“Consensus wisdom” is a handy way of keeping up with events. Nobody likes to be the person who says “I don’t know” when the boss asks a question about something important. But unfortunately, “consensus wisdom” is often wrong, as Ipsos MORI confirm in their new ’Perils of Perception‘ survey, As the authors note:
“It highlights how wrong the public across 40 countries are about key global issues and features of the population in their country.”
The chart above highlights one of the key results, which has major implications for companies and investors:
It shows the actual percentage of wealth owned by the poorest 70% of the population in each country
It also shows people’s perception of the percentage owned by this poorest 70%
Only 3 countries have an accurate perception – the UK, Australia and Belgium
India is the most inaccurate, with a 29 point gap between perception and actual
Other major countries are nearly as bad – the US has a 21 point gap, Russia and China have a 17 point gap, Brazil and Germany have a 15 point gap
As Ipsos MORI note, the problem is that middle class people usually think:
“The rest of the population is more like them, than they really are….On average, just 15% of total wealth is owned by the bottom 70% across these countries – but the average guess is almost twice that at 29%. (My emphasis)
“Some countries are incredibly inaccurate: Indians think this group owns 39% of the country’s wealth when actually only 10% do. The US is also significantly out: Americans think the bottom 70% own 28% of the country’s wealth, when it’s actually a quarter of that at 7%.
The Ipsos data helps to explain why companies and investors are often wildly over-optimistic when planning new investments. This has become a major problem in the Emerging Markets (EMs), where many senior executives have assumed after visiting the chosen country that vast numbers of people are becoming “middle class”:
They stay in good hotels, company-chosen for safety and service, with other guests from similar backgrounds
Their local colleagues and partners are usually middle class and suffer from the over-optimism recorded by the polls
They rarely visit areas where most people live, as colleagues and the hotel often tell them these are “too dangerous”
The past few years of high profile stimulus policies has only added to the confusion.
Most visitors were immediately impressed to find an expensive new airport when they landed. They were similarly upbeat to find shopping malls filled with western luxury goods. Naturally, they assumed this meant the economy was booming. And, of course, the major international banks were happy to supply them with imaginative and glossy reports on the country’s potential, in the hope of winning lucrative project work.
In reality, however, they have been fooled. This appearance of “middle class living” was financed by debt, not wages:
Average GDP/capita in the world is just $10k according to the IMF
Wealthy G7 countries such as the US are at $56k, with the UK at $44k, Germany at $41k and France at $38k
The EMs are very much poorer, and will take decades to catch up, even if they continue to do well
Russia is the richest BRIC country at $9.2k, followed by Brazil at $8.7k, China at $8.1k and India at just $1600
The end result, unfortunately, is that many companies have effectively been wearing rose-tinted spectacles when making investment decisions. They now face a very difficult time as these plants all start to come online.
President-elect Donald Trump has made it clear he will impose tariff barriers to force US manufacturers to reshore production back to the US. In turn, many EMs will no doubt put up trade barriers to protect their own industry. Supply chains will be hit from two angles at once. Not only will imports from the EMs reduce, but exports to the EMs will also decline:
Ford’s decision this week to abandon its planned $1.6bn Mexican investment is a clear sign of what is to come
They were at least able to cancel. If it had already been built, it would probably now become a “white elephant”.
Unfortunately, this creates a further problem for “consensus wisdom”. Much of what appeared to be true during the SuperCycle is no longer correct. As I noted on Monday, economic criteria are no longer the key to future profitability.
The next 12 months are therefore likely to see more change than we have seen in the past 20 years. Companies and investors that fail to quickly realign their perceptions with reality will risk finding life very difficult indeed.
Serious questions need to be asked about the likely level of future demand growth for oil and auto sales in Emerging Markets (EMs), as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Oil market volatility has reached near-record levels in H1 this year, as the first chart shows. It has averaged nearly 10% a week, and over the past quarter-century its three-month average has only been higher during the Gulf War and the subprime crash. Yet there have been no major supply disruptions or financial shocks to justify such a dramatic increase. Instead, July’s report from the International Energy Agency reminds us that:
“OECD commercial inventories built by 13.5 mb in May to end the month at a record 3 074 mb. Preliminary information for June suggests that OECD stocks added a further 0.9 mb while floating storage has continued to build, reaching its highest level since 2009.”
