The end of the Economic SuperCycle

Landing page Infographic

A paradigm shift is underway in global petrochemical and polymer markets, as I discuss in a new article for ICIS Chemical Business.

Previously successful business models, based on the supply-driven principle, no longer work. As our new study, “Demand – the New Direction for Profit”, explains, companies now need to adopt demand-led strategies if they want to maintain revenue and profit growth.

The infographic above highlights the key issues:

  • During the 1980s/1990s, the BabyBoomers – the largest and wealthiest generation that the world has ever seen – entered the Wealth Creator generation (those aged 25 – 54), when income and spending peak
  • They powered an Economic SuperCycle
  • The world’s largest economy, the USA, suffered just 18 months of recession in 25 years between 1983 – 2007
  • The demand surge created the phenomenon of globalisation, integrating Eastern Europe, then China and India, into the global economy
  • It peaked between 1995 – 2000, when all the BabyBoomers (born 1946-70) were in the Wealth Creator generation

But then the oldest Boomers began to join the New Old generation of those aged 55+.  In the past, they would have died very quickly – life expectancy, even just a century ago, was only 46 years in the West, and 26 years in emerging economies.  But major advances in healthcare, food/water safety, and personal lifestyles meant that the average 65-year old could instead hope to live another 15 – 20 years.

Demand growth began to decline.  The New Old already own most of what they need, and their incomes decline as they enter retirement.

Policymakers refused to accept this obvious fact.  Instead, they claimed to be able to produce constant growth by boosting financial markets.  First they created the subprime bubble in the USA, and then today’s stimulus bubble.  This had created $57tn of debt by 2014, nearly the size of the global economy.  Clearly, this could not continue:

  • China was the first to change economic course, when President Xi Jinping took office in 2013
  • The Great Unwinding of policymaker stimulus began in August 2014

China had been responsible for more than half of the stimulus spending under the previous leadership.  So its New Normal policies had a major impact on the global credit bubble.

Since then, oil and commodity prices have collapsed, and economies dependent on exports to China have gone into recession.  Global GDP fell by a record $3.8tn in 2015 in current dollars.  Inflation is turning into deflation.

But still, policymakers in the developed world refuse to accept that demographic changes are driving the global economy.  Instead, they are creating even more debt – which can probably never be repaid.

What are companies and investors to do?  As the infographic below describes, they have a clear choice ahead:

  • They can either hope that somehow these new stimulus policies will succeed despite past failure
  • Or, they can join the Winners who are now starting to develop new revenue and profit growth by adopting demand-led strategies

Please click here if you would like to download a copy of the feature article, and click here to download a copy of the Study brochure.

New Normal infographic

$1.8tn of stimulus later, Japan’s household spending unchanged

Japan spend Mar16A3 years of massive stimulus spending in Japan has had no impact on the problem it was supposed to solve.  This is highlighted by new government data on household spending for 2015, as the charts above confirm – they compare 2015 data with that for 2012, before Abenomics began:

  • Spending was almost exactly the same at every age group in 2015 versus 2012, when premier Abe took office
  • Spending in the peak age range of 50 – 59 was just ¥250/year higher, and  ¥7900 lower in the 40 -49 age group
  • It still declines 31% once people reach the age of 70 – critically important with Japan’s ageing population
  • In US$ terms, of course, the numbers are lower due to Abe’s focus on devaluing the yen since he took office
  • US$ spending in the two peak age groups of 40 – 49, and 50 – 59, has fallen by $15k/year to $29k/year

This matters, because consumer spending is 60% of Japanese GDP.

The quite scary result is that the Bank of Japan has spent ¥200tn ($1.84tn) since Abe came to power on its quantitative easing programme.   Yet the Abenomics policy has completely failed to achieve its major objectives of boosting GDP and inflation:

As a result, Japan now has the world’s highest level of government debt as a percentage of GDP at 226%.

Yet premier Abe and Bank of Japan Governor Kuroda refuse to accept that their policies have failed.  Instead, just like the European Central Bank yesterday, they have decided to implement their policies on a greater scale.  Thus Japan introduced negative interest rates in January, meaning that the Bank now charges you to deposit money with it.

