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.
I well remember the questions a year ago, after I published my annual Budget Outlook, ‘Budgeting for the Great Unknown in 2018 – 2020‘. Many readers found it difficult to believe that global interest rates could rise significantly, or that China’s economy would slow and that protectionism would rise under the influence of Populist politicians.
MY ANNUAL BUDGET OUTLOOK WILL BE PUBLISHED NEXT WEEK
Next week, I will publish my annual Budget Outlook, covering the 2019-2021 period. The aim, as always, will be to challenge conventional wisdom when this seems to be heading in the wrong direction.
Before publishing the new Outlook each year, I always like to review my previous forecast. Past performance may not be a perfect guide to the future, but it is the best we have:
The 2007 Outlook ‘Budgeting for a Downturn‘, and 2008′s ‘Budgeting for Survival’ meant I was one of the few to forecast the 2008 Crisis. 2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year, as demand grows in line with a recovery in global GDP“. Please click here if you would like to download a free copy of all the Budget Outlooks.
THE 2017 OUTLOOK WARNED OF 4 KEY RISKS
My argument last year was essentially that confidence had given way to complacency, and in some cases to arrogance, when it came to planning for the future. “What could possibly go wrong?” seemed to be the prevailing mantra. I therefore suggested that, on the contrary, we were moving into a Great Unknown and highlighted 4 key risks:
- Rising interest rates would start to spark a debt crisis
- China would slow as President Xi moved to tackle the lending bubble
- Protectionism was on the rise around the world
- Populist appeal was increasing as people lost faith in the elites
A year later, these are now well on the way to becoming consensus views.
- Debt crises have erupted around the world in G20 countries such as Turkey and Argentina, and are “bubbling under” in a large number of other major economies such as China, Italy, Japan, UK and USA. Nobody knows how all the debt created over the past 10 years can be repaid. But the IMF reported earlier this year that total world debt has now reached $164tn – more than twice the size of global GDP
- China’s economy in Q3 saw its slowest level of GDP growth since Q1 2009 with shadow bank lending down by $557bn in the year to September versus 2017. Within China, the property bubble has begun to burst, with new home loans in Shanghai down 77% in H1. And this was before the trade war has really begun, so further slowdown seems inevitable
- Protectionism is on the rise in countries such as the USA, where it would would have seemed impossible only a few years ago. Nobody even mentions the Doha trade round any more, and President Trump’s trade deal with Canada and Mexico specifically targets so-called ‘non-market economies’ such as China, with the threat of losing access to US markets if they do deals with China
- Brexit is worth a separate heading, as it marks the area where consensus thinking has reversed most dramatically over the past year, just as I had forecast in the Outlook:
“At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.
“Today’s Populist politicians don’t seem to care about these risks. For them, the allure of arguing for “no deal”, if they can’t get exactly what they want, is very powerful. So it would seem sensible for executives to spend time understanding exactly how their business might be impacted if today’s global supply chains came to an end.”
- Populism is starting to dominate the agenda in an increasing number of countries. A year ago, many assumed that “wiser heads” would restrain President Trump’s Populist agenda, but instead he has surrounded himself with like-minded advisers; Italy now has a Populist government; Germany’s Alternativ für Deutschland made major gains in last year’s election, and in Bavaria last week.
The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better. As a result, voters start to listen to Populists, who offer seemingly simple solutions to the problems which have been ignored by the elites.
Next week, I will look at what may happen in the 2019 – 2021 period, as we enter the endgame for the policy failures of the past decade.
The post “What could possibly go wrong?” appeared first on Chemicals & The Economy.
The combination of ageing populations and declining fertility rates means the world is following the Japanese model into deflation – despite all the efforts of policymakers to artificially induce price rises via their money-printing. As discussed last November, under the title. ”Oil price fall set to push Japan back into deflation“, it was already clear then that the impact of Abenomics had peaked in mid-year.
Inflation had temporarily hit 3.7% after the sales tax increase and yen devaluation. By November, a panicked Governor Kuroda, head of the central bank, was pushing through an emergency stimulus policy. But as the chart above confirms, his measures have had little effect. July inflation was just 0.2%. The issue is one of common sense:
- Most policymakers insist on seeing supply/demand balances through rose-tinted glasses
- They imagine that demand is always constant, if only the right tax and spend policies are adopted
- They thus ignore the human factor altogether, and claim that 70 year-olds will spend as much as 30 year-olds
- Yet their own official data confirms what common sense would tell us on this issue
What worries me now, is what happens next? Japan’s former central bank head, Governor Shirakawa, had an excellent grasp of the economic impact of demographic change. He was a major influence on our thinking in Boom, Gloom and the New Normal, as he argued that Japan’s:
“Low growth was mainly attributable to demographics, or more specifically, a rapid aging of the population”….
“The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices. Given that other developed countries will face the same problems despite some differences in timing and magnitude, the economic effects of demographics deserve further study.”
