“Nobody could ever have seen this coming” is the normal comment after sudden share price falls. And its been earning its money over the past week as “suddenly” share prices of some of the major “story stocks” on the US market have hit air pockets, as the chart shows:
- Facebook was the biggest “surprise”, falling 20% on Thursday to lose $120bn in value
- Twitter was another “surprise”, falling 21% on Friday to lose $7bn
- Netflix has also lost 15% over the past 16 days, losing $27bn
- Tesla has lost 20% over the past 6 weeks, losing $13bn
These are quite major falls for stocks which were supposed to be unstoppable in terms of their market advances.
Of course, their supporters could say it was just a healthy correction and a “buying opportunity”. And they might add that so far, other “story stocks” such as Alphabet, Apple and Amazon are still doing well. But others might say a paradigm shift is underway, and these sudden shocks are just the early warning that the central banks’ Quantitative Easing bubble is finally starting to burst.
They might have a point, looking at the second set of charts:
- Twitter stopped being a major growth story as long ago as 2015, since when its user growth has been relatively slow, even going negative in some quarters
- Facebook stopped showing major growth in active users 18 months ago – and in 2018, it has been flat in N America and losing subscribers in Europe, whilst Asia and the Rest of the World are also heading downwards
- Tesla, of course, has been a serial disappointment. Its founder, Elon Musk, was brutally honest when founding the company in 2003, saying it had a 10% chance of success. Since then, it has mostly failed to meet its production targets. It was supposed to be making 5000 Tesla 3 cars a week by the end of last year, but according to Bloomberg’s Model 3 tracker, it is currently producing only 2825/week. Around 0.5 million buyers have paid their $1k deposits and are still waiting for their car – and Tesla needs their cash if its not to run out of money
- Netflix is another “story stock” now seeing a downturn in subscriber growth. Yet at its peak it had a market value of $181bn, with net income for this quarter forecast by the company at just $307m. Like Tesla, it was valued at a higher value than comparable businesses such as Disney, which have had solid earnings streams for decades.
The common factor with all 4 stocks is that they have a great “narrative” or “story”. Elon Musk has held investors spellbound whilst he told them of unparalleled riches to come from his innovation. This seemed to be the same with Facebook until the furore arose over the data user scandal with Cambridge Analytica. Twitter and Netflix have also had a great “story”, which overcame the need to show real earnings even after years of investment.
THE LIQUIDITY BUBBLES ARE STARTING TO BURST AS CENTRAL BANK STIMULUS SLOWS
In other words, reality seems to be starting to intrude on the “story”, just as it did at the end of the dot-com bubble in 2000, and the US subprime bubble in 2008. The key, then as now, is the end of the stimulus policies that created the bubbles, as the 3rd set of charts shows:
- Slowly but surely, the US Federal Reserve is finally raising interest rates back to more normal levels
- And more importantly, China’s shadow bank lending is declining – H1 was down by $468bn versus 2017
Even the European Central Bank and the Bank of Japan have signalled they might finally be about to cut back on the combined $5.75tn of lending, often at negative rates, that they pumped into the markets between 2015 – March 2018.
The issue is simple. All bubbles need more and more air to be pumped into them to keep growing. Once the air stops being added, they start to burst. And for the moment, at least, Facebook, Twitter, Netflix and Tesla are all acting as the proverbial canary in the coal mine, warning that the great $33tn Quantitative Easing bubble may be starting to burst.
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Is global economic growth really controlled by monetary policy and interest rates? Can you create constant growth simply by adjusting government tax and spending policy? Do we know enough about how the economy operates to be able to do this? Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?
- As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
- Then something changed in the early 1980s, and recessions seemed to become a thing of the past
- Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
- For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant
Why was this? Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed? Was it luck, that nothing much happened to upset the global economy? Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius? Perhaps.
THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD
Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?
- 1921 – 1945. Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
- 1946 – 1970. Births averaged 10.1m/year, a 15% increase over 25 years
- 1970 – 2016. Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born
Babies, as we all know, are important for many reasons.
Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP. So right from their birth, they were set to have an outsize impact on the economy:
- Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
- The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
- US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
- But then they began a sustained fall to today’s record low levels as supply/demand rebalanced
BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT
The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth. Consumer spending is 60% – 70% of GDP in most developed economies. And so both supply and demand began to increase exponentially. In fact, the Boomers actually turbocharged supply and demand.
Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children. US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level. On average, US women have just 1.9 babies today.