Clearly these are increasingly desperate measures, which have a vanishingly small chance of being successful.  Past performance is no guarantee of future results, but it is usually the best guide that we have.  And understandably, Japan’s Diet (its parliament) is becoming very concerned – Governor Kuroda has been summoned for questioning a record 25 times so far this year.

One major concern is that Japan’s value proposition for foreign investors is looking increasingly unattractive:

  • Foreigners have to pay the government to lend it money (and so are guaranteed to get back less than they lend)
  • They also know devaluation remains a key policy, meaning that the return in their currency will probably be lower
  • And GDP growth is almost impossible with Japan’s median age now 47 years and its population will decline 600k/year by 2020

Premier Abe initially promised that he would restore the country to growth within 2 years, and push inflation to at least 2%.  Today, 3 years later, his Abenomics policies have entered the end-game.  Some investors will no doubt continue to maintain positions in Japan, as it is still the world’s 3rd largest economy.

But they will no doubt be keeping a close eye on their exit opportunities.  When the rush starts, nobody will want to be left behind.

Chemical companies see difficult times ahead in 2016

New NormalThe chemical industry remains the best leading indicator for the global economy.  That much is clear from the warnings it has delivered over the past year:

It really is a clear and consistent track record.  And it is far superior to the performance of financial markets, who find themselves at the mercy of central bank manipulation – with vast amounts of electronic money being forced on investors, who have to then bid up prices in response – as happened again, yesterday.

So what do latest company statements tell us about the outlook in detail?

  • US companies are no longer confident of riding out the storm due to the collapse of their feedstock cost advantage and the rise of the US$
  • European companies see no recovery in end-user markets, but have been supported by lower oil prices and currency values
  • The Middle East has seen margins hit by lower oil prices, whilst Asia has been in the eye of the storm as China slows

The key issue is that we are moving into the New Normal world, as we discuss in our major new Study, Demand – the New Direction for Profit.  China’s slowdown and the collapse of oil prices highlight that we are seeing a paradigm shift in demand patterns.  Companies, as the chart highlights, can no longer rely on previously successful supply-driven business models.

Instead, as I will discuss on Monday, we all have to relearn how to operate demand-led models again.

The summary of 2015 company results is as follows:
Air Products. “Unfavourable currency and lower energy pass-through of 5% each more than offset volume and pricing increases of 1%”
Air Liquide. “Improved margins and revenue”
Akzo Nobel. ““We expect 2016 to be a challenging year. Difficult market conditions continue in Brazil, China and Russia. No significant improvement is anticipated in Europe, particularly in the Buildings and Infrastructure segment. Deflationary pressures continue and currency tailwinds are moderating”
Ashland. “Income down 11% due to a drop in sales”
BASF. “In the chemicals segment, the good earnings of the first three quarters of 2015 will not be matched and a significantly lower contribution is expected”
Axiall.”Sales fell because of lower values for chlorine and caustic soda”
BP. “Improved operational performance and benefits from our simplification and efficiency programmes leading to lower costs”
Braskem. “Brazil’s petrochemical industry should face a challenging year similar to the one in 2015, when domestic sales contracted 5.4% and domestic demand for chemicals fell 6.8%”
Celanese. “We took a number of steps to improve our competitive position”
CP Chem. “Reduced margins, as well as decreased equity earnings”
Covestro. “All three regions in which the company operates recorded comparable volume growth last year”
Dow. “Global economy continues to be volatile with consistent demand being driven by the consumer”
Clariant. “Have been able to offset the negative impact of the stronger Swiss franc”
DSM.”Intends to reduce costs and control its capital expenditure”
DuPont. “Lower ethylene prices and volumes, together with a negative currency impact of $19m, could not offset cost reductions, continued productivity improvements and increased demand in the auto sector”
Eastman. “Attributed the decline to propane hedges and lower sales volumes from acetate tow”
Enterprise. “2015 was very rough for our industry, and 2016 appears to be even more difficult given the low pricing environment”
ExxonMobil. “Lower margins, as well as unfavourable foreign exchange, tax and inventory effects”
Honeywell. “Favourable impact of raw materials pass-through pricing in its Resins & Chemicals business”
Huntsman. “We expect continued EBITDA pressure on our cyclical businesses”
INEOS. “Weakening markets in Asia, particularly China”
LG Chem. ““Overall sales have decreased due to slow recovery of the global economy and oil price plunge”
Lonza. ““Healthy market demand, combined with significantly better operational performance bolstered the strong results”
LyondellBasell. “Record performance from our olefins and polyolefins – Europe, Asia and International, intermediates and derivatives, and technology segments”
MOL. “Downstream general environment will be still supportive for our industry”
OMV. “Higher refining margin and petrochemical results”
Oxiteno. “Sharp slowdown in Brazil”
PPG. ““Results improved despite the persistent, unfavorable impact of weaker foreign currencies”
Petronas. “We expect the market to continue to be challenging moving forward”
PetroRabigh. “Petrochemical margins were low last year because of the slump in crude prices”
Praxair. ““The macro-economic headwinds faced in 2015 from negative currency translation and the slowdown in global industrial activity have not yet abated”
Reliance. “Falling feedstock costs have allowed for margin expansion”
Repsol. “Improved margins at the chemicals business”
SABIC. “Average selling prices of its products, particularly in the metals segment, slumped”
Sasol. “Negatively impacted by challenging and highly volatile global markets, marked by a steep decline in global oil and commodity chemical prices, partly offset by a weaker rand exchange rate”
Saudi Kayan. “Higher sales volumes were offset by declines in average selling prices of products”
Shell. “Contributions from the chemicals business fell mainly as a result of weaker base chemicals and intermediates industry conditions”
Sipchem. “Selling prices of its products declined”
Solvay. “Sales were mainly supported by a favourable impact of favourable exchange rates of 7%”
Synthos. “Weakening market conditions and the problems related to Litvinov”
Tasnee. “Steep decline in selling prices and higher expenses”
TOTAL. ““Petrochemical margins in Europe increased in 2015 due to strong demand for polymers and the decrease in raw material costs”
Unipetrol. “significant decline in petrochemical production and sales volumes of petrochemical products due to Litvinov outage”
Univar. “Sales fell across all regions it operates in during the fourth quarter”
Vopak. ““Looking ahead, we expect 2016 occupancy rates of our global terminal network to exceed 90%”
Westlake, “Higher sales volumes could not offset lower selling prices”

