Contingency planning is essential in 2020 as “synchronised slowdown” continues

The IMF has now confirmed that the world economy has moved into the synchronised slowdown that I forecast here a year ago. Its analysis also confirms the importance of the issues highlighted then, including “rising trade barriers and increasing geopolitical tensions”, a sharp decline in manufacturing, contraction in the auto industry and structural forces such as the impact of ageing populations.

Capacity Utilisation (CU%) data from the American Chemistry Council has therefore once again proved to be the best leading indicator for the global economy. It has been far more reliable than stock markets, where valuations continue to be massively distorted by central bank stimulus. And unfortunately, the latest data shows no sign of any improvement as the chart confirms, with November’s CU% now back at November 2012’s level at 81.7%.

Of course, it remains very easy to ignore the warning signs. ‘Business as usual’ is always the most popular forecast, as we saw a year ago when the consensus assumed a sustainable economic recovery was finally underway. And it would be no great surprise if, in a year’s time, consensus opinion starts to claim that “nobody could have seen recession coming”.

This is why it seems likely that businesses will now start to divide into Winners and Losers. As the IMF note in their analysis, the current situation is “precarious”, with a number of potential downsides starting to crystallise. On a macro view, these include the growing supply chain risks created by Brexit, where the UK expects to leave the EU at the end of this month.

Anyone with experience of trade negotiations knows that these normally take years rather than months to complete. No Deal is therefore the most likely outcome in a year’s time at the end of the transition period.

This will have a major impact on industries with complex and highly integrated downstream value chains like autos, chemicals and aerospace. Contingency planning is therefore on the critical path for any company that currently relies on product flowing seamlessly and tariff-free across the UK-EU27 border.

Of course, potential Losers will continue to nurse the hope that the UK government might reverse its refusal to accept the 2-year extension offered by the EU. But anyone who followed the recent UK election campaign knows this is an unlikely outcome.

The chemical industry also has its own specific challenges to face, given the growing impact of US shale gas-based expansions in the polyethylene area. This is no great surprise, as I have been warning about the likely consequences of these supply-led expansions since they were first announced in 2014 . But unfortunately, the combination of stock market euphoria over the shale gas revolution and the Federal Reserve’s easy money policy meant that the core assumptions were never properly challenged.

Euphoria remained the rule even after the oil price collapse at the end of 2014 disproved the assumption that prices would always be above $100/bbl. And it continued despite President Trump’s election. As a self-confessed “tariff man”, his policies were always likely to upset the idea that plants could be sited half-way across the world from their markets.

Warning signs were also obvious around the assumption that China’s growth would remain at double-digit rates, creating an ongoing need for major imports. And more recently, concerns over climate change and plastic waste issues have created further question marks over the outlook for single-use plastic demand.

Incumbents are often slow to understand the likely impact of potentially disruptive developments on their businesses. Business discussions around the boardroom and water cooler can often take place in a parallel universe to those that happen outside the office with friends and family.

The upstream oil industry is currently providing a classic example of this phenomenon as it promotes the idea that despite mounting concerns over the role of fossil fuels in climate change, chemicals can somehow replace lost oil demand into transport. Yet as former Saudi Oil Minister Yamani warned back in 2000, “the Stone Age didn’t end for lack of stones, and the Oil Age will end long before the world runs out of oil”.

Unfortunately, therefore, it seems likely that 2020 will see today’s synchronised slowdown continuing to challenge consensus optimism. Contingency planning around recession risks should therefore be top of the agenda, particularly for companies with high debt levels.

But at the same time, better placed companies have a once in a generation opportunity to take advantage of the paradigm shifts now underway, as adoption rates accelerate up the typical S-curve. These Winners are likely to discover that their best days still lie ahead of them, given the range and scale of the new opportunities that are emerging.

Please click here to download my full 2019 Outlook (no registration necessary).

