The UK goes to the polls on 8 June in a surprise General Election. And premier Theresa May has clearly decided to base her campaign on a ”Who governs Britain?” platform, as she highlighted when launching her campaign last week:
“Britain’s negotiating position in Europe has been misrepresented in the continental press, the European Commission’s stance has hardened and threats against Britain have been issued by European politicians and officials. All of these acts have been deliberately timed to affect the result of the general election that will take place on June 8….there are some in Brussels who do not want these talks to succeed. Who do not want Britain to prosper.”
In reality, of course, all that has happened is that Brussels is behaving exactly at Theresa May herself forecast, when campaigning a year ago for the UK to Remain in the EU:
“In a stand-off between Britain and the EU, 44% of our exports is more important to us than 8% of the EU’s exports is to them….The reality is that we do not know on what terms we would win access to the single market…It is not clear why other EU member states would give Britain a better deal than they themselves enjoy. ”
May’s rhetoric will no doubt give her a large majority, given the weakness of the Labour opposition. She has also promised to be “a bloody difficult woman” during the Brexit negotiations that follow the election. But what is good for an election win, may not be such good news for London house prices. These are at all-time record levels in terms of the critical price/earnings ratio, and were already heading into an inevitable downturn as the City AM chart shows:
Massive over-building at the top end of the market means there are now 59k high-end apartments under construction in London, yet annual sales of new-build flats are just 6k
Sales have also been hit by the hike in purchase tax (stamp duty) to 10% above £925k ($1.2m) and 12% on purchases over £1.5m
The UK’s 2 million ‘buy-to-let’ landlords, most of whom are in London, have also been hit by a combination of a higher tax take on their income and tighter borrowing criteria for mortgages
China’s capital controls means its buyers have had to pull back, as it becomes more difficult to move money overseas. They have been the largest buyers of residential property in central London
Now this downturn could well become a perfect storm, as May’s “battle with Brussels” risks an exodus of highly-paid finance and other professionals from London. As the BBC reports: “More than one million people work in the financial services sector in the UK and it pays over £70bn a year in taxes to the government, 11.5% of all receipts.”
FINANCIAