Intuition’s great benefit is that it provides a different perspective. Thus the intuitive concept behind the launch of the IeC Downturn Monitor was that April 2011 would prove a watershed moment for policymakers’ Recovery Scenario after 2008′s financial crisis. Their Scenario essentially had two elements:
- Acting as a ‘lender of last resort’ when the major banks stopped lending to each other and the rest of the world
- Building a framework for a full and sustained recovery in the global economy
Policymakers’ first target was achieved by April 2011, but the second target looks as far away as ever as the chart shows for the benchmark portfolio:
- The central banks have mistakenly focused on liquidity programmes (brown arrows) to support financial markets. Thus the S&P 500 Index has gained 34% (purple line)
- Similarly the new Japanese policy of ‘Abenomics‘ has pushed the US$ up 29% versus the yen (brown) as it aimed to create inflation by devaluing the currency
- But chemical prices – the best leading indicators for the real economy – have instead mostly fallen, as weak demand has caused loss of pricing power
The worst result has been in China. Its prices for PTA (red), the raw material for polyester, have fallen 25%. But naphtha (black), the main feedstock for Asian and European petchems, has also fallen 17%. Whilst Brent oil (blue) has fallen 12% as the ‘correlation trade’ has begun to unwind. Even US polyethylene (orange) has struggled, with its price down 10%, despite benefiting from the shale gas boom. Only benzene (green), with its supply greatly reduced by the downturn in refining and petchems, has seen prices remain in a more stable pattern.
2014 now sees policymakers in a race against time. The major central banks have so far spent $16tn in boosting liquidity, whilst a total $33tn has been spent on overall stimulus efforts. This money can only be repaid if growth does now start to return to SuperCycle levels.
We are thus at the T-junction described by PIMCO, the world’s largest bond fund manager. One road leads to strong growth: the other to a world where lack of growth in the real economy leads to default in financial markets – either via major spending cutbacks and tax rises, or via an inability to repay the money borrowed.
The blog didn’t know how developments would play out when it first launched the Monitor nearly 3 years ago. But the way the Monitor now highlights the dilemma we face, confirms the insight that intuition can provide.
Benchmark price movements since April 2011 are below with ICIS pricing comments, and the Monitor chart above:
PTA China, red, down 25%. “Sellers and buyers seeing squeezed margins because of high production costs, coupled with prevailing weak demand on poor downstream market conditions”
Naphtha Europe, black, down 17%. “Europe is structurally long on naphtha, and sellers need to export to the US gasoline and Asian petrochemical sectors to keep stocks in balance”
Brent crude oil, blue, down 12%
HDPE USA export, orange, down 10%. “ Interest was weak as most global buyers have made arrangements to purchase January cargoes and are in no hurry to pursue February material”
Benzene Europe, green, up 5%. ”Outlook for the upcoming month was less certain”
US$: yen, brown, up 29%
S&P 500 stock market index, purple, up 34%
Most of today’s executives and policymakers grew up during the SuperCycle. Many therefore continue to believe that a return to constant growth is somehow inevitable. Sadly, of course, they are doomed to disappointment.
And disappointment is the predominant message from the blog’s usual quarterly review of company results. Thus BASF note that “achieving our earnings target is significantly more challenging today than we had expected”. Equally, there is a widespread reluctance to accept that today’s economic downturn is secular and not just cyclical.
Most companies thus see the world as being in separate silos, and assume that weakness in Europe, for example, is somehow separate from the slowdown in China. In reality, of course, they are cause and effect – ageing European populations no longer to need to buy from China’s export-orientated economy. So China’s growth is inevitably slowing, and for the next 5 – 10 years it will remain slow, whilst it goes through the painful and difficult task of refocusing on domestic demand.
US-based companies have the hardest job in accepting this New Normal. The short-term demands of financial markets mean they have to run hard just to stand still. Sadly, therefore, many are using the windfall of lower natural gas prices to boost earnings today, rather than investing for the future. So they are ferociously continuing to cut costs and restructure. The alternative, of building new revenue streams for the future, would require increased spending to produce the new products and services that will be required – and therefore lower earnings today.
Air Liquide. “Costs associated with restructuring and layoffs in western Europe weighing on profitability”
Akzo Nobel. “Conditions remain tough and, as we have previously indicated, we do not expect an early improvement in the external trends our businesses are facing.”
Arkema. “Market conditions in Europe are challenging, in particular in France where growth prospects have deteriorated”
Ashland. “Sharply lower guar shipments for oil drilling”
Axiall. “This is clearly a different environment than we expected at the beginning of the year”
BASF. “Achieving our earnings target is significantly more challenging today than we had expected at the beginning of the year”
BP. “Margins and volumes are expected to remain under pressure for the rest of the year”
Bayer. “North American growth offset slumps in most other regions”
Braskem. “A rise in sales volume growth and a recovery in international resins spreads”
Brenntag. “We do not see the promise of any significant improvement in the macroeconomic environment”
Celanese. “Much of China’s industrial chemical market is in turmoil because demand has just not grown”
ChevronPhillips. “Plant outages and turnaround activity”
Clariant. “Expects stability in mature markets but rising uncertainties in emerging economies”
Croda. “Challenging trading environment has inevitably held back certain parts of the business”
DSM. “Nutrition business generated €249m in earnings, up 28% year on year”
Dow. “US continues to be a bright spot among the economies of the world”
Dow Corning. “Significant oversupply and high raw materials costs”
DuPont. “Considering alternatives for the performance chemicals business but had not yet made any decisions”.
