Whisper it not to your friends in financial markets, but the global economy is moving into recession.
The US stock markets keep making new highs, thanks to the support from the major western central banks. But in the real world, where the rest of us live, the best leading indicator for the global economy is clearly flashing a red light:
- On the left is Prof Robert Shiller’s CAPE Index, showing the US S&P 500’s valuation is at levels only seen before in 1929 and 2000
- On the right is the American Chemistry Council’s global chemical Capacity Utilisation (CU%), which has fallen back to May 2013’s level
They can’t both be right about the outlook.
Chemicals are known to be the best leading indicator for the global economy. Their applications cover virtually all sectors of the economy, from plastics, energy and agriculture to pharmaceuticals, detergents and textiles. And every country in the world uses relatively large volumes of chemicals.
The chart shows the very high correlation with IMF GDP data. Even more usefully, the data is never more than a few weeks old. So we can see what is happening in almost real time.
And the news is not good. The CU% has been in decline since January 2018, and it is showing no sign of recovery. In fact, our own ‘flash report’ on the economy, The pH Report’s Volume Proxy Index, is showing a very weak performance as the charts confirm:
- The Index focuses on the past 6 months, and shows a very weak performance. It has gone negative even though September – November should be seasonally strong months, as businesses ramp up their activity again after the holidays
- Even more worrying is that the main Regions are currently in a synchronised slowdown. And each time they have tried to rally, they have fallen back again – a sign of weak underlying demand
And, of course, we are now moving into the seasonally slower part of the year, when companies often destock for year-end inventory management reasons. So it is unlikely that we will see a recovery in the rest of 2019, whether or not a US-China trade deal is signed.
The problem is very simple:
They see no need to focus on understanding major challenges such as the potential impact of ageing populations on economic growth, the retreat from globalisation and the rise of protectionism, or the increasing importance of sustainability.
Perhaps they are right. But the evidence from the CU% on developments in the real world suggests a wake-up call is just around the corner.
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.
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.
“By Monday, the third straight day of flooding, the aftermath of Hurricane Harvey had left much of the region underwater, and the city of Houston looked like a sea dotted by small islands. ’This event is unprecedented,’ the National Weather Service tweeted. ‘All impacts are unknown and beyond anything experienced.’”
This summary from the New York Times gives some idea of the immensity of the storm that struck large parts of Texas/Louisiana last week, including the 4th largest city in the US. And this was before the second stage of the storm.
I worked in Houston for 2 years, living alongside the Buffalo Bayou which flooded so spectacularly last week. The photo above from the Houston Chronicle shows the area around our former home on Saturday, still surrounded by water. Today, as the rest of America celebrates the Labor Day holiday, the devastated areas in Texas and Louisiana will be starting to count the cost of rebuilding their lives and starting out anew:
Some parts of the Houston economy will recover remarkably quickly. It is a place where people aim to get things done, and don’t just sit around waiting for others to do the heavy lifting
But as Texas Governor Abbott has warned, Harvey is “one of the largest disasters America has ever faced. We need to recognize it will be a new normal, a new and different normal for this entire region.”
The key issue is that the Houston metro area alone is larger in size than the economies of Sweden or Poland. And as Harris County Flood Control District meteorologist Jeff Lindner tweeted:
“An estimated 70% of the 1,800-square-mile county (2700 sq km), which includes Houston, was covered with 1½ feet (46cm) of water”
Already the costs are mounting. Abbott’s current estimate is that Federal funding needs alone will be “far in excess of $125bn“, easily topping the costs of 2005′s Hurricane Katrina in New Orleans. And, of course, that does not include the cost, and pain, suffered by the majority of homeowners – who have no flood insurance – or the one-third of auto owners who don’t have comprehensive insurance. They will likely receive nothing towards the costs of cleaning up.
SOME PARTS OF THE ECONOMY HAVE THE POTENTIAL FOR A QUICK RECOVERY
Companies owning the large refineries and petrochemical plants in the affected region have all invested in the maximum amount of flood protection following Katrina, when some were offline for 18 months
Oil platforms in the Gulf of Mexico are used to hurricanes and are already coming back – Reuters reports that only around 6% of production is still offline, down from a peak of 25% at the height of the storm
It is hard currently to estimate the impact on shale oil/gas output in the Eagle Ford basin, but the Oil & Gas Journal reports that 300 – 500 kb/d of oil production is shut-in, and 3bcf/d of gas production
ExxonMobil is now restarting the country’s second-biggest refinery at Baytown, and Phillips 66 and Valero are also restarting some operations, whilst ICIS reports that a number of major petrochemical plants are now being inspected in the expectation that they can soon be restarted
Encouragingly also, it seems that insurance companies are planning to speed up inspections of flooded properties by using drone technology, which should help to process claims more quickly. Loss adjusters using drones can inspect 3 homes an hour, compared to the hour taken to inspect on roof manually. But even Farmers Insurance, one of the top Texas insurers, only has 7 drones available – and has already received over 14000 claims.
