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.
Companies and investors are starting to finalise their plans for the coming year. Many are assuming that the global economy will grow by 3% – 3.5%, and are setting targets on the basis of “business as usual”. This has been a reasonable assumption for the past 25 years, as the chart confirms for the US economy:
- US GDP has been recorded since 1929, and the pink shading shows periods of recession
- Until the early 1980’s, recessions used to occur about once every 4 – 5 years
- But then the BabyBoomer-led economic SuperCycle began in 1983, as the average Western Boomer moved into the Wealth Creator 25 – 54 age group that drives economic growth
- Between 1983 – 2000, there was one, very short, recession of 8 months. And that was only due to the first Gulf War, when Iraq invaded Kuwait.
Since then, the central banks have taken over from the Boomers as the engine of growth. They cut interest rates after the 2001 recession, deliberately pumping up the housing and auto markets to stimulate growth. And since the 2008 financial crisis, they have focused on supporting stock markets, believing this will return the economy to stable growth:
- The above chart of the S&P 500 highlights the extraordinary nature of its post-2008 rally
- Every time it has looked like falling, the Federal Reserve has rushed to its support
- First there was co-ordinated G20 support in the form of low interest rates and easy credit
- This initial Quantitative Easing (QE) was followed by QE2 and Operation Twist
- Then there was QE3, otherwise known as QE Infinity, followed by President Trump’s tax cuts
In total, the Fed has added $3.8tn to its balance sheet since 2009, whilst China, the European Central Bank and the Bank of Japan added nearly $30tn of their own stimulus. Effectively, they ensured that credit was freely available to anyone with a pulse, and that the cost of borrowing was very close to zero. As a result, debt has soared and credit quality collapsed. One statistic tells the story:
“83% of U.S. companies going public in the first nine months of this year lost money in the 12 months leading up to the IPO, according to data compiled by University of Florida finance professor Jay Ritter. Ritter, whose data goes back to 1980, said this is the highest proportion on record. The previous highest rate of money-losing companies going public had been 81% in 2000, at the height of the dot-com bubble.”
And more than 10% of all US/EU companies are “zombies” according to the Bank of International Settlements (the central banks’ bank), as they:
“Rely on rolling over loans as their interest bill exceeds their EBIT (Earnings before Interest and Taxes). They are most likely to fail as liquidity starts to dry up”.
2019 – 2021 BUDGETS NEED TO FOCUS ON KEY RISKS TO THE BUSINESS
For the past 25 years, the Budget process has tended to assume that the external environment will be stable. 2008 was a shock at the time, of course, but time has blunted memories of the near-collapse that occurred. The issue, however, as I noted here in September 2008 is that:
“A long period of stability, such as that experienced over the past decade, eventually leads to major instability.
“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.”
This is the great Hyman Minsky’s explanation for financial crises and panics. Essentially, it describes how confidence eventually leads to complacency in the face of mounting risks. And it is clear that today, most of the lessons from 2008 have been forgotten. Sadly, it therefore seems only a matter of “when”, not “if”, a new financial crisis will occur.
So prudent companies will prepare for it now, whilst there is still time. You will not be able to avoid all the risks, but at least you won’t suddenly wake up one morning to find panic all around you.
The chart gives my version of the key risks – you may well have your own list:
- Global auto and housing markets already seem to be in decline; world trade rose just 0.2% in August
- Global liquidity is clearly declining, and Western political debate is ever-more polarised
- Uncertainty means that the US$ is rising, and geopolitical risks are becoming more obvious
- Stock markets have seen sudden and “unexpected” falls, causing investors to worry about “return of capital”
- The risks of a major recession are therefore rising, along with the potential for a rise in bankruptcies
Of course, wise and far-sighted leaders may decide to implement policies that will mitigate these risks, and steer the global economy into calmer waters. Then again, maybe our leaders will decide they are “fake news” and ignore them.
Either way, prudent companies and investors may want to face up to these potential risks ahead of time. That is why I have titled this year’s Outlook, ‘Budgeting for the end of “Business as Usual“. As always, please contact me at firstname.lastname@example.org if you would like to discuss these issues in more depth.