Eastman. “Greater volumes from acquisition of Solutia”
Evonik. “Market conditions during the quarter were far more difficult than expected”.
ExxonMobil. “Volume and mix effects increased second-quarter chemical earnings by $120m”
Huntsman. “Many areas of the global economy continue to moderate or languish”
Kemira. “Net profit fell 88% partly as a result of €27m in restructuring fees and efficiency savings writedowns”
Kronos. “Continue to focus on initiatives to improve our global production efficiencies and manufacturing flexibility”
LG Chem. “Expects seasonal demand growth and the gradual recovery in the global economy”
Lanxess. “Trading conditions for our businesses remain tough and the fragile sentiment in Europe is now evident in other markets that are important for us, such as China and Brazil”
Linde. “An environment which is proving challenging to everyone”
LyondellBasell. “The environment for the rest of the year remains highly changeable”
Marubeni. “Deterioration of profits in the petrochemical product business”
Methanex. “Higher sales volumes and prices of methanol”
Mitsubishi Chemical. “Recovering domestic demand and improved export environment”
Nova. “Lower margins in olefins, partially offset by higher margins and increased sales volumes in polyethylene”
OMV. “Higher margins, lower sales”
Oxychem. “Continued weak economic conditions in Europe and slowing demand in Asia”
PPG. “Sales volume results were also mixed, similar to the respective regional trends”
Praxair. “Our on-site business continued to be very strong”
SABIC. “Cost cuts propped up margins even though sales revenue declined”
Siam Cement. “Strong performance in its chemicals business”
Shell. “Contributions from chemicals were lower as a result of the industry environment in Europe”
Shin-Etsu. “Robust PVC shipments by its US subsidiary to central and South America”
Solvay. “Decisions by some of our customers to delay investments”
Tosoh. “Production and domestic shipments of olefin products including ethylene and propylene increased”
Tronox. “Selling prices are showing signs of stabilising”
Versalis. “Weak commodity demand impacted by the current economic downturn as well as declining benchmark cracking margins”
Wacker. “Persistently difficult market and competitive environment”
Wanhua. “Expecting higher revenues following completion of technical upgrade of MDI plant in Ningbo”
How has your company reacted to the clear signals from China’s new leadership that they intend to take the economy on a new path?
Has it updated its existing contingency plan, and warned employees and shareholders that things may get very tough for a few years? If not, why not? Even companies who don’t trade directly with China will likely find competition increasing, as other companies try to replace lost China sales elsewhere.
There is certainly little doubt that a major slowdown is now underway. Last Friday, Australia’s Labor government announced it was reducing expected tax revenues by A$33bn (US$30bn) – only 10 weeks after having published its original estimates. Yet as co-author John Richardson notes in this excellent letter to the Australian Financial Review, there is simply no excuse for this terrible mistake.
Please ask your CEO and business leaders how your company is placed on this critical issue. Are they as ready as possible for the slowdown?
The news that Labor has had to write down $33bn in tax receipts in the space of just ten weeks serves as a very good illustration of how so many governments, financial institutions, banks and companies have got China so badly wrong.
Just a few months ago, the wishful thinkers easily outweighed the realists, who had been warning for years that China’s deep structural problems threatened a severe economic slowdown. In Chapter 6 of our eBook, Boom, Gloom & The New Normal, published 18 months ago, we highlighted the risks ahead. One wonders who has been advising Labor about outcomes for China?
Could its advisers have included financial institutions, such as the International Monetary Fund, which are constrained for political reasons in what they can say about China? If they tell the truth, they run the risk of being denied access to data by government agencies – and of falling out of favour with senior politicians. As for the investment banks, selling a one-dimensional China success story has served them well financially for many years.
The Labor Party and the Coalition need to have a credible plan for Australia if China’s GDP growth falls to as little as 3-4% over the next decade – one quite possible scenario. Perhaps a public debate on this subject during the General Election campaign would be a step in the right direction.
Perth, W Australia
There are two great myths in the modern world. One, as discussed yesterday, is that central banks can restore growth to SuperCycle levels. The other is that China’s economy will grow consistenly at high rates for the next decade. Both are wishful thinking, not robust strategies.
The chart above highlights the problems with the second myth. China’s GDP data is routinely manipulated to ensure local Communist Party leaders meet their targets. Instead, the blog focuses on two much more reliable economic indicators:
• Electricity consumption (green line) is up 4.9% this year versus 2011
• Bank lending (red column) fell 14% in October
New premier-designate Li Keqiang has said electricity consumption (like bank lending) is one of only 3 ‘real’ indicators, with the GDP figure being ‘man-made and therefore unreliable’. It grew 14% last year as the impact of the 2008-10 stimulus programmes peaked, and was forecast to rise 10% this year by the government. This target cannot now be met.
Similarly, the jump in bank lending between May – September was clearly due to pre-Congress jockeying for power. Local Party bosses and the powerful State Owned Enterprises were given $1.1tn of loans for their pet projects. But October’s lending has slipped again.
Also worrying was the lack of any sign in the leadership speeches that Xi and Li intend to press on with the policy changes proposed by the World Bank and notionally agreed at last March’s Party Conference. Instead, as David Pilling noted in the Financial Times:
“Protests against environmental degradation, local corruption and illegal land grabs have reached such a level that the internal security budget now outstrips that allocated to national defence.”
China’s new leadership faces a very difficult few years. Even the official GDP growth target was reduced to only 7% per annum in President Hu’s Congress speech. The real number is likely, as this year, to be a lot lower.