Today, the failure of his successor’s policies is confirming the wisdom of Shirakawa’s insight. 70 year-olds are not 30 year-olds:
- They do not have the income that would enable them to spend in the same way
- And they do not need to spend the same amount as they already own most of what they need.
Japan’s recent policies have been the equivalent of trying to make water run uphill. But now China’s New Normal policies are the catalyst for reality to appear. Today’s chaotic markets are a sign that investors are starting to realise they have been fooled.
It is going to be a very bumpy ride as we return to a world that operates by the fundamentals of supply/demand, and not by central bank stimulus.
We seem to be approaching Stage 2 of the Great Unwinding of policymaker stimulus, as the economic implications of demographic change become ever stronger.
The combination of today’s ageing populations with the collapse in fertility rates means it is totally unrealistic to expect growth rates to continue at the SuperCycle levels of the past. They were turbo-charged by the BabyBoomers being in their prime period of income and spending growth – especially as female Boomers entered the workforce in unparalleled numbers.
Yesterday’s New York Times confirmed this common sense fact for the US economy:
“Over the last 40 years, the American economy has grown at an average of 2.8%/year. That’s slower than the 3.7% average from 1948 to 1975, but the future looks even gloomier because that 2.8 figure relied on two favorable trends that are now over: women entering the work force, and baby boomers reaching their prime earning years.
“After 2020, with the percentage of the American population that is of prime working age shrinking, the Congressional Budget Office expects growth to stabilize at 2.2%….(given the) demographic headwinds caused by baby-boom retirements.”
It is also not difficult to look forward, and see where we will be in 5 years time, if we take off our rose-tinted glasses. John Richardson and I did this in chapter 4 of our eBook, Boom, Gloom and the New Normal’. We made 10 forecasts for the world in 2020:
- A major shake-out will have occurred in Western consumer markets.
- Consumers will look for value-for-money and sustainable solutions.
- Young and old will focus on ‘needs’ rather than ‘wants’.
- Housing will no longer be seen as an investment.
- Investors will focus on ‘return of capital’ rather than ‘return on capital’.
- The term ‘middle-class’ when used in emerging economies will be recognised as having no relevance to Western income levels.
- Trade patterns and markets will have become more regional.
- Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities.
- Taxation will have been increased to tackle the public debt issue.
- Social unrest will have become a more regular part of the landscape.
The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.
Companies therefore need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.
We could instead decide to ignore all of this potential unpleasantness.
But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.
Boom, Gloom and the New Normal is available for download in PDF or Kindle format
The world is about to be hit by a demand shock equivalent to 1973′s supply shock. Yet, astonishingly, most commentators remain so focused on central bank activity, that they have completely missed what is happening. Here’s how it is playing out.
You may remember the ‘The pH Report‘ forecast in early December that:
“Oil prices are likely to continue falling to $50/bbl and probably lower in H1 2015, in the absence of OPEC cutbacks or other supply disruption. Critically, China’s slowdown under President Xi’s New Normal economic policy means its demand growth will be a fraction of that seen in the past.
“This will create a demand shock equivalent to the supply shock seen in 1973 during the Arab oil boycott. Then the strength of BabyBoomer demand, at a time of weak supply growth, led to a dramatic increase in inflation. By contrast, today’s ageing Boomers mean that demand is weakening at a time when the world faces an energy supply glut. This will effectively reverse the 1973 position and lead to the arrival of a deflationary mindset.”
The reason is that central banks have created a debt-fuelled ‘Ring of Fire’, and as the map shows, major fault lines are now opening up across the world – and creating warning tremors of the earthquakes ahead.
These are unlikely to lead to a repeat of 2008′s financial collapse. But their effect will be magnified by the fact they are all linked to debt burdens that can probably never be repaid.
THE FAULT LINES LEADING OUT FROM CHINA ARE BECOMING WIDE OPEN
China’s New Normal policies were the starting point for the opening of the fault lines:
- June saw the first impact as Beijing house prices fell; now property tax revenue is down a third nationally
- Oil demand then weakened, as the Great Unwinding of China’s stimulus policies continued
- The US$ also began to strengthen, as the US Federal Reserve tapered its money-printing activity
- These moves were mutually supportive, as financial players then saw no need to buy oil as a ‘store of value’
- The first fault lines thus opened between China and Russia/Middle East as oil prices collapsed
Last week, a new set of fault lines opened to Australia and South Africa, as copper prices and mining company shares began to collapse due to major selling in China.
Copper has an importance beyond its own markets. It is widely seen as Dr Copper – an important indicator for the entire global economy. Its price decline, along with that of most other commodities, will add to deflationary pressure:
- China’s slowing economy is exporting deflation around the world – its producer prices fell 3.3% last month
- The Eurozone went into deflation last month, with consumer prices down 0.2%
- Japan’s return to deflation is now just a matter of time, despite premier Abe’s money-printing
- Switzerland’s sudden removal of its currency cap means its deflation will become entrenched
- And US inflation has already fallen to just 0.8%, making deflation very likely there before too long
Even more significant was that the tremors from Switzerland ‘s revaluation opened the fault lines across the Atlantic to New York. Currency brokers around the world suffered major losses, as the franc initially soared 40% in 2 minutes versus the euro.