It is hard to imagine today the extraordinary change that this created:
- Until the 1970s, most women would routinely lose their jobs on getting married
- As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
- But since 1950, life expectancy has increased by around 10 years to average over 75 years today
- In turn, this meant that women no longer needed to stay at home having babies.
- Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work
This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.
But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows. Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:
- In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017). There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
- In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each. But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%. However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators
CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000. But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”. The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.
As I warned back in January 2016 using the words of the OECD’s William White:
“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
That recession is now coming close. There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.
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More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle. World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.
Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other. But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:
- After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
- The major slowdown was in Asia, particularly China, as its lending began to slow
And then on Friday, President Trump confirmed the opening of his long-planned trade wars:
- He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
- Similar tariffs were already in place on imports from China, Russia and other countries
- America’s longest standing allies have since imposed their own sanctions in retaliation
- The stage is now set for a developing global trade war as more countries join in
PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election. His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:
- Those policies marked in red are now being introduced
- Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
- Yet companies, commentators and analysts have preferred to ignore the obvious
It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:
“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”
As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:
“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.”
BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST
Unsurprisingly, financial markets have chosen to ignore this rise in protectionism. For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies. As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:
- When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
- Since then it has peaked at 33.3, above the 1929 peak
- Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue
The right-hand chart confirms the bubble nature of the rally:
- It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
- Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going“
- Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010
“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.”
As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).
FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.
Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers. This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:
- Essentially the deal was that consumers in richer countries got cheaper, well-made, products
- People in poorer countries gained paid employment for the first time in history by making these products
History also suggests President Trump will be proved wrong with his March suggestion that: “Trade wars are good and easy to win”. Like all wars, they are easy to start and increasingly difficult to end.
So far, financial markets have ignored these uncomfortable facts. They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.
But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending. Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.
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Today, we have “lies, fake news and statistics” rather than the old phrase “lies, damned lies and statistics”. But the general principle is still the same. Cynical players simply focus on the numbers that promote their argument, and ignore or challenge everything else.
The easiest way for them to manipulate the statistics is to ignore the wider context and focus on a single “shock, horror” story. So the chart above instead combines 5 “shock, horror” stories, showing quarterly oil production since 2015:
- Iran is in the news following President Trump’s decision to abandon the nuclear agreement, which began in July 2015. OPEC data shows its output has since risen from 2.9mbd in Q2 2015 to 3.8mbd in April – ‘shock, horror’!
- Russia has also been much in the news since joining the OPEC output agreement in November 2016. But in reality, it has done little. Its production was 11mbd in Q3 2016 and was 11.1mbd in April- ‘shock, horror’!
- Saudi Arabia leads OPEC: its production has fallen from 10.6mbd in Q3 2016 to 9.9mbd in April- ‘shock, horror’!
- Venezuela is an OPEC member, but its production decline began long before the OPEC deal. The country’s economic collapse has seen oil output fall from 2.4mbd in Q4 2015 to just 1.5mbd in April- ‘shock, horror’!
- The USA, along with Iran, has been the big winner over the past 2 years. Its output initially fell from 9.5mbd in Q1 2015 to 8.7mbd in Q3 2016, but has since soared by nearly 2mbd to 10.6mbd in April- ‘shock, horror’!
But overall, output in these 5 key countries rose from 35.5mbd in Q1 2015 to 36.9mbd in April. Not much “shock, horror” there over a 3 year period. More a New Normal story of “Winners and Losers”.
So why, you might ask, has the oil price rocketed from $27/bbl in January 2016 to $45/bbl in June last year and $78/bbl last Friday? Its a good question, as there have been no physical shortages reported anywhere in the world to cause prices to nearly treble. The answer lies in the second chart from John Kemp at Reuters:
- It shows combined speculative purchases in futures markets by hedge funds since 2013
- These hit a low of around 200mbbls in January 2016 (2 days supply)
- They then more than trebled to around 700mbbls by December 2016 (7 days supply)
- After halving to around 400mbbls in June 2017, they have now trebled to 1.4mbbls today (14 days supply)
Speculative buying, by definition, isn’t connected with the physical market, as OPEC’s Secretary General noted after meeting the major funds recently: “Several of them had little or no experience or even a basic understanding of how the physical market works.”
This critical point is confirmed by Citi analyst Ed Morse: “There are large investors in energy, and they don’t care about talking to people who deal with fundamentals. They have no interest in it.”
Their concern instead is with movements in currencies or interest rates – or with the shape of the oil futures curve itself. As the head of the $8bn Aspect fund has confirmed:
“The majority of our inputs, the vast majority, are price-driven. And the overwhelming factor we capitalise on is the tendency of crowd behaviour to drive medium-term trends in the market.” (my emphasis).
