Ageing Perennials set to negate central bank stimulus as recession approaches

The world’s best leading indicator for the global economy is still firmly signalling recession.  That’s the key conclusion from the chart above, showing latest data on global chemical industry Capacity Utilisation (CU%) from the American Chemistry Council.

The logic behind the indicator is compelling:

  • Chemicals are one of the world’s largest industries, and also one of the most diverse
  • Every country in the world uses relatively large volumes of chemicals
  • And their applications cover virtually all sectors of the economy
  • They include plastics, energy and agriculture as well as detergents and textiles

If you want to know the outlook for the global economy, the chemical industry will provide the answers.

It also has an excellent correlation with IMF data, and benefits from the fact it has no “political bias”. It simply tells us what is happening in real-time in the world’s 3rd largest industry.

And now it is telling us that the CU% is continuing to fall. It was down at 83.1% in January, well below the long-term average of 86.5%.  In fact, it has fallen sharply from that level since December 2017.

Ironically, it was exactly a year ago that the world’s major central banks were congratulating themselves on the success of their policies. “Yes”, they said, “it had taken longer than expected, but we can finally declare victory for our post-2008 stimulus policies”.

Unfortunately, however, this confidence was misplaced as the second chart suggests.

It shows there was a brief rebound in 2010 after the 2008 Crisis as the first round of stimulus took place. But then growth fell back again.

Instead of learning the lesson, the banks decided to do more of the same.  But repeating the same action in the hope of a different result is not terribly sensible.  And so it has proved.

Next month will see the IMF’s new estimate for 2018’s GDP growth (black line). Chemical industry CU% data (the red line) suggests it will have to be revised downwards, once again.

Already, it seems, the central banks are preparing their next round of stimulus. They have finally recognised the slowdown underway in the key areas of the economy such as autos, housing and electronics:

  • China has already panicked, with January seeing record levels of loans
  • Similarly the US Federal Reserve has promised it will go slowly with any further interest rate rises, or might even reduce them
  • The Bank of Japan’s former deputy governor has warned of recession as global demand weakens
  • Most recently, the European Central Bank has completely reversed course, after suggesting as recently as December that strong growth meant further stimulus was unnecessary

As the 3rd chart shows, the key aim for the western central banks is simply to support stock markets such as the S&P 500. They are determined to keep them moving steadily upwards, in the belief this will stimulate growth. But this, of course, is wishful thinking.  As the Financial Times reported last week, the combined result of stimulus and President Trump’s tax cuts has been that:

“US companies handed their shareholders a record-shattering $1.25tn through dividends and buybacks last year, lifting the post-crisis bonanza to nearly $8tn.”

And as the independent Pew Research Center reported last year:

“Today’s real average wage (that is, the wage after accounting for inflation) has about the same purchasing power it did 40 years ago. And what wage gains there have been have mostly flowed to the highest-paid tier of workers.”

YOU CAN’T PRINT BABIES – AND IT IS PEOPLE THAT CREATE DEMAND

The final chart highlights the “problem” for the central banks.  Their financial models, and all their thinking, are based on the experience of the post-1945 BabyBoomer SuperCycle.

The vast numbers of babies born between 1946-70 first created massive inflation in the 1960s-70s, as demand outstripped supply. But then they created more or less constant growth as the Boomers moved into the workforce. They turbo-charged demand as Western women stopped having enough children to replace the population after 1970, and instead went back into the workforce – creating the two-income family for the first time in history.

But after 2000, this growth began to weaken as the oldest Boomers moved out of the Wealth Creator 25 – 54 age group, when consumption peaks along with earnings.  And today’s “problem” is really that, wonderfully, we now have a entirely new generation of Perennials aged 55+.

They will soon be over one-fifth of the global population, double the percentage in 1950.  In the developed western economies, they are already a third of the population, due to the collapse of fertility rates.  This is great news for us as individuals. But it is bad news for economic growth as Perennials already own most of what they need, and their earnings reduce as they retire.

The S&P 500 and other asset markets are already rising due to central bank promises of more support.