Boris Johnson will have to disappoint someone in 2020 as the UK finally leaves the EU

Finally, after three and a half years, the UK has reached “the end of the beginning” with Brexit, in Winston Churchill’s famous phrase.

Since the referendum, its leaders have consistently refused to confront the real choices that have to be made over what type of Brexit it wants to have:

  • In June 2016, then premier David Cameron walked away from the issue by resigning immediately after the referendum
  • His successor, Theresa May, followed this by setting out her ’red lines’, as shown in the chart. But she never said what she did want, effectively leaving No Deal as the default option
  • On the Labour side, Jeremy Corbyn indulged in the same game-playing, even refusing to say which way he would vote in a new referendum

As a result, the myth grew up that there was a wonderful option called ‘WTO terms’, which would allow the UK to do exactly as it liked on standards, regulations, freedom of movement etc. Yet it would still have complete access to the EU27 market without any need for quotas or Customs barriers.

Unfortunately for all those who have indulged in such wishful thinking, 2020 is likely to provide an abrupt and painful wake-up call.  Once the UK has left the EU in January, Johnson will have to make major choices, and on a very tight timescale.

The government’s key mistake all along was to table its Article 50 notification to leave without having first decided what it wanted from the new relationship with the EU27. And by dismissing the role of “experts” and key Brussels negotiators such as Sir Ivan Rogers, it also never properly understood what might be possible from an EU27 perspective.

Now the need for choices is going to become apparent, as the Transition Agreement only runs to December 2020, and any request for an extension has to be agreed by June.  Johnson has said he will not ask for an extension, and so this narrows the choices:

  • France has said the UK can leave with a ”unique” trade deal encompassing most of the current arrangements, if the UK agrees to maintain today’s standards and regulations into the future. In effect, this would be a Norway-type deal, where the UK becomes a rule-taker, without any say in how the rules are made
  • The alternative is to leave with No Deal, as anyone with experience of trade deals knows that it is simply impossible to square all the necessary circles involved in reaching a new deal in less than 5 – 7 years. The reason is simply that trade deals create winners and losers, and the losers always complain, very loudly

One likely example of a deal-breaker is fisheries policy.

Fishing accounts for just 0.1% of the UK economy, and employs only 24k people out of a total workforce of 33m. And contrary to popular belief, not only have foreign boats been fishing in UK waters for centuries, but 70% of the fish eaten in the UK is imported (cod etc) – with 80% of fish caught by UK fishermen  exported (herring, shellfish etc).

But it was core to the Leave campaign, and Johnson is likely to find it hard to ignore – even if that means fishermen end up facing quotas, tariffs, Customs barriers and a collapse of conservation policies.

Johnson is happy to break promises, as he did over N Ireland when agreeing to the EU27’s terms for the Withdrawal Agreement. But it would be rather soon after the election to break his promise over fishing or, indeed, his promise not to extend the Transition period.

As a result, Theresa May’s legacy will finally be fulfilled, as No Deal remains the default option.  And at that point, the UK will learn very painfully that you really cannot “have your cake and eat it”, despite Johnson’s claims to the contrary.

ACS Chemistry & the Economy webinar on Thursday

Please join me for the next ACS Chemicals & Economy webinar on Thursday, at 2pm Eastern Standard Time, USA, when we will discuss:

  • The contrast between the downbeat outlook for the chemical market and the upbeat stock market
  • The challenges facing US shale gas polyethylene exports due to the US-China trade war and concerns over single-use packaging
  • The problem of drug shortages, and whether pharmaceutical supply chains are still ‘fit for purpose’

As usual, the webinar will be moderated by Bill Carroll, former ACS President.

Registration is free, and you can sign up by clicking here.

What’s next for Brexit and chemicals?

The UK is about to go to the polls again to try and decide the Brexit issue.  Chemicals will be one of the industries most affected by the decision, as it depends on cross-border supply chains.  As the UK Chemical Industries Association has warned:

“The chemical industry in the UK and in Europe needs a relationship with the European Union that delivers: frictionless, free trade; regulatory consistency and alignment; and access to skilled people.”

