Resilience amidst headwinds is key for H2

Resilience is set to become the key issue as we look forward to H2, as I note in a new analysis for ICIS Chemical Business. None of us have ever seen the combinations of events that are potentially ahead of us. And none of us can be sure which way they will develop. So it seems essential that we start to create contingency plans to build corporate resilience ahead of their possible arrival.

Of course, we can all hope that we are just seeing a series of false alarms, and that business as usual will end up as the outcome. But hope is not a strategy. Even if we optimistically believe it is an 80% probability, the scale of the potential problems under more pessimistic scenarios suggests it would be prudent to decide ahead of time how to tackle them. Everyone will have their own list of possible outcomes. Mine is as follows:

  • Business as usual. Central bank rate cuts avoid recession risk; Presidents Trump and Xi reach stable agreement to roll back tariffs; oil market tensions disappear in the Middle East; Brexit uncertainty is put on hold with another extension period; sustainability concerns over single use plastics are put on back-burner
  • Gathering clouds. China’s vast offshore borrowing creates increasing risk of corporate defaults as growth slows, particularly if the trade war continues; geo-political risks mount in the Middle East; Brexit leads to major friction between the UK and EU27; more major consumer products companies decide to end use of single-use plastics
  • Storm warnings issued. Debt problems morph into major bankruptcies, impacting a range of supply chains around the world; US – Iran tensions mount in the Middle East causing oil prices to rise sharply; regional tensions mount as the world settles into a new Cold War between the USA and China; polymer volumes are hit by a rapid escalation of consumer concerns over single-use plastics

Asia is likely to prove the catalyst for this potential next crisis, if it hits. China has begun to deleverage over the past 2 years, taking $2tn out of its high-risk shadow banking sector. But unfortunately this tightening has driven many of the riskiest businesses into the offshore dollar markets, where naïve western fund managers have rushed to place their bets – driven by their need to achieve higher returns than are available in their domestic bond markets.

If world trade continues to slow as the chart from Reuters shows, and the remnimbi starts to weaken, then some of these borrowers will inevitably default. In turn, this risks a chain reaction across world markets, impacting not only the zombies but also their supply chain partners.

What would your company do in these circumstances? As the American writer Ernest Hemingway noted in ‘The Sun also Rises’, there are two ways to go bankrupt, “gradually, then suddenly”. And the suddenness of the final stage makes it almost impossible for companies to survive if they have not used the gradual stage to create contingency plans. History unfortunately shows that when markets turn, executives suddenly find they have very little time in which to think through how to respond.

Governments will also be in the line of fire, due to their debt levels. And it is unlikely that politicians will know how to respond. They used to be clear about the key issue for the voters, as Bill Clinton famously observed in 1992 – “it’s the economy, stupid”. But today’s politicians instead simply assume that central banks can always print more money to overcome financial and economic crises. They have forgotten the simple mnemonic that many of us learnt at school, namely that “to ASSUME can make an ASS of U and ME”.

Time spent now on building your company’s resilience to potential future challenges may therefore prove time very well spent, if hopes for ‘business as usual’ turn out to have been wishful thinking.

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CEOs need new business models amid downturn

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.

BASF’s second profit warning highlights scale of the downturn now underway

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.

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.

US chemicals slip back into Contraction mode as cycle peaks

US inventory Apr14The above chart from the excellent American Chemistry Council (ACC) weekly report may look a bit baffling at first.  But it is worth attention, as it highlights the current state of the industry in real time:

  • It shows US chemical shipments on the vertical axis, and change in inventory on the horizontal axis
  • Both are shown on a 3 month moving average (3MMA), to allow easy identification of turning points
  • It starts in the top half of the graph labelled Expansion in December 2007 (12-07)
  • Shipments then reduce and inventories build to take it into Contraction by December 2008 (12-08)
  • Next, inventories gradually reduce and shipments rise, taking it back to Expansion by December 2009 (12-09)
  • The Expansion peak was in 2010 (12-10), and the line moved back into Contraction by December 2011 (12-11)
  • Since then it hovered between Expansion and Contraction, with a short period in Expansion in 2012 (12-12)

As the ACC comment on the latest data, showing January/February 2014 moving back into Contraction mode (1-14)

The most recent data indicate that for the industry as a whole (excluding pharmaceuticals) inventories posted a 1.9% Y/Y gain on a 3MMA basis. Inventories continued to outpace shipments (with a 1.6% Y/Y deterioration on a 3MMA basis) in this comparison. The gap (shipment growth over inventories growth) narrowed from -4.5 percentage points in January to -3.5 percentage points in February suggesting that the balance is moving away from normal. This is in the wrong direction but is far from its widest (at -21.2 percentage points) deficit gap in January 2009.”

