The End of “Business as Usual”

In my interview for Real Vision earlier this month, (where the world’s most successful investors share their thoughts on the markets and the biggest investment themes), I look at what data from the global chemical industry is telling us about the outlook for the global economy and suggest it could be set for a downturn.

“We look at the world and the world economy through the lens of the chemical industry. Why do we do that? Because the chemical industry is the third largest industry in the world after energy and agriculture. It gets into every corner of the world. Everything in the room which you’ll be watching this interview is going to have chemicals in it. And the great thing is, we have very good, almost real time data on what’s happening.

“Our friends at the American Chemistry Council have data going back on production and capacity utilization since 1987. So 30 years of data, and we get that within 6 to 8 weeks of the end of the month. So whereas, if you look at IMF data, you’re just looking at history, we’re looking at this is what’s actually going on as of today.

“We look, obviously, upstream, as we would call it, at the oil and feedstocks markets, so we understand what’s happening in that area. But we also– because the chemical industry is in the middle of the value chain, you have to be like Janus. You have to look up and down at the same time, otherwise one of these big boys catches you out.

“And so we look downstream. And we particularly look at autos, at housing, and electronics, because those are the big three applications. And of course, they’re pretty big for investors as well. So we see the relative balance between what’s happening upstream, what’s  happening downstream, where is demand going, and then we see what’s happening in the middle of that chain, because that’s where we’re getting our data from.

“As the chart shows, our data matches pretty well to IMF data. It shows changes in capacity utilization, which is our core measurement. If if you go back and plot that against history from the IMF, there is very, very good correlation. So what we’re seeing at the moment– and really, we’ve been seeing this since we did the last interview in November— is a pretty continuous downturn.

“One would have hoped, when we talked in November, we were talking about the idea that things have definitely cooled off. Some of that was partly due to the oil price coming down. Some of that was due to end of year destocking. Some of that was due to worries about trade policy. Lots of different things, but you would normally expect the first quarter to be fairly strong.

“The reason for this is that the first quarter– this year, particularly– was completely free of holidays.  Easter was late, so there was nothing to interrupt you there. There was the usual Lunar New Year in China, but that always happens, so there’s nothing unusual about that.

And normally what happens is, that in the beginning of the new year, people restock. They’ve got their stock down in December for year end purposes, year end tax purposes, now they restock again. And of course, they build stock because the construction season is coming along in the spring and people tend to buy more cars in that period, and electronics, and so on.

“So everything in the first quarter was very positive. And one wouldn’t normally be surprised to start seeing stock outs in the industry, particularly after a quiet period in the fourth quarter. And unfortunately, we haven’t seen any of that. We’ve seen– and this is worth thinking about for a moment– we’ve seen a 25% rise in the oil price because of the OPEC Russia deal, but until very recently we haven’t seen the normal stock build that goes along with that.”


As we note in this month’s pH Report, however, this picture is now finally changing as concern mounts over oil market developments – where unplanned outages in Venezuela and elsewhere are adding to the existing cutbacks by the OPEC+ countries. Apparent demand is therefore now increasing as buyers build precautionary inventory against the risk of supply disruption and the accompanying threat of higher prices.

In turn, this is helping to support a return of the divergence between developments in the real economy and financial markets, as the rise in apparent demand can easily be mistaken for real demand. The divergence is also being supported by commentary from western central banks.  This month’s IMF meeting finally confirmed the slowdown that has been flagged by the chemical industry since October, but also claimed that easier central bank policies were already removing the threat of a recession.

We naturally want to hope that the IMF is right. But history instead suggests that periods of inventory-build are quickly reversed once oil market concerns abate.

Please click here if you would like to see the full interview.

Chemical industry flags rising risk of global recession in 2017, with Trump set to “clear the decks” at the start of his first term

ACC Dec16The chemical industry is the best leading indicator that we have for the global economy.  It has an excellent correlation with IMF data, and also benefits from the fact it has no “political bias”.  It simply tells us what is happening in real-time in the world’s 3rd largest industry.

Sadly, the news is not good.