RECOVERY FOR MOST PEOPLE AND BUSINESSES WILL TAKE MUCH LONGER
For the 45 or more people who have died in the floods, there will be no recovery.
Among the living, 1 million people have been displaced and up to 500k cars destroyed. 481k people have so far requested housing assistance and 25% of Houston’s schools have suffered severe or extensive flood damage.
These alarming statistics highlight why clean-up after Harvey will take a long time. Basic services such as water and sewage are massively contaminated, with residents being told to boil water in many areas. The “hundreds of thousands of people across the 38 Texas counties affected by Harvey” using their own wells are particularly at risk.
And as the New York Times adds:
“Flooded sewers are stoking fears of cholera, typhoid and other infectious diseases. Runoff from the city’s sprawling petroleum and chemicals complex contains any number of hazardous compounds. Lead, arsenic and other toxic and carcinogenic elements may be leaching from some two dozen Superfund sites in the Houston area”
FEW IN HOUSTON HAVE FLOOD INSURANCE
Then there is the issue that, as the chart from the New York Times shows, most of those affected by Harvey don’t have home insurance policies that cover flood damage. Similarly, a survey in April by insurer Aon found that:
“Less than one-sixth of homes in Harris County, Texas, whose county seat is Houston, currently have active National Flood Insurance Program policies. The county has about 1.8 million housing units.”
As the Associated Press adds:
“Experts say another reason for lack of coverage in the Houston area was that the last big storm, Tropical Storm Allison, was 16 years ago. As a result, people had stopped worrying and decided to use money they would have spent for insurance premiums on other items.”
Even those with insurance will get hit by the low levels of coverage – just $250k for a house and $100k for contents. Businesses carrying insurance also face problems, according to the Wall Street Journal, as they depend on the same Federal insurance scheme, which:
“Was primarily designed for homeowners and has had few updates since the 1970s. Standard protections for small businesses, including costs of business interruption and significant disaster preparation, aren’t covered, and maximum payouts for damages haven’t risen since 1994.
The maximum coverage for business property is $500k, and the same cap applies to equipment and other contents, far below many businesses’ needs. And even those with insurance find it difficult to claim, according to a study by the University of Pennsylvania and the Federal Reserve Bank of New York after Hurricane Sandy in 2012:
“More than half of small businesses in New York, New Jersey and Connecticut that had flood insurance and suffered damages received no insurance payout. Another 31% recouped only some of their losses.”
Auto insurance is a similar story. Only those with comprehensive auto insurance are likely to be covered for their loss – and even then, people will still suffer deductions for depreciation. According to the Insurance Council of Texas:
“15% of motorists have no car insurance, and of those who do, (only) 75% have comprehensive insurance. That leaves a lot of car owners without any protection.”
In other words, around 1/3rd of car owners probably have no insurance cover against which to claim for flood damage.
HARVEY’S IMPACT WILL BE LONG-TERM
It is clearly too early, with flood waters still rising in some areas, to be definitive about the implications of Hurricane Harvey for Houston and the affected areas in Texas and Louisiana.
Of course there are supply shortages today, and the task of replacement will created new demand for housing and autos. But over the medium to longer term, 3 key impacts seem likely to occur:
It will take time for the supply of oil, gas, gasoline and other refinery products, petrochemicals and polymers to fully recover. There will inevitably also be some short-term shortages in some value chains. But within 1 – 3 months, most if not all of the major plants will probably be back online
It will take a lot longer for most people affected by Harvey to recover their losses. Some may never be able to do this, especially if they have no insurance to cover their flooded house or car. And those working in the gig economy have little fall-back when their employers have no need for their services
The US economy will also be impacted, as Slate magazine warned a week ago, even before the full magnitude of the catastrophe became apparent:
“For the U.S. economy to lose Houston for a couple of weeks is a human disaster—and an economic disaster, too….Given that supply chains rely on a huge number of shipments making their connections with precision, the disruption to the region’s shipping, trucking, and rail infrastructure will have far-reaching effects.”