The problem is two-fold:
- Financial markets are now reaching the hard part of the Great Unwinding of policymaker stimulus, which began nearly two years ago as we have described in beyondbrics. Their key role of price discovery has been subverted by the tidal waves of central bank liquidity, and today’s elevated levels of volatility suggest it will be a difficult journey back, as markets return to valuations that are instead based on the fundamentals of supply and demand
- Life has not stood still over the past few years, and so there will also be plenty of surprises along the way as players are forced to recognise that many of their core assumptions are either untrue or out of date. The excitement of the 2009–2014 stimulus period, for example, seems to have led many investors to ignore the 2012 warning from then Saudi oil minister Ali al-Naimi that “Oil demand will peak way ahead of supply”. Today, they are being forced to play catch-up, as they digest the implications of Saudi Arabia’s new National Transformation Plan. Yet its core objective that “Within 20 years, we will be an economy that doesn’t depend mainly on oil”, is clearly linked to Naimi’s earlier insight.
New data from the US Energy Information Agency (EIA) confirms Saudi Arabia’s need for a change of direction, as the chart shows. The EIA’s reference case scenario out to 2040 suggests that US energy consumption will increasingly be led by natural gas and renewables, and notes that
“Petroleum consumption remains similar to current levels through 2040, as fuel economy improvements and other changes in the transportation sector offset growth in population and travel.”
Nor are these trends confined to the US. As Nick Butler has argued recently in the FT, conventional forecasts of ever-rising energy demand driven by rising populations and rising prosperity in the EMs appear far too simplistic. Instead, as he notes: “Demand has stagnated and in some areas is falling.”
Developments in the transportation sector (the largest source of petroleum demand), confirm that a paradigm shift is now underway along the whole value chain. As Dan Amman, president of GM, highlighted in the FT last year, when discussing the value proposition for city dwellers of buying a new car:
“It’s the last thing you should do because you buy this asset, it depreciates fairly rapidly, you use it 3 per cent of the time, and you pay a vast amount of money to park it for the other 97 per cent of the time.”
China’s slowdown confirms the depth of the challenge to conventional thinking about future auto and oil demand. Many still assume that EMs will account for two thirds of global auto sales by 2020, and underpin future oil demand growth. But the China-induced collapse of commodity export revenues in formerly high-flying economies such as Brazil and Russia means that this rosy scenario is also in need of major revision.
As noted last November, Brazil was temporarily the world’s fourth largest auto market in 2013, whilst Russia was forecast to reach fifth position by 2020. But as the chart of H1 sales in the BRIC countries shows, volumes in both countries have almost halved since then. China’s own sales growth is also slowing, as the government’s need to combat pollution has led it to focus on implementing policies aimed at boosting the role of car sharing and public transport – while its focus on electric vehicles is a further downside for future oil demand.
As we move into H2, it therefore appears that the fundamental assumptions behind the $3tn of energy market debt – $100/bbl oil and double-digit economic growth in China – are looking increasingly implausible. And given oil’s pivotal role in the global economy, today’s near-record levels of oil market volatility may also be trying to warn us that wider problems lie ahead for financial and energy markets.
Attention has rightly been focused on the collapse of oil prices over the past 6 months. These have further to fall, but the major part of the move must now be behind us. After all, Brent was at $104/bbl when I first forecast the move in mid-August, and closed at $56/bbl last night, so probably “only” has $20/bbl-$30/bbl further downside.
But there are 2 elements to this Great Unwinding. The other is the surge in the value of the US$. The US$ Index (versus the world’s other major currencies) has already broken out of its 30-year downtrend since my August forecast.
I suspect the US$’s resurgence will now assume much greater importance as its impact becomes more widely recognised.. As I noted back in September:
- “The US$ Index has fluctuated 25% on several occasions between 72 and 90 since the middle of 2008
- First there was a ‘flight to safety’ in H2 2008, as the Financial Crisis took place
- Then the US Fed pushed the value down again with its first Quantitative Easing (QE)
- When traders tried to buy the US$ again in 2010, new QE programmes kept the $ weak..