As the chart shows, based on the latest American Chemistry Council data, Capacity Utilisation (CU%) fell to just 78.4% in October.  This is only just above the lowest reading ever seen, of 77% at the bottom of the sub-prime crisis in March 2009. The pattern is also worryingly familiar:

  Then the CU% peaked in May 2007 at 95.1%, before declining to 88% by October 2008, and collapsing to 77%
  This time, the CU% peaked at 80.7% in December 2015 and has been falling ever since, month by month
  Given that the industry is normally around 8 – 12 months ahead of the wider economy, due to its early position in the supply chain, this means it is highly likely that the global economy will move into recession during 2017

Of course, nobody ever wants to forecast recession.  And there are always plenty of reasons why something might be “different this time”.  But it would certainly seem prudent for companies and investors to develop a Recession Scenario for their business for 2017. given the track record of the CU% indicator.

Indeed, there are a number of reasons to suggest that any recession might be severe.  Bill White, the only central banker to warn of the subprime crisis, warned in January that “the world faces wave of epic debt defaults“, and then added in September that:

The global situation we face today is arguably more fraught with danger than was the case when the crisis first began. By encouraging still more credit and debt expansion, monetary policy has ‘‘dug the hole deeper.’’…In practice, ultraeasy policy has not stimulated aggregate demand to the degree expected but has had other unexpected consequences.  Not least, it poses a threat to financial stability and to potential growth going forward….the fundamental problem is not inadequate liquidity but excessive debt and possible insolvencies. The policy stakes are now very high.”

  When White spoke, the implications of the UK’s Brexit vote were still only just beginning to be recognised
  Since then, US President-elect Donald Trump has announced his 100-Day Plan to reshape America’s world role
  Major uncertainty is building in Europe with Italy’s referendum plus Dutch, French and German elections
  India’s economy is weakening as the currency reforms have taken 86% of its cash out of circulation
  Plus, there are ever-present risks from China’s housing bubble, and the potential for a trade war with the USA

Of course, many of the same people who said that Brexit would never happen, and that Trump would never win, are now lining up to tell us everything will still be the same in the end.  But they should really have very little credibility.

What many investors also seem to be forgetting is that Trump has been a long-time CEO.  And new CEOs normally write-off everything in their first year of office.  This gives them the double bonus of being able to (a) blame the previous CEO and (b) then take credit for any improvement.

As Trump would no doubt like a second term of office from 2021, he has every incentive to “clear the decks” in 2017.


Chemical production continues to slow across most regions

ACC data Sept14Chemical production is currently the best leading indicator for the wider economy, as financial markets have lost their power of price discovery due to the impact of central bank stimulus.

The above chart, based as always on the excellent American Chemistry Council (ACC) data, continues to flash the orange warning signal first seen last month.  The key issue then was the very worrying slide in operating rates during the seasonally strong Q2.  As the ACC had noted then, ”growth stalled in Q2“.

Today, it seems the weak performance is continuing with production slowing almost everywhere:

  • Global growth peaked at 5% in April, but has since fallen to just 3.3% (black line)
  • N America improved in August, but as the ACC comment, ”even with a competitive edge and some-what stronger recovery, production has been limited by weakness elsewhere in the globe (green)
  • Latin America has fallen very sharply, down from 1.2% growth in March to a 3.9% fall in August (red)
  • W Europe has fallen from 4% growth in May to 2.9% in August (light blue)
  • Central/Eastern Europe has collapsed from 2.4% growth in February to a 3% fall in August (orange)
  • Middle East/Africa has slowed from 8.4% growth in February to 6.7% in August (dark blue)
  • Asia has slowed sharply from 8.3% growth in March to 5.6% in August (purple)

Some individual countries have also seen very sharp falls.  Germany, for example, has gone from 4.8% growth in February to a fall of 3.5% in August.  India has crashed from 12.9% growth in January to 3.4% in August.  Japan has fallen from 9.2% growth in March to just 0.8% in August.  Mexico has gone from 1% growth in April to a 2.8% fall in August.  Russia has gone from 4.2% growth in January to a fall of 10.4% in August.

Only one major country has maintained a relatively strong growth level – China.  It peaked at 11.1% in April, and saw 8.8% growth in August.  But, of course, this stability is due to its shift to become an exporter, rather than importer, following the loss of its downstream markets in the West.  This confirms the blog’s conclusion yesterday when discussing Sinopec’s financial performance.