“World faces wave of epic debt defaults” – central bank veteran

Only one central banker spotted the subprime crisis before it occurred – William White.  Now he is warning that the world will have to revive the Old Testament concept of “debt jubilees“, with much of today’s debt being written off:

“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief.  Emerging markets were part of the solution after the Lehman crisis.  Now they are part of the problem, too.

“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.

Long-standing readers will remember that White was one of my guides in 2007-8, when forecasting the subprime crisis.  He was then Chief Economist for the central bankers’ bank (the Bank for International Settlements).   I summarised his July 2007 Report in ‘4 risks to the world economy’, and the July 2008 Report as ‘The difficult task of damage control’.  Unfortunately, I was one of the few to take him seriously.

Today, he is Chairman of the OECD Review committee and continues to speak his mind.  His analysis parallels my own concept of the ‘Ring of Fire’ created by central bank stimulus policies, set out in the map above:

  • It focuses on the massive changes underway in China, where President Xi has cut back dramatically on stimulus lending since taking office
  • Xi has particularly squeezed the shadow banking sector, responsible for most of the speculative property lending that has done such damage to China’s economy
  • As a result, commodity-based companies around the world, and countries, are in crisis
  • Mining company shares have been in freefall for months, as investors wake up to the fact that stimulus has created vast surpluses in key products
  • Even worse is that China’s slowdown is creating major recessions in countries in a wide arc from Brazil through South Africa, Asia, Australia, the Middle East and Russia

I will look at the potential implications of White’s analysis in more detail on Wednesday.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 72%
Naphtha Europe, down 64%. “European petrochemical producers are maximising propane cracking because of the co-products derived from it”
Benzene Europe, down 58%. “Prices have risen sharply this week, with players now seeing product short for January and early February.”
PTA China, down 47%. “Overall buying appetite continued to be thin in the market”
HDPE US export, down 42%. “Chinese end-users still showed strong resistance to the relatively firm-priced cargoes”
¥:$, down 16%
S&P 500 stock market index, down 3%

Japan goes back into recession as stimulus policies fail, again

Japan GDP Nov15This week’s economic data from Japan confirmed, once again, that demographic changes are far more important for the economy than monetary stimulus.