“If we assume for a moment that the US$ continues to rise, then the recent flows of money into high-risk assets will quickly reverse. These have been largely created by the Fed’s decision to supply unlimited amounts of low-cost money:
- Pension funds and hedge funds have simply bought anything that offered a high yield, in a desperate effort to maintain their returns for investors and pensioners
- They have only thought about the need to focus on ‘reward’, and have ignored the fact that high reward usually also means ‘high risk’
“But if money flows back into the US$, then ‘risk’ will return with a bang. Who will buy all the assets that are being sold?”
Today, this is no longer a theoretical question, as the chart above shows. In the 6 months since I forecast the move, the Index has now reached the 100 level, last seen 12 years ago in Q1 2003. That is a massive move in such a short time. And as the New York Times notes:
“The soaring value of the American dollar is rippling across the globe. As it rises, it is threatening emerging economies where companies have taken on trillions’ worth of dollar-based debt in recent years.”
The scale of this risk is not at all well understood. And yet, as I noted last week, US$ debt in the Emerging Markets has grown 20-fold from $0.1tn to $2tn over the past decade. It is larger than the US high-yield corporate bond market, and 4x the size of Europe’s high-yield bond markets.
High yield always means high risk. But at least some investors have a good understanding of the risk in US and European bond markets. Very few have the same understanding of the Emerging Markets. Most investors have simply bought their bonds from a prospectus: they were desperate to gain a better yield than available in the West.
Now they will find out the hard way that that many of the companies in which they have invested cannot afford to repay the loan, due to the loan’s value having just increased dramatically due to the rise in the US$. The sorrowful sequence is as follows:
- Companies in Emerging Markets decided to borrow more cheaply by borrowing in US$
- Their aim was to take advantage of the US Federal Reserve’s zero interest rate policy
- But today they are finding out the real cost of the loan, as the capital value has risen by up to 50% in some cases, such as Russia
- So, of course, they are most unlikely to be able to repay the loan, especially as their profits are also under pressure from the slowdown in China and other Emerging Markets
The US$ has been in a downtrend for 30 years, since the Plaza Accord in 1985. Now, as often happens, the recovery is happening very fast indeed. It will be a very bumpy ride ahead.
The global economy really isn’t getting any better. That’s the key conclusion from the blog’s quarterly survey of company results for Q2.
Of course, some companies are doing well – either because of shale gas economics, or their own market positioning. But consumer giant Unilever summarised the general picture very well:
“Market growth continued to slow in emerging countries, particularly in Asia, as macro-economic pressures weighed on consumer spending in our categories. Developed markets remained weak with little sign of any recovery in North America or Europe“.
Its global rival Nestle described a similar picture, with its successes being achieved despite headwinds in most of its major markets.
Of course, each quarter we are assured by policymakers that recovery is now certain. But every quarter we are disappointed. This month, even the new deputy chairman of the US Federal Reserve, Stanley Fischer has admitted that:
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back”
And in the past few weeks it has become clear that some major investors, as well as leading central bankers, are starting to take a serious interest in the blog’s Demographic Scenario.
The benefit of this Scenario is that it explains the economic developments of the past 50 years in a simple and common-sense fashion. It does not require us to believe that central bankers have somehow become ‘Masters of the Universe’, able to change people’s entire behaviour via the simple manipulation of monetary policy.
As a result, the blog is now making a ‘Speed Read’ available of the background to the Scenario’s central arguments. It collects together the 2 page summaries from ICB that accompanied the monthly publication of each chapter of ‘Boom, Gloom and the New Normal’, written by the blog and co-author John Richardson.
Please click here to download the ‘Speed Read’ (no registration required).
The blog is also now offering a new strategy workshop to help your business realign itself with the profitable growth areas of this New Normal.