China is now well on the way to becoming a major exporter of many key petrochemicals.  And it will continue to reduce its import needs from Asia and other regions as fast as possible.”

The sharp global slowdown now underway confirms that companies and investors have been the victims of a collective delusion in recent years.  We accepted the assurances of the central banks that they could easily restore growth to previous Boomer-led levels, despite the ageing of the global BabyBoomer population.

But central banks can only print money, they can’t create babies.  And only babies, when they grow up, can create sustained demand growth.

Chemical production data doesn’t lie.  It makes clear that we are instead heading for an abrupt change of economic course as we enter the New Normal.


Slide in Q2 operating rates is bad omen for H2 economic outlook

ACC OR Jul14The chemical industry is the best leading indicator for the global economy.  The slide in operating rates (OR%) around the world during the seasonally strong Q2 period. is a clear warning that global economic growth may be stalling.

This should be a major wake-up call for anyone still hoping that growth may recover to the Boomer-led SuperCycle level.  The latest update from the American Chemistry Council’s excellent weekly report makes sober reading:

  • The global OR% was just 83.4% in June, down from 83.7% in June 2013
  • This was well below the 92% long-term average between 1987-2013
  • It was also well below the minimum 88% level seen in the SuperCycle

The chart also confirms last month’s comment from Dow CEO, Andrew Liveris, that “for a couple of years after 2008, we had a head-fake that the growth might have returned, but it didn’t”.  OR% temporarily jumped to around 87%, but then fell back again – despite massive continued stimulus by governments and central banks.

The ACC report also highlights that “growth stalled in Q2“.  Yet it should be the seasonally strongest quarter of the year:

  • Global growth rates fell from 4.8% in March to 3.5% in June
  • In the US, the ACC report that “production of basic chemicals fell” in June, despite the shale gas cost advantage
  • Latin America collapsed from 1.4% growth in March to a fall of 2.9% in June
  • W European growth halved from 3% in March to 1.4% in June, with Germany falling from 4.3% to a negative 0.9%
  • Central/Eastern Europe fell from 1.6% in March to a negative 0.1% in June, with Russia falling to a negative 2.9%
  • Asia-Pacific fell from 8.3% in March to 6.8% in June, with India collapsing from 6.5% to a negative 0.4%

Outside the chemical industry, the data also points in the same direction:

  • US GDP growth has been just 2.3% over the past 2.5 years, after inventory build is discounted
  • This is less than 1% per year, despite $10tn of stimulus
  • China’s steel demand grew just 0.4% in H1 this year, according to the official steel association.  Rail freight actually fell 1.4% in June versus June 2013
  • This confirms, if confirmation was needed, that China’s reported GDP growth of 7.5% was pure fiction
  • As China’s Academy of Social Sciences warns:  “The current situation serves as a reminder of how defective and unsustainable our growth model is. There can be no delay in altering the traditional investment- and export-driven model

The same realisation also seems to be dawning in financial markets, which have only been held aloft by a wave of debt.  Now investors will have to wake up to the fact that most of the debt will never be repaid.

Companies need to recognise that we have all been the victims of a collective delusion, and rapidly change course before it is too late:

  • They need to abandon their ambitious growth strategies and instead prepare for tough times ahead
  • Those in Asia can no longer ignore China’s change of course
  • It is becoming an exporter of many products, rather than an importer,  in order to maintain employment
  • Companies also need to review the $123.5bn of new US shale gas-related projects, as most will prove unprofitable due to lack of demand.

Q3 is the time when budgets and strategies are set for the next few years.  So it is not too late for a change of course.

Otherwise, in 5 years’ time, when all this new capacity is online, new managements will scratch their heads and wonder how the industry maintained the collective delusion for so long.  But by then, the money will have been spent.