Now, of course, this could simply be the effect of the unusually cold weather in the US, as was originally claimed by the US Federal Reserve.  But the failure of the line to maintain a strongly positive position in the Expansion section since the end of 2011 is a worrying sign.

During this period, we have seen unprecedented stimulus efforts by policymakers, with interest rates at historic lows.  Yet last week’s US employment report showed employment was still 2 million people lower than at the pre-Crisis peak in November 2007.  Employment has never before failed to recover over a 6-year period after a downturn, since records began in 1939.

As the Wall Street Journal commented on the detail of the employment report, the number of those working part-time but wanting full-time jobs also rose by 224k to 7.4m, adding:

The manufacturing sector, for instance, shed 1,000 positions as it struggles to gain traction as firms work through high inventories, weather-related slowdowns and a weak global backdrop.”

Seasonally, we are now moving past the strongest months of the year.  Easter next week will clearly slow demand in much of the West.  Hopefully, there will then be some recovery in May before the holiday period and seasonally weaker H2.

It thus looks increasingly likely that Dow CEO Andrew Liveris was right to warn back in 2012 that the chemical industry cycle would peak by 2015-16. 

Against this background, it becomes increasingly hard to understand why companies are still planning to bring major new capacity online from 2017 onwards.  The new capacity, coinciding with an overall market downturn, could well have a disastrous impact on operating rates and profits.

 

 

BBC reports ‘How China Fooled the World’

BBC China Feb14Last night, the BBC ran a 1 hour documentary by its senior editor Robert Peston, who won countless awards for his work during the subprime crisis.  It completely confirmed the arguments put forward by the blog in recent months about the scale of the economic crisis now facing China.  The BBC introduced the documentary as follows:

Robert Peston travels to China to investigate how this mighty economic giant could actually be in serious trouble. China is now the second largest economy in the world and for the last 30 years China’s economy has been growing at an astonishing rate. While Britain has been in the grip of the worst recession in a generation, China’s economic miracle has wowed the world.

“Now, Peston reveals what has actually happened inside China since the economic collapse in the west in 2008. It is a story of spending and investment on a scale never seen before in human history – 30 new airports, 26,000 miles of motorways and a new skyscraper every five days have been built in China in the last five years. But, in a situation eerily reminiscent of what has happened in the west, the vast majority of it has been built on credit. This has now left the Chinese economy with huge debts and questions over whether much of the money can ever be paid back.

“Interviewing key players including the former American treasury secretary Henry Paulson, Lord Adair Turner, former chairman of the FSA, and Charlene Chu, a leading Chinese banking analyst, Robert Peston reveals how China’s extraordinary spending has left the country with levels of debt that many believe can only end in an economic crash with untold consequences for us all”

Peston himself sees China’s current economic slowdown as the 3rd wave of the global financial crisis, following on from the subprime crash in 2008 and the Eurozone crisis of 2011:

“Over the past few years, China has built a new skyscraper every five days, more than 30 airports, metros in 25 cities, the three longest bridges in the world, more than 6,000 miles of high speed railway lines, 26,000 miles of motorway, and both commercial and residential property developments on a mind-boggling scale.

“Now there are two ways of looking at a remaking of the landscape that would have daunted Egypt’s pharaohs and the Romans. It is, of course, a necessary modernisation of a rapidly urbanising country. But it is also symptomatic of an unbalanced economy whose recent sources of growth are not sustainable.

“Perhaps the big point of the film I have made, How China Fooled the World, is that the economic slowdown evident in China, coupled with recent manifestations of tension in its financial markets, can be seen as the third wave of the global financial crisis which began in 2007-08 (the first wave was the Wall Street and City debacle of 2007-08; the second was the eurozone crisis).”

The blog fears that many companies are going to be caught unawares by the problems now emerging in China.  If you need help to reorient yourself quickly, please get in touch at phodges@iec.eu.com.  We are able to help.