OIL PRICES ARE NOW AT LEVELS THAT USUALLY LEAD TO RECESSION
The hedge funds have been the real winners from all the “shock, horror” stories. These created the essential changes in “crowd behaviour”, from which they could profit. But now they are leaving the party – and the rest of will suffer the hangover, as the 3rd chart warns:
- Oil prices now represent 3.1% of global GDP, based on latest IMF data and 2018 forecasts
- This level has been linked with a US recession on almost every occasion since 1970
- The only exception was post-2009 when China and the Western central banks ramped up stimulus
- The stimulus simply created a debt-financed bubble
The reason is simple. People only have so much cash to spend. If they have to spend it on gasoline and heating their home, they can’t spend it on all the other things that drive the wider economy. Chemical markets are already confirming that demand destruction is taking place.:
- Companies have completely failed to pass through today’s high energy costs. For example:
- European prices for the major plastic, low density polyethylene, averaged $1767/t in April with Brent at $72/bbl
- They averaged $1763/t in May 2016 when Brent was $47/bbl (based on ICIS pricing data)
Even worse news may be around the corner. Last week saw President Trump decide to withdraw from the Iran deal. His daughter also opened the new US embassy to Jerusalem. Those with long memories are already wondering whether we could now see a return to the geopolitical crisis in summer 2008.
As I noted in July 2008, the skies over Greece were then “filled with planes” as Israel practised for an attack on Iran’s nuclear facilities. Had the attack gone ahead, Iran would almost certainly have closed the Strait of Hormuz. It is just 21 miles wide (34km) at its narrowest point, and carries 35% of all seaborne oil exports, 17mb/d.
As Mark Twain wisely noted, “history doesn’t repeat itself, but it often rhymes”. Prudent companies and investors need now to look beyond the “market-moving, shock, horror” headlines in today’s oil markets. We must all learn to form our own judgments about the real risks that might lie ahead.
Given the geopolitical factors raised by President Trump’s decision on Iran, I am pausing the current oil forecast.
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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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As promised last week, today’s post looks at the impact of the ageing of the BabyBoomers on the prospects for economic growth.
The fact that people are living up to a third longer than in 1950 should be something to celebrate. But as I noted in my Financial Times letter, policymakers are in denial about the importance of demographic changes for the economy.
Instead, their thinking remains stuck in the past, with the focus on economists such as Franco Modigliani, who won a Nobel Prize for “The Life Cycle Hypothesis of Savings”, published in 1966. This argued there was no real difference in spending patterns at different age groups.
Today, it is clear that his Hypothesis was wrong. He can’t be blamed for this, as he could only work with the data that was available in the post-War period. But policymakers should certainly have released his theories were out of date.
The chart highlights the key issue, by comparing average US and UK household spending in 2000 v 2017:
- In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, and 12.5m in the UK. They spent an average of $62k and £33.5k each ($2017/£2017)
- There were 36m US households headed by someone in the 55-plus New Older cohort, and 12.4m in the UK, who spent an average of $45k and £22.8k each
- In 2017, the number of Wealth Creator households was almost unchanged at 66m in the US and 11.9m in the UK. Their average spend was also very similar at $64k and £31.9k each
- But the number of New Older householders had risen by 55% in the US, and by 24% in the UK, and their average spend was still well below that of the Wealth Creators at $51k and £26.4k respectively
Amazingly, despite this data, many policymakers still only see the impact of today’s ageing Western populations in terms of likely increases in pension and health spending. They appear unaware of the fact that ageing populations also impact economic growth, and that they need to abandon Modigliani’s Hypothesis.
As a result, they have spent trillions of dollars on stimulus policies in the belief that Modigliani was right. Effectively, of course, this means they have been trying to “print babies” to return to SuperCycle levels of growth. The policy could never work, and did not work. Sadly, therefore, for all of us, the debt they have created can never be repaid.
This will likely have major consequences for financial markets.
As the chart from Ed Yardeni shows, company earnings estimates by financial analysts have become absurdly optimistic since the US tax cut was passed.
The analysts have also completely ignored the likely impact of China’s deleveraging, discussed last month.
And they have been blind to potential for a global trade war, once President Trump began to introduce the populist trade policies he had promised in the election. Last week’s moves on steel and aluminium are likely only the start.
Policymakers’ misguided faith in Modigliani’s Hypothesis and stimulus has instead fed the growth of populism, as the middle classes worry their interests are being ignored. This is why the return of volatility is the key market risk for 2018.
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