The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
Brent crude oil, down 3%
US$: yen, down 2%
Naphtha Europe, down 2%.  “Cheap propane stocks are eating away naphtha’s market share in the petrochemical sector”
PTA China, up 1%. Producers offered cost-linked formula to stem losses, but buyers face difficulties in passing down the additional costs to their customers”
Benzene, Europe, up 5%. “Prices reversed course amid limited downstream appetite for further increases in August, which is traditionally a slow month because of summer shutdowns and the holiday period across Europe”
S&P 500 stock market index, up 5%
HDPE US export, up 7%. “Some higher trades were heard, and material remained in tight supply”

Recovery has been delayed, again

D'turn 12Oct13

Recovery has been delayed, again.  That is the clear message from the blog’s extensive discussions with key executives in global and regional markets over the past 2 weeks.

In summary as this ICIS video interview suggests, the picture is as follows:

  • Base chemical demand has broadly fallen from peak levels in Q3 
  • Most chemical buyers built inventory in Sept. because they thought Syrian issues would take oil prices higher
  • Wiser counsels prevailed over Syria, however, but buyers have no need to buy further volumes in October
  • November is also likely to be weak as Q3 inventory is worked down
  • December will see the usual low volumes, as everyone looks to de-stock inventory into year-end

Equally, pressure is now building on crude oil markets.  These have long been decoupled from the fundamentals of supply/demand, but the ICIS market reports below suggest a broad decline in demand is now taking place.  The sequence is easy to follow:

  • Chemical demand, the best leading indicator for the global economy, is weak
  • US ethylene prices are at a 15-month low
  • Refinery runs are now reducing, as oil product demand is also weak
  • Refinery margins are also weakening, meaning less demand for crude oil

Critically also, we are in October, normally one of the 4 seasonally strongest months for demand in the year (January, March, May are the others).  Plants should be running at peak rates to complete orders before the holiday season arrives.

None of this will come as a surprise to blog readers.  But it is clearly coming as a major shock to financial markets, who have been convinced that recovery had now become inevitable.  The blog’s own conversations with Wall Street analysts, for example, reveal incredulity that this might be happening.  Most have instead been publishing research notes since May that said the precise opposite.

Of course, policymakers also have an easy excuse for their mistake.  They can and will simply blame the US budget/debt ceiling debate, which has also taken them by complete surprise.  Then they will probably also be totally shocked to find that Germany’s new government, as and when it is formed, is not prepared to hand over large amounts of money to bail out Southern Europe.

The butterflies that the blog described in its August New Statesman article are now flapping their wings very hard.  Please be careful out there.  It is already getting quite scary.

The chart shows latest benchmark price movements since January with ICIS pricing comments below:

Benzene Europe, green, down 19%. ”Q4 was previously expected to see some bullishness, owing to several cracker turnarounds and feedstock limitations, but this has so far not emerged”
PTA China, red, down 12%. “Market players questioned why Asian PTA producers still tried to maintain operations amid negative margins and poor demand”
Naphtha Europe, black, down 3%. “A sharp fall in refining margins was lending support to the idea of further run cuts across NWE refineries, which might result in reduced naphtha supply”
Brent crude oil, blue, down 1%.
HDPE USA export, up 16%. “US prices going to Brazil are not competitive with product from elsewhere….markets elsewhere that would normally received product from the US are sourcing with products from other countries such as South Korea.”
US$: yen, orange, up 12%
S&P 500 stock market index, purple, up 16%

Ageing populations mean decades of slower growth

G7 in 2012.pngThe next few decades will see very much slower economic growth in most countries. This will have critical implications for business strategy, as the blog summarises in a new Research Note. Encouragingly, the Financial Tmes has devoted a column to its argument, focusing on the implications for the UK.

The Research challenges the current consensus view that growth is inevitably constant as long as the policy mix is correct:

• It highlights how the Western BabyBoom led to an extra 33m babies being born between 1946-70, equal to Canada’s current population
• Using US and UK government data, it then shows how this led to a growth SuperCycle as these Boomers came into their peak consumption period between 25-54 years
• However, as the chart shows, since 2001 the Boomers have been moving into the 55+ age group, when household spending starts to fall away quite rapidly
• Essentially, the Boomers no longer need to buy so many new products, but instead require only replacement items, which can be deferred if necessary
• It also makes a link with Japan, where the Governor of the Bank of Japan is very concerned that the world is sleepwalking into the same issues that have impacted its economy over the past 2 decades

Tomorrow, the blog will highlight the key implications of these changes for Company Boards and senior executives.