Please click here to download a copy of all my Budget Outlooks 2007 – 2018.
Suddenly, businesses across Europe are waking up to the realisation that the UK is currently on course to leave the European Union (EU) on 29 March next year, without a deal on trade and customs. As Katherine Bennett, the UK boss of aerospace giant, Airbus, warned on Friday:
“This is not project fear, this is dawning reality.”
As the BBC reported on Friday: “Airbus has warned it could leave the UK if it exits the European Union single market and customs union without a transition deal…It also said the current planned transition period, due to end in December 2020, was too short for it to make changes to its supply chain. As a result, it would “refrain from extending” its UK supplier base. It said it currently had more than 4,000 suppliers in the UK.”
BMW, which makes the iconic Mini and Rolls Royce, added:
“Clarity is needed by the end of the summer.”
Similarly Tom Crotty, group director at INEOS, the giant petrochemicals group, said several companies were putting investment decisions on hold because of Brexit uncertainty:
“The government is relatively paralysed … it is not good for the country.”
THE RANGE OF TOPICS COVERED BY THE BREXIT NEGOTIATIONS IS VERY LARGE
This is why my IeC colleagues and I have now launched Ready for Brexit on the 2nd anniversary of the UK’s referendum to leave the EU. We are particularly concerned that many small and medium-sized businesses (SMEs) – the backbone of the European economy – are failing to plan ahead for Brexit’s potential impact.
As our Brexit Directory above shows, Brexit creates a wide range of challenges and opportunities:
- Customs & Tariffs: Export/Import Registration, Labelling, Testing, VAT
- Finance: Payment Terms, Tax & VAT, Transfer Pricing
- Legal: Contracts, Free Trade Agreements, Intellectual Property
- Services & Employment: Banking, Insurance, Investment, Property
- Supply Chain: Documentation, Regulation, Transport
And yet, today, nobody knows on what terms the UK might be trading with the other EU 27 countries after 29 March. Or indeed, all the other countries where UK trade is currently ruled by EU agreements.
The EU is a rules-based organisation, and the legal position is very clear:
- The UK has notified the EU of its intention to leave by 29 March
- Negotiations are underway over a possible Withdrawal Agreement, which would set new terms for UK trade with the EU 27 after this date
- The proposed Transition Agreement, which would extend the deadline for leaving until 31 December 2020, will only apply if this Withdrawal Agreement is finalised in the next few months
Ready for Brexit will keep its subscribers updated on developments as they occur, as well as providing news and insight on key areas of business concern.
A NUMBER OF VERY DIFFERENT OPTIONS EXIST FOR FUTURE UK-EU TRADE ARRANGEMENTS
The UK has been in the EU for 45 years. Unsurprisingly, as the slide above confirms, the negotiations are proving extremely complex. Both sides have their own objectives and “red lines”, and compromise is proving difficult.
The negotiators not only have to deal with all the trade issues covered in the Ready for Brexit Directory, but also critical political questions such as the trading relationship between N Ireland and Ireland after Brexit. That, in turn, is complicated by the fact that the UK government depends on Democratic Unionist Party (DUP) votes for its majority, and the DUP is opposed to any “special deal” on customs for the Irish border.
BUSINESSES NEED TO RECOGNISE THERE MAY BE “NO DEAL” AFTER 29 MARCH
I have taken part in trade negotiations, and negotiated major contracts around the world. So I entirely understand why Brexit secretary David Davis has insisted:
“The best option is leaving with a good deal but you’ve got to be able to walk away from the table.”
Similarly, International Trade Secretary Liam Fox is right to warn that:
“The prime minister has always said no deal is better than a bad deal. It is essential as we enter the next phase of the negotiations that the EU understands that and believes it… I think our negotiating partners would not be wise if they thought our PM was bluffing.”
The issue is simply that many businesses, and particularly SMEs, have so far ignored all these warnings.
According to a poll on the Ready for Brexit website, only a quarter have so far begun to plan for Brexit. Half are thinking about it, and almost a quarter don’t believe it is necessary. This is why we have produced our easy-to-use Brexlist checklist, highlighting key areas for focus.