Of course, the same people who missed the start of the Great Unwinding are still arguing that “everything is for the best, in this best of all possible worlds“.
But chemical markets remain the best leading indicator we have for the global economy. They told us in April that a downturn had begun. And today I am hearing reports of some major bankruptcies underway in China. There will be many more globally, as companies find themselves with high-priced inventory whilst demand remains weak.
In 1973, the inflation shock was led by oil, as Boomer demand created massive supply shortages. Now, 40 years later, oil is taking us into deflation. The reason is simple – the ageing Boomers no longer need, or can afford, to maintain their previous levels of demand.
WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 59%. “Weakening oil and energy prices and slow derivative demand are weighing on the market”
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Downstream ethylene volumes are being purchased on a strict hand-to-mouth basis, whilst the propylene market is long”
PTA China, down 45%. ”Sentiment was largely weaker during the week as buyers were trying to maintain low inventories amid an uncertain market outlook”
¥:$, down 15%
HDPE US export, down 19%. “Export prices tumbled across the board in response to lower ethylene and energy market values. But prices still can fall much lower. Traders reported INEOS auctioned off 8-10 rail-cars at prices 15% below published market prices”
S&P 500 stock market index, up 3%
Who would have believed the blog would still be here, 7 years after it began with a post from Thailand in June 2007? Who would have believed the range of developments that have appeared for it to discuss over this period?
It started at the end of the SuperCycle as central banks pumped cash into the global economy, and prices soared along with demand. It was a lonely voice in the wilderness, worrying about US subprime loans. Then we had the Crisis itself, famously forecast by the blog and memorialised in the article ‘The Crystal Blog’ in November 2008.
Nobody wanted to learn the lesson that you can’t create sustainable growth by increasing debt levels. Instead, we had the central banks and governments pumping unheard-of amounts of cash into the global economy. China decided to launch the biggest credit bubble in history. Unsurprisingly, much of this stimulus, as in China, has actually made matters worse, not better. And since 2011, growth has actually begun to weaken.
In the middle of this second period, the blog began to publish its view of the outlook with fellow-blogger John Richardson. ‘Boom, Gloom and the New Normal’ argued the seemingly obvious point that:
- Economic growth is dominated by personal consumption, usually 60%+ of developed economies
- In turn, consumption and wealth creation is primarily dependent on the generation aged 25 – 54 years
- Their earnings increase as their careers progress, whilst they spend more as their children grow up
- As a result, growth was now inevitably slowing due to ageing populations and low fertility rates
It then developed its view of how this New Normal would force businesses to refocus their activities. And it described what this would mean for manufacturing, the commercial world, and research, as well as for political stability. Its summary of the likely outlook for the world in 2020, published 3 years ago, has clearly stood the test of time:
“The New Normal World in 2020
“All of us would love to be able to see into the future. Chapter 4 of our new eBook, ‘Boom, Gloom and the New Normal’, does just this. It offers 10 predictions about how the world will look in 2020:
- A major shake-out will have occurred in Western consumer markets
- Consumers will look for value-for-money and sustainable solutions
- Young and old will focus on ‘needs’ rather than ‘wants’
- Housing will no longer be seen as an investment
- Investors will focus on ‘return of capital’ rather than ‘return on capital’
- The term ‘middle-class’ when used in emerging economies will be recognised as having no relevance to Western income levels
- Trade patterns and markets will have become more regional
- Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities
- Taxation will have been increased to tackle the public debt issue
- Social unrest will have become a more regular part of the landscape
“The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.
“Companies will need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.”
The blog’s readership has proved amazingly loyal over the past 7 years. Readership has grown steadily, as shown in the map, with the majority reading the blog on a more or less daily basis.
Readers are also very keen to promote the blog to their friends and colleagues. As a result, the blog has had the privilege of speaking at a wide range of events around the world, including major conferences, Board Retreats, business meetings and industry events. It also writes regularly for the Financial Times and presents 6-monthly webinars for the American Chemical Society.
The blog is very grateful to its readers for their support, and to all those at ICIS for their encouragement and assistance. Thank you all very much.
WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 3%. “Due to worsening market conditions, several PTA makers have either kept their PTA units shut or were operating at lower run rates”
US$: yen, down 3%
Brent crude oil, up 4%
Naphtha Europe, up 6%. “Improved ethylene margins in turn could encourage producers to ramp up cracker run rates, boosting demand for feedstock naphtha”
S&P 500 stock market index, up 7%
HDPE US export, up 7%. “Prices just slightly too high to garner much interest from the international market”
Benzene, Europe, up 9%. “Limiting the increases downstream on styrene are market fundamentals, with downstream demand weak, supply plentiful and spot prices little changed since early June.”