Next Tuesday at 11.00 GMT, I will be presenting at the second live ICIS webinar on Brexit’s potential impact on the industry, along with ICIS deputy news editor, Tom Brown and ICIS Chemical Business Deputy Editor, Will Beacham.

The webinar will cover the following:
• Update on the political situation, possible scenarios, how to prepare for Brexit
• Trade deal scenarios and tariffs
• Impact on UK and Europe petrochemicals

Please register here to join this free webinar.

Global economy hits stall speed, whilst US S&P 500 sets new records

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.

Budgeting for paradigm shifts and a debt crisis

It is now 8 years since John Richardson and I published our 10-year forecast for 2021 in Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’. Remarkably, its core conclusions are very relevant today, as the summary confirms.

Unfortunately, as we feared, policymakers refused to junk their out-of-date models, despite the lesson of the 2008 financial crisis. Instead, they doubled down on their failed stimulus policies.

  • Yet nearly 1/3rd of the world’s High Income population are in the Perennials 55+ age group and are a replacement economy
  • As a result, and as we suggested in 2011, central bank policies have not, and cannot, produce sustainable growth or inflation

As a result, they have created record levels of government, corporate and individual debt – which can never be repaid. Even the IMF has now started to recognise the timebomb that has been created:

“We look at the potential impact of a material economic slowdown – one that is half as severe as the global financial crisis of 2007-08. Our conclusion is sobering: debt owed by firms unable to cover interest expenses with earnings, which we call corporate debt at risk, could rise to $19tn. That is almost 40% of total corporate debt in the economies we studied.”

Already we are starting to see the unwinding of some of the most extreme examples of the bubbles that have been created in asset prices:

And if the IMF are right, which is almost certain, we must expect major bankruptcies to take place over the next few years.  Over-leveraged businesses go bust very quickly when profits decline, as they can no longer pay their interest bills.

As with the run-up to the 2008 crisis, the signs of trouble are already building. The Fed has had to provide $200bn of support to overnight money markets in New York over the past 6 weeks, and is having to add another $60bn/month into next year.

Companies now face a binary choice as they finalise their Budgets for 2020-2022.

They can choose to ignore what is happening in the real world and continue to hope ‘business as usual’ will continue? Or they can start contingency planning by working through the implications of our forecasts for their Downside Scenario?

One key issue is that our 2021 predictions included paradigm shifts as well as economic forecasts. And as the chart above shows, the transitions associated with paradigm shifts are now accelerating:

  • It took decades for the telephone, electricity, autos and even the radio to reach most Americans
  • But it took only years for the microwave, computer, cellphone and internet to become mainstream

It is clear that a whole series of major paradigm shifts are now underway, as I noted 2 weeks ago:

  • Climate change is finally being taken seriously by legislators and many companies
  • This will lead to dramatic declines in the use of fossil fuels for both transport and petrochemicals
  • It highlights how sustainability is now the key issue for corporate strategy, replacing globalisation
  • Affordability is also moving up the agenda, and will become critical as the debt crisis starts to impact

The problem is that incumbents, as we have seen with central banks, are usually very slow to notice what is happening in the real world outside their office or factory.  The reason is simple – they forget what they have discussed with their friends and family once they go to work. Group-think instead takes over, and everyone goes blindly on believing their own propaganda until it is too late.

German car company VW was a classic example of a blinkered strategy. As top executives now recognise, it was only the “dieselgate” emissions disaster that enabled new management to introduce the Transform 2025 strategy based on a transition to Electric Vehicles.

Most companies don’t face the near-death challenge faced by VW in 2015. But they do face major challenges over the next 2-3 years, which will require them to implement major shifts in their strategy if they want to continue to grow revenue and profits in the future.

The good news is that these challenges can be turned into opportunities with hard work and imagination.  Please let me know if I can help you to achieve the necessary transformation.