But one thing is certain. Third time around, the main result of more stimulus will again be to increase today’s already high levels of debt and inequality.  It cannot return us to SuperCycle levels of growth.

UK risks “crashing out” of EU after election without trade deal

Car

 

Yesterday, senior EU negotiators warned that “the chances of Britain crashing out of the EU without a new (trade) deal were now “over 50%””.  Clearly, therefore, the UK’s preparations are not going well.

Instead of building trust, the UK’s Brexit Secretary, David Davis, seems to think that threats – such as promising “the row of the summer– are the best way to open discussions.

I have taken part in major trade and contract negotiations around the world.  Based on this experience, I believe his strategy is very unlikely to succeed.  It risks instead leading to a populist-style “Battle with Brussels”, which the UK will lose.  The UK will then crash out of the EU – with no deal on trade – long before the March 2019 deadline.

PREMIER MAY IS IGNORING HER OWN WARNING LAST YEAR
My key concern is that premier Theresa May seems to be ignoring her own warning before last June’s referendum:

The EU is a single market of more than 500m people, representing an economy of almost £11tn ($14bn) and a quarter of the world’s GDP.  44% of our goods and services exports go to the EU, compared to 5% to India and China.  We have a trade surplus in services with the rest of the EU of £17bn.  And the trading relationship is more inter-related than even these figures suggest.  Our exporters rely on inputs from EU companies more than firms from anywhere else: 9% of the ‘value added’ of UK exports comes from inputs from within the EU, compared to 2.7% from the United States and 1.3% from China….(my emphasis)

I am not alone in my fears. UK industry is becoming very worried about what may happen.  Paul Drechsler, President of the Confederation of British Industry (CBI), spelt out the key issue last week  – the need to maintain access to the Single Market and Customs Union.  He described the journey of a computer chip made today in Cardiff’s tech hub:

“The chip is bought by a company in Germany. The metals inside it are sourced from South Africa and Turkey, using free trade agreements the UK has through its EU membership.  Some of the plastics inside it are processed in Poland and Spain. Engineers from France, Croatia and Hungary worked alongside Brits in Cardiff to design it.  When finished, it is packaged by a worker from Bangor, Wales and delivered to the port by a driver from Slovakia.

“The chip has been made to European standards, its design protected by a Europewide trademark.  It was insured with a financial package covered by EU passporting and, when incorporated into a machine and put in the shop, it will meet Europewide levels of consumer protection.

“In other words, for that chip, and the British company that makes it, to remain as competitive as today we need: three new trade deals, free movement of EU citizens, three new sets of internationally approved regulatory and copyright standards and an agreement on EU financial services passporting.”(my emphasis)

A hard Brexit, without access to the Single Market or Customs Union, will not just impact the UK. As the CBI example confirms, today’s complex and extended supply chains mean that companies across the EU27, and around the world, will find their trade disrupted.

RULES AND REGULATIONS ARE AS IMPORTANT AS TARIFF BARRIERS TO MOST COMPANIES
Many in the UK chemicals industry – the UK’s largest manufacturing export earner – are also very worried.  Its largest customer, the car industry, is totally dependent on global supply chains and just-in-time delivery, as the chart shows. Going back to a pre-Single Market world of tariffs, customs barriers, endless form-filling and border delays will lead to major uncertainty and loss of business.

And, of course, tariff barriers – although important – are not the only issue. The future role of the European Court of Justice, and the rules and regulations under which products are sold, are even more critical, as a new survey by the British Coatings Federation confirms:

“Over three quarters of our members said that a separate UK chemical regulatory system would be bad for business. Maintaining regulatory equivalence with key EU regulations (REACH, CLP and BPR) through continued relations with institutions such as the European Chemicals Agency is essential to ensure we have a strong UK manufacturing base that can import chemical raw materials from Europe, and export finished goods such as paints, coatings printing inks and wallpaper without being at a competitive disadvantage.”