“NOTHING IS AGREED UNTIL EVERYTHING IS AGREED”
As the UK and EU negotiators have said many times over the past 2 years, “nothing is agreed until everything is agreed“. These 7 words should be written above every business’s boardroom table:
- They remind us that it may prove impossible to agree a Withdrawal Agreement between the UK and EU27
- And without a Withdrawal Agreement, there will be no Transition Agreement
Instead, the UK would then simply leave the EU in 278 days time on World Trade Organisation terms.
If you don’t know what WTO terms would mean for your business, you might want to visit Ready for Brexit and begin to use its Brexlist checklist *.
* Ready for Brexit offers users a free one-month trial including access to the Brexlist. After this there is an annual fee of £195 to access the platform. Discounts are available for companies who want to help SMEs in their supply chains to prepare for Brexit, and for trade associations who would like to offer the service to their members.
The post Airbus warns of “dawning reality” there may be no Brexit deal appeared first on Chemicals & The Economy.
Its been a long time since oil market supply/demand was based on physical barrels rather than financial flows:
First there was the subprime period, when the Fed artificially boosted demand and caused Brent to hit $147/bbl
Then there was QE, where central banks gave free cash to commodity hedge funds and led Brent to hit $127/bbl
In 2015, as the chart highlights for WTI, the funds tried again to push prices higher, but could only hit $63/bbl
Then, this year, the funds lined up to support the OPEC/Russia quota deal which took prices to $55/bbl
As the Wall Street Journal reported:
“Dozens of hedge-fund managers and oil traders attended a series of closed-door meetings in recent months with OPEC leaders—the first of their kind, according to Ed Morse, Citigroup Inc.’s global head of commodities research, who helped organize some of the events.”
These developments destroyed the market’s key role of price discovery:
Price discovery is the process by which buyer and seller agree a price at which one will sell and the other will buy
But subprime/QE encouraged this basic truth to be forgotten, as commodities became a new asset class
Investment banks saw the opportunity to sell new and highly profitable services to sleepy pension funds
They ignored the obvious truth that oil, or copper or any other commodity are worthless on their own
There was never any logic for commodities to become a separate new asset class. A share in a company has some value even if the management are useless and their products don’t work properly. Similarly bonds pay interest at regular intervals. But oil does nothing except sit in a tank, unless someone turns it into a product.
The impact of all this paper trading was enormous. Last year, for example, it averaged a record 1.1 million contracts/ day just in WTI futures on the CME. Total paper trading in WTI/Brent was more than 10x actual physical production. Inevitably, this massive buying power kept prices high, even though the last time that supplies were really at risk was in 2008, when there was a threat of war with Iran.
Finally, however, the commodity funds are now leaving. Even Andy Hall, the trader known as “God” for his ability to control the futures market, is winding up his flagship hedge fund as he:
“Complained that it was nearly impossible to trade oil based on fundamental trends in supply and demand, which are now too uncertain.”
Hall seemed unaware that his statement exactly described the role of price discovery. Markets are not there to provide guaranteed profits for commodity funds. Their role via price discovery is to help buyers and sellers balance physical supply and demand, and make the right decisions on capital spend. By artificially pushing prices higher, the funds have effectively led to $bns of unnecessary new capital investment taking place.
NOW MARKETS WILL HAVE TO PICK UP THE PIECES
The problem today is that markets – which means suppliers and consumers – will now have to pick up the pieces as the funds depart. And it seems likely to be a difficult period, given the length of time in which financial players have ruled, and the distortions they have created.
Major changes are already underway in the physical market, with worries over air quality and climate change leading France, the UK, India and now China to announce plans to ban sales of fossil-fuelled cars. Transport is the biggest single source of demand for oil, and so it is clear we are now close to reaching “peak gasoline/diesel demand“.
OPEC obviously stands to be a major loser. Over the past year, the young and inexperienced Saudi Crown Prince Mohammed bin Salman chose to link up with the funds. His aim was keep prices artificially high via an output quota deal between OPEC and Russia. But history confirms that such pacts have never worked. This time is no different as the second chart from the International Energy Agency shows, with OPEC compliance already down to 75%.