Air Liquide. “New contracts in growing markets”
Air Products. “Strong sales for its electronics and performance materials and higher pricing for its merchant gases”
Akzo Nobel. ”Long-running cost and efficiency programme starts to bear fruit”
Arkema. “All divisions registered lower sales and EBITDA margins in Q2″
Ashland. “Global restructuring programme and a $12m charge because of a pension adjustment”
Axiall. “Dramatically lower profits and somewhat lower sales”
BASF. “Expects the global economy to post a weaker growth than previously expected this year”
BP. “In the petrochemicals business, the challenging environment is expected to continue”
Bayer. “Higher volumes, lower raw material prices and our efficiency improvements”
Borealis. “Stronger margins from polyolefins offset weaker-than-expected results in fertilizers”
Braskem. “Spreads of thermoplastic resins and key basic petrochemicals fell in Q2″
Brenntag. “Modest signs of recovery in Europe/NAFTA and ongoing challenges in LatAm and Asia”
Celanese. “Sales rose as well as equity in the net earnings of affiliates”
CP Chem. “Higher realised olefins and polyolefins chain margins”
Clariant. “Volatile and challenging business environment compared to the previous year”
Croda. “Weak consumer demand in Europe impacted the business, particularly in personal care”
Dow. “Ongoing slow growth and volatility in the global marketplace”
DSM. “Weaker performance of polymer intermediates, particularly caprolactam”
DuPont. “Drive greater growth and value with a simplified, streamlined support structure and a smaller cost base”
Eastman. “Net sales were $2.46bn, up less than 1%”
Evonik. “Pricing pressure continued to weigh on profits”
ExxonMobil. “Margins were flat as improved commodities were offset by weaker specialties”
Huntsman. “Improved pricing and stronger demand for key products”
INEOS. “US cracker business environment was strong with top of cycle margins and high operating rates”
Indorama. “Most producers operating at below cost over last two years”
K&S. “Given the starting position on global potash markets, we had a solid first half of the year”
Kemira. “Currency headwinds and divestments”
LG Chem. “Overall performance has decreased due to stronger Won and slow recovery of sluggish industry”
Lanxess. “Continuing low earnings level and increasing competition show the need for further action”
Lonza. “Implementation of growth projects and restructuring”
LyondellBasell. “Jump in profit was driven primarily by the American olefins and polymers business”
MOL. ““The main driver was an adverse external environment”
Methanex. “Industry environment remains favourable, with steady demand and limited new supply additions expected”
Nova. Lower margins in its olefins operations in Joffre, Alberta, and Corunna, Ontario”
Novozymes. “Positive sales impact from its partnership with US agrochem giant Monsanto”
Nestle. “N America trading environment remained subdued. Latin America was helped by pricing, reflecting inflationary pressures…Europe a deflationary environment where consumer confidence remains fragile…China was challenged, but we see fundamentals improving”
OMV. “Performance was lower than the preceding three-month period, primarily because of a decrease in ethylene spreads”
Olin. “Lower volumes and lower prices meant that netbacks declined about 11%
PKN Orlen. “Petrochemical model margin was recorded at €741/t in Q2 against €729/t in 2013
PPG. “Volume growth and improved year-over-year earnings in all major regions”
PTT. “Significant decrease in paraxylene price pressured by supply surplus”
Petronas. “Heavy plant turnarounds and planned maintenance activities during the period”
PolyOne. “Specialty now contributing two-thirds of our segment income”
Petro Rabigh. “Higher prices and sales volumes of its petrochemical products”
Praxair. “Sales growth was driven by new projects in North America and Asia, as well as disciplined price execution”
Reliance. “9.3% year-on-year increase in revenue”
SABIC. “Higher output and sales volumes”
SCG. “Chemicals division posted Q2 profit down 14% year on year, despite a 24% jump in sales”
Shell. “Improved base chemicals industry conditions mainly in North America”
Solvay. “Transformation is delivering on all fronts”
Synthomer. ““Strong competition between glove manufacturers has caused ongoing margin pressure”
TVK. “Improved operational efficiency, favourable currency effects, and lower energy costs”
Tasnee. “Improved margins at its petrochemicals unit, and higher sales volumes”
TOTAL. “Petrochemical margins remained high in the US but retreated in Europe and Asia”
Trinseo. “Lower costs in styrene and butadiene”
Tronox. “Sales volumes increased across multiple products and geographic regions”
Unilever. “Market growth continued to slow in emerging countries, particularly in Asia, as macro-economic pressures weighed on consumer spending in our categories. Developed markets remained weak with little sign of any recovery in North America or Europe”
Versalis. “Increased oil-based feedstock costs, continued weakness in commodity demand, which reflected slow economic growth and increasing competition from Asian producers”
Vopak. “Lower revenues and higher depreciation costs”
Wacker. ““Rising volumes, better prices for polysilicon and good coverage of fixed costs”
Westlake. “Benefit from low-cost ethane-based ethylene production”
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”