Japan’s premier Abe took power in 2012, promising to end the decline in Japan’s economic growth.  He appointed a new Governor for the Bank of Japan, and claimed that his “3 arrows policy” would quickly create an economic boom.  But as the chart shows from the Guardian/Zerohedge, Monday’s data showed that Japan has gone back into recession again.

It didn’t take rocket science to forecast this back in April 2013, after Abe had announced his new policies:

“Unfortunately, however, this bold new initiative is also doomed to fail, for one simple reason. As in all developed economies, household consumption accounts for almost 2/3rds of Japan’s GDP. And Japan not only has the oldest population in the world (median age is 45 years). Nearly half of its population are over 50 and so are already in their low-spending years”.

Japan spend Nov15The latest data for Japan’s consumer spending confirms there has been little change since 2013, as the chart shows:

  • It highlights how spending declines past the age of 50 in virtually all major areas
  • The reason is simple common sense – older people already own most of what they need, and their incomes decline as they move into retirement

Instead, the main result of the stimulus has been to boost Japan’s financial markets, and to devalue the currency. It has been a wonderful ride for the speculators, as the Nikkei Index has soared from 8750 at the end of 2012 to a peak of over 20000 last August.  Similarly the value of the yen has fallen over 50% versus the US$ over the same period. The Bank of Japan claimed this would boost inflation by causing import prices to rise, but this theory has also proved incorrect with Japan’s consumer price inflation back at 0% in September.

Unfortunately, Abe’s failed experiment has not been cost free.  The Bank of Japan began its stimulus programme in April 2013 by spending Yen 60tn/month, and increased this spend to Yen 80tn/month in October last year, making the total cost roughly equal to $1tn by the end of this year.  This debt still has to be repaid, putting a further burden on the economy.  And, of course, there is no guarantee that premier Abe will now abandon his failed experiment – as last year, he may simply decide to increase the cost still further.

Even more worrying is that the lesson of the failure is still not recognised by other policymakers.  Thus the European Central Bank seems likely to repeat Japan’s mistake of “doubling down” on its own stimulus policy, despite clear evidence that it has also failed to achieve the promised results.

Deflation returns to the major economies as stimulus fails, again

Deflation Oct15aNext week, I will publish my annual Budget Outlook, covering the 2016-2018 period.    The aim, as always, is to challenge conventional wisdom when this seems to be heading in the wrong direction:

Please click here if you would like to download a free copy of all the Budget Outlooks.

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.

Last year’s Outlook returned to the Scenario approach, given the potential for further policymaker stimulus.  This provides a short-term ‘sugar-high’ for financial markets, which feast on the supply of free cash to push prices higher. There was indeed more stimulus from the Bank of Japan in November and from the European Central Bank in March.

Neither effort has worked however.  And thus the Outlook’s main Scenario has indeed come true.  All major developed country economies are now back in deflation, as the chart above confirms.  As I wrote last year:

“The most likely Scenario focuses on the Great Unwinding of policymaker stimulus now underway.  This is taking us into the final stages of the Cycle of Deflation, which has been building since the ‘dot-com bubble’ burst in 2000.

“The key feature of this Scenario is that the world is now becoming demand-constrained.  In the past, advantaged-cost supply was key to success.  “If you build it, they will come” was the motto.

“But today, it is becoming widely recognised that we have a supply glut in most key areas – certainly in energy and commodity markets, and also further down most value chains….

“Of course, deflation wouldn’t be a major issue today if markets had been allowed to operate normally after 2000.  Most Western countries had moved into budget surplus, and were not burdened with today’s debt levels.

“But we are where we are.”

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 52%
Naphtha Europe, down 49%. “Petrochemical demand is starting to soften and this might continue throughout Q4, especially if the price spread between naphtha and propane continues to be as wide as today”
Benzene Europe, down 59%. “European benzene spot values continued to move in tandem with crude oil fluctuations as well as developments in the US Gulf market this week”
PTA China, down 41%. “Major producers do not expect major increases in demand for PTA cargoes in the near term owing to the bearish outlook for downstream polyester”
HDPE US export, down 35%. “Domestic export prices edged up for most grades this week because Texas warehouses are full of material going offshore”
¥:$, down 17%
S&P 500 stock market index, up 4%