Consumers will also pay, as they have to pick up the bill for the investments made when people imagined oil prices would always be $100/bbl. And consumers, along with OPEC populations, will also end up suffering if the shock of lower oil prices creates further geopolitical turmoil in the Middle East.
As always, “events” will also play their part. As anyone involved with oil markets knows, there seems to be an unwritten rule that says:
If the market is short of product, producing plants will suddenly have force majeures and stop supplying
If the market has surplus product, demand will suddenly reduce for some equally unexpected reason
The rule certainly seems to be working today, as the catastrophe of Hurricanes Harvey, Irma and Jose creates devastation across the Caribbean and the southern USA.
Not only is this reducing short-term demand for oil, but it will also turbo-charge the move towards renewables. Mllions of Americans are now going to want to see fossil fuel use reduced, as worries about the impact of climate change grow.
Interviewed for this Reuters article, I suggest today’s low levels of market volatility could be “the calm before the storm”
Saikat Chatterjee and Vikram Subhedar, AUGUST 11, 2017 / 5:06 PM
LONDON (Reuters) – After this week’s war of words between the United States and North Korea triggered the biggest fall in global stocks since the U.S. presidential election, investors are wondering what other off-radar shocks may be waiting to rock world markets.
Although there is little sign so far that investors are protecting themselves against a major sell-off, some say the current environment masks latent risks.
“Every day, our risk models tell us to take more risk because of falling volatility but with markets being where they are, we have to be very careful in not following them blindly,” said James Kwok, head of currency management at Amundi in London. ”So we try to project scenarios on what can go wrong and where are markets not looking.”
Such has been the extraordinary period of stability in financial markets in recent years that world stocks have hit a series of record highs while gauges of broad market volatility have plunged to record lows. That benign investment environment has been fostered by central banks which have pumped vast sums of cash into economies since the global financial crisis that began a decade ago, lifting asset prices globally.
Flows into most asset classes have already overtaken peaks reached before the financial crisis. For example, inflows into active and passive equity funds have nearly doubled to $10.9 trillion at the end of June 2017 from a September 2007 peak, according to Thomson Reuters Lipper data. Inflows into bonds have meanwhile increased nearly three-fold to $4.1 trillion in that period.
Broad market gauges of risk, such as the CBOE Volatility Index .VIX, better known as the VIX, and its bond market counterpart, the Merrill Lynch Option volatility index .VOL remain pinned near record lows despite a spike this week. But analysts say low market volatility masks the heavy weight of options written on these gauges by investment banks betting that the calm conditions will persist for a long time.
That has been accompanied by the growing popularity of inverse-volatility ETF products, which have doubled in value this year as market volatility has cratered. Morgan Stanley strategists say the volume of bets on volatility remaining low means even a small increase in price swings could force some of these leveraged bets to unwind, triggering shock waves in the financial system and sending stock markets tumbling.
Daily percentage changes are important in the volatility world because a lot of these exchange-listed products and notes are rebalanced daily based on these changes, so that any large change would automatically trigger selling pressure elsewhere.
“This is why lower volatility creates higher risk,” said Christopher Metli, a Morgan Stanley quantitative derivatives strategist in a recent note. He estimates that a 12 point rise in the VIX could send the S&P 500 index down by 3.5 percent. A move of that magnitude was last seen after Britain’s shock Brexit vote in June 2016.
But a spike in volatility is not the only scenario worrying investors.
Other risks markets may be ignoring include the implications of a messy British exit from the European Union and the risks that the Qatar crisis could spiral out of control in the Middle East and hit oil prices. Even the prospect of a newcomer at top of the U.S. Federal Reserve when Janet Yellen steps down in 2018 could prove unnerving.
“Today’s low volatility is the calm before the storm and doesn’t reflect the real world in which companies are operating, or the major uncertainties that are developing,” said Paul Hodges, chairman at International eChem, a consultancy.
Another variable is the expectation that central banks will soon start unwinding their massive post-crisis stimulus measures, with unpredictable results. One of the biggest risks seen lurking is the rise and growing influence on the world’s stock markets of passive funds, which aim to track rather than beat benchmarks and charge lower fees than their more actively-managed peers.