BREXIT RISKS ARE BEING IGNORED IN THE UK ELECTION CAMPAIGN
Given the criticality of these issues for the economy, they should be the major topic of the current election campaign. But instead May’s election manifesto simply promises:

“As we leave the European Union, we will no longer be members of the single market or customs union but we will seek a deep and special partnership including a comprehensive free trade and customs agreement.”

She seems to expect the Brexit negotiations to follow the pattern of the Treaty of Lisbon in 2014:

  Then the UK appeared to “opt out” of key domestic and legal policies to pacify the Eurosceptic tabloid media
  Behind the scenes, however, it negotiated a special Protocol 36
  After signing the Treaty, the UK immediately “opted back in” to many of the policies via Protocol 36

But it is very hard to see how this can happen with Brexit, as EU Commission President Juncker warned last month.

I am therefore not optimistic about the outcome of the talks.  I correctly warned – over a year ago – that Brexit was likely.  Having followed developments since then, I find it hard to believe the EU 27 will allow May a back-door re-entry via a new Protocol 36-type deal, after a “hard Brexit”.  This seems a totally unrealistic objective.

I hope I am wrong.  But if I am right, the current UK government strategy means there is no “business as usual” option for the vast majority of UK companies – or for many EU 27 and non-European businesses.  I fear, as I have warned since March 2016, “Brexit will hit UK, Eurozone and global economies“.

 

Chemical industry is the best indicator of EM outlook – and the outlook is not good

Policymakers would be better off following the fortunes of the chemical industry, if they wanted to forecast the global economy, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Capacity utilisation (CU%) in the chemical industry has long been the best leading indicator for the global economy. The IMF’s recent downward revision of its global GDP forecast is further confirmation of the CU%’s predictive power. As the first chart shows, the CU% went into a renewed decline last October, negating hopes that output might have stabilised. March shows it at a new low for the cycle at just 80.1 per cent, according to American Chemistry Council (ACC) data.

By comparison, the CU% averaged 91.3 per cent during the baby boomer-led economic supercycle from 1987 to 2008. This ability to outperform conventional economic models is based on the industry’s long history and wide variety of end-uses. It touches almost every part of the global economy, enabling it to provide invaluable insight on an almost real-time basis along all the key value chains – covering upstream markets such as energy and commodities through to downstream end-users in the auto, housing and electronics sectors. Chemical industry production growth provides similar real-time insight into the major economies, using a year-on-year comparison. Current data for the Bric economies is particularly revealing, as the second chart highlights.

China’s post -2008 stimulus programme had provided critical support for all four countries. But as discussed on beyondbrics last year, China’s adoption of its New Normal economic policies during 2013 initiated a Great Unwinding. Chemical industry production growth has nearly halved since 2014 to just 5.7 per cent a year today. And as discussed last month, much of this output is now aimed at boosting exports (to preserve jobs) rather than to supply domestic demand. There are an increasing number of key products where China has moved from being the world’s major importer to a net exporter – with a consequent negative effect on margins.

Brazil was the early loser from China’s change of economic direction. Its monthly output declined very sharply in early 2014 as China’s stimulus-related infrastructure and construction demand slowed, and growth turned negative in June 2014. Output then staged a minor recovery in the middle of 2015, but has since fallen back to -4.6 per cent again. Brazil now no longer needs to import major polymers such as polyethylene, and has instead become a net exporter.

Russia was similarly impacted by China’s policy reversal, and its monthly output went negative in mid-2014. The collapse of the rouble then temporarily mitigated the downturn, by supporting exports and increasing the attractions of local production versus more expensive imports. But output growth has since staged a precipitate decline since last summer, falling by more than two-thirds from September’s peak of 14.9 per cent to just 4.2 per cent in March.

India has seen similar volatility. Output growth turned negative during 2014, but then staged a mild recovery in 2015 before a renewed decline took place, leaving March output barely positive at 0.4 per cent. In principle, India’s domestically oriented economy should make it more resilient to China’s slowdown, but it is still impacted by the second-order effects of increased competition in Asian markets. Not only is China ramping up its own exports of key products, but companies that had formerly relied on exporting to China are now having to find new homes for their product.

