymakers have been fooled once again by the activities of the hedge funds in boosting “apparent demand”:

“For the last 6 months, everyone who buys oil or other commodity-related products has been busy building as much inventory as they could afford. In turn, of course, this has made it appear that demand has suddenly begun to recover. At last, it seems, the “synchronised global recovery” has arrived.

Except, of course, that it hasn’t. The hedge funds didn’t buy 15 days-worth of oil to use it. They bought it to speculate, with the OPEC-Russia deal providing the essential “story” to support their buying binge.”

This downturn is worrying not only because it contradicts policymakers’ hopes, but also because Q1 volumes should be seasonally strong:

  • Western companies should be restocking to meet the surge of spring demand
  • Similarly, China and the Asian markets should now be at peak rates after the Lunar New Year

HIGHER OIL AND COMMODITY PRICES ARE CAUSING DEMAND DESTRUCTION
The problem is that most central bankers and economists don’t live in the real world, where purchasing managers and sales people have bonuses to achieve.  As one professor told me in January:

“Economists would tend to be skeptical about concepts such as “apparent demand”. Unless this a secret concept (and it doesn’t seem like it is), other investors should also use it, and then the oil price should already reflect it. Thus, there wouldn’t be gains to be made (unless you’re quicker than everyone else or have inside information)…”

But in the real world, H2’s inventory build has now been replaced by destocking – whilst today’s higher oil prices are also causing demand destruction.  We have seen this many times before when prices have risen sharply:

  • Consumers only have limited amounts of spare cash
  • When oil prices jump, they have to cut back in other areas
  • But, of course, this is only confirmed afterwards, when the spending data is reported
  • Essentially, this means that policymakers today are effectively driving by looking in the rear-view mirror

RISING DEBT LEVELS CREATE FURTHER HEADWINDS FOR GROWTHNew data from the US Federal Reserve Bank of St Louis also highlights the headwinds for demand created by the debt build-up that I discussed last week.  As the chart shows:

  • US borrowing was very low between 1966-79, and $1 of debt created $4.49 in GDP growth
  • Borrowing rose sharply in the Boomer-led SuperCycle, but $1 of debt still created $1.15 in GDP growth
  • Since stimulus programmes began in 2000, however, $1 of debt has created just $0.36 of GDP growth

In other words, value destruction has been taking place since 2000.  The red shading tells the story very clearly, showing how public debt has risen out of control as the Fed’s stimulus programmes have multiplied – first with sub-prime until 2008, and since then with money-printing.

RISING INTEREST RATES CREATE FURTHER RISKS
Last week saw the yield on the benchmark US 10-year Treasury Bond reach 3%, double its low in June 2016.  It has risen sharply since breaking out of its 30-year downtrend in January, and is heading towards my forecast level of 4%.

Higher interest rates will further slow demand, particularly in key sectors such as housing and autos.  And in combination with high oil and commodity prices, it will be no surprise if the global economy moves into recession.

Chemicals is providing the vital early warning of the risks ahead.  But as usual, it seems policymakers prefer to wear their rose-coloured spectacles.  And then, of course, as with subprime, they will all loudly declare “Nobody could have seen this coming”.

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West faces “demographic deficit” as populations age

Rising life expectancy, and falling fertility rates, mean that a third of the Western population is now in the low spending 55-plus age group.  Given that consumer spending is around two-thirds of the economy in developed countries, the above charts provide critically important information on the prospects for economic growth.

They show official data for household spending in 3 of the major G7 economies in 2017 – the USA, Japan and the UK:

  • Each country reports on a slightly different basis in terms of age range and headings, but the basics are similar
  • US spending peaks in the 45 – 54 age group: Japanese spending peaks at age 55; UK spending peaks at age 50
  • After the age of 75, US spending falls 46% from its peak and UK spend falls 53%: after the age of 70, Japanese spending falls 34%

The data confirms the common sense conclusion that youthful populations create a potential demographic dividend in terms of economic growth.  Conversely, ageing populations have a demographic deficit and will see lower growth, as.older people already own most of what they need, and their incomes go down as they enter retirement.

The Western world has been, and still is, a classic case study for this demographic effect in action, as the second chart shows:

  • In 1950, only 16% of Westerners were in the New Old 55-plus age group; 39% were in the 25-54 age group that drives economic growth and wealth creation; and 45% were under 25 as the BabyBoom got underway
  • But by 2015, the percentage of New Olders had doubled to 31%, whilst the percentage of Wealth Creators was virtually unchanged at 41% and only 28% were under 25 (as fertility rates collapsed after 1970)

The Boomers were the largest and wealthiest generation that the world has ever seen, and as they joined the workforce they created an economic Super-Cycle. This was turbo-charged by the fact that, for the first time in history, Western women began to re-enter the workforce after childbirth:

  • In the US, for example, women’s participation rate nearly doubled from 34% in 1950 to a peak of 60% in 1999
  • And after the Equal Pay Act of 1963, their earnings rose to 62% of men’s by 1979 and to 81% by 2005 (since when it has flatlined)

But since 2001, the oldest Boomer, born in 1946, has been leaving the Wealth Creator age group.  By 2013, the average Boomer had left it.  And since 1970, Western fertility rates have been below replacement levels (2.1 babies/woman).  So the Western economy now faces a double squeeze:

  • The Boomers who created the SuperCycle are no longer making a major contribution to economic growth
  • The number of new Wealth Creators is now relatively smaller, due to the collapse of fertility rates

In the past, very few Boomers would have lived beyond retirement age, as the 3rd chart confirms based on UN Population Division data.  So, sadly, they would have been irrelevant in terms of economic growth.  But, wonderfully, this is no longer true today:

  • In 1950, average US life expectancy for men was just 66 years and 72 years for women.  UK men died at age 67, and women at age 72.  Japanese men died at age 61, and women at age 65
  • Today, US men are living an extra 11 years and women 9 years more.  UK men are living an extra 12 years and women 11 years more.  Japanese men are living an extra 19 years and women 22 years more
  • By 2030, the UN forecasts suggest US men will be living 20% longer than in 1950, and women 16% longer.  In the UK, men will be living 23% longer and women 18% longer.  In Japan, men will be living 35% longer, and women 37% longer

By 2030, 36% of the Western population will be New Olders, almost equal to the 37% who are Wealth Creators.

Clearly there is no going back to SuperCycle growth levels.  I will look at this critical issue in more detail next week.

 

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