The proportion of stocks on the main U.S. benchmark equity index that are now owned by such passive investors has nearly doubled since the 2008 crisis to 37 percent. But redemption pressures on large passive investors could exacerbate any market selloff.
Apple Inc (AAPL.O), a stock market darling, has a fifth of its outstanding stock held by index funds with Vanguard, BlackRock and State Street making up the top three holders, according to latest Thomson Reuters data. The head of sales of a large British-based bond fund said some of its clients are trying to put together pools of money with which to snap up beaten-down stocks if a large emerging market-focused ETF is faced with sudden redemption pressures.
“We get a lot of queries on what are some of the risks that markets may be overlooking, and that is what keeps us up at night,” he said.
Reporting by Saikat Chatterjee and Vikram Subhedar, Graphic by Saikat Chatterjee and Ritvik Carvalho; Editing by Catherine Evans
40 years ago, the vast majority of the British people were in favour of joining the European Economic Community. 67% voted in favour, in the 1975 referendum to confirm the UK’s entry. Virtually all mainstream politicians were in support, with only the left-wing of the Labour Party strongly anti on the grounds that it was a “capitalist club”.
As the photo shows, the Conservative Party was overwhelmingly in favour of entry, with Margaret Thatcher campaigning strongly for a Yes vote. Later, as prime minister, she welcomed the 10th anniversary of membership:
“The unity of Europe is a goal for which I pledge my government to work”
Today, of course, that bedrock of support has disappeared, if the opinion polls are right. Why has this happened?
- One argument is that Europe changed direction, and began to focus on social reform rather than wealth creation
- A second is that many Conservatives never got over the trauma of being forced out of the European Exchange Rate Mechanism by George Soros in 1992
- A third is that the UK doesn’t admire the economic performance of the eurozone, in the way that it used to admire Germany’s economic achievements
All these arguments have some truth in them, but they miss the critical point. As the Nobel jury noted when awarding their Peace Prize to the EU in 2012:
“The dreadful suffering in World War II demonstrated the need for a new Europe. Over a seventy-year period, Germany and France had fought three wars. Today war between Germany and France is unthinkable. This shows how, through well-aimed efforts and by building up mutual confidence, historical enemies can become close partners.”
In 1975, everyone in the UK knew about the dreadful suffering in World War II. The older generation had endured years of nightly bombing raids, even if they weren’t actually fighting for the lives. And the younger generation could still see evidence of destruction all around them, as bombsites were a prominent feature in the major UK cities.
Families also retained powerful memories of the horrors of World War I and its aftermath:
- Millions of people had died in the trenches between 1914-1918, and countless others had been maimed for life
- Tens of millions died in the inter-War years, as political instability led to the rise of the dictators, Hitler and Stalin
- This political failure also led to economic failure and the immense hardship suffered in the 1930s Depression
Today, of course, all of this history has largely been forgotten.
The facts also show that the UK today has a vastly improved standard of living compared to 40 years ago:
- Young people’s earnings today are twice what they were in 1975, when adjusted for inflation
- The basic rate of tax has fallen from 35% to 20% today and the top rate has fallen from 83% to 45%
- Millions of people every year now routinely travel across Europe for business or holiday
- Nobody now has to go to their local post office with their passport, in order to claim their allocation of £50 travel money – which only ended in 1979, when capital controls were finally abolished
Was this all due to the European project? Could the UK have done better outside Europe? Who knows? Life is not a spreadsheet, where we can go back and decide to do a different “what if?” calculation. But clearly, the UK has done well since it joined the EU.
The UK referendum is not about immigration, or whether Brussels should decide the shape of the UK’s sausages, or any of the other populist issues being raised by the Leave campaign. It is about one over-riding issue – namely the best way to preserve peace and prosperity in the UK and across Europe.
The great statesman Winston Churchill wisely remarked that “democracy is the worst form of government, except for all the others.” We can all argue about aspects of the EU today, but in terms of safeguarding peace and prosperity, all the other alternatives would be worse, and probably far worse.