These developments in capacity utilisation and output confirm that major changes are taking place in the global economy and the formerly high-flying Bric economies. Policymakers would perhaps do better with their forecasts if they looked beyond their theoretical models – and focused instead on the chemical industry’s proven ability to provide real-time insight into the underlying transformation taking place in global demand patterns.

Slide in Q2 operating rates is bad omen for H2 economic outlook

ACC OR Jul14The chemical industry is the best leading indicator for the global economy.  The slide in operating rates (OR%) around the world during the seasonally strong Q2 period. is a clear warning that global economic growth may be stalling.

This should be a major wake-up call for anyone still hoping that growth may recover to the Boomer-led SuperCycle level.  The latest update from the American Chemistry Council’s excellent weekly report makes sober reading:

  • The global OR% was just 83.4% in June, down from 83.7% in June 2013
  • This was well below the 92% long-term average between 1987-2013
  • It was also well below the minimum 88% level seen in the SuperCycle

The chart also confirms last month’s comment from Dow CEO, Andrew Liveris, that “for a couple of years after 2008, we had a head-fake that the growth might have returned, but it didn’t”.  OR% temporarily jumped to around 87%, but then fell back again – despite massive continued stimulus by governments and central banks.

The ACC report also highlights that “growth stalled in Q2“.  Yet it should be the seasonally strongest quarter of the year:

  • Global growth rates fell from 4.8% in March to 3.5% in June
  • In the US, the ACC report that “production of basic chemicals fell” in June, despite the shale gas cost advantage
  • Latin America collapsed from 1.4% growth in March to a fall of 2.9% in June
  • W European growth halved from 3% in March to 1.4% in June, with Germany falling from 4.3% to a negative 0.9%
  • Central/Eastern Europe fell from 1.6% in March to a negative 0.1% in June, with Russia falling to a negative 2.9%
  • Asia-Pacific fell from 8.3% in March to 6.8% in June, with India collapsing from 6.5% to a negative 0.4%

Outside the chemical industry, the data also points in the same direction:

  • US GDP growth has been just 2.3% over the past 2.5 years, after inventory build is discounted
  • This is less than 1% per year, despite $10tn of stimulus
  • China’s steel demand grew just 0.4% in H1 this year, according to the official steel association.  Rail freight actually fell 1.4% in June versus June 2013
  • This confirms, if confirmation was needed, that China’s reported GDP growth of 7.5% was pure fiction
  • As China’s Academy of Social Sciences warns:  “The current situation serves as a reminder of how defective and unsustainable our growth model is. There can be no delay in altering the traditional investment- and export-driven model

The same realisation also seems to be dawning in financial markets, which have only been held aloft by a wave of debt.  Now investors will have to wake up to the fact that most of the debt will never be repaid.

Companies need to recognise that we have all been the victims of a collective delusion, and rapidly change course before it is too late:

  • They need to abandon their ambitious growth strategies and instead prepare for tough times ahead
  • Those in Asia can no longer ignore China’s change of course
  • It is becoming an exporter of many products, rather than an importer,  in order to maintain employment
  • Companies also need to review the $123.5bn of new US shale gas-related projects, as most will prove unprofitable due to lack of demand.

Q3 is the time when budgets and strategies are set for the next few years.  So it is not too late for a change of course.

Otherwise, in 5 years’ time, when all this new capacity is online, new managements will scratch their heads and wonder how the industry maintained the collective delusion for so long.  But by then, the money will have been spent.

 

WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
Brent crude oil, down 3%
US$: yen, down 2%
Naphtha Europe, down 2%.  “Cheap propane stocks are eating away naphtha’s market share in the petrochemical sector”
PTA China, up 1%. Producers offered cost-linked formula to stem losses, but buyers face difficulties in passing down the additional costs to their customers”
Benzene, Europe, up 5%. “Prices reversed course amid limited downstream appetite for further increases in August, which is traditionally a slow month because of summer shutdowns and the holiday period across Europe”
S&P 500 stock market index, up 5%
HDPE US export, up 7%. “Some higher trades were heard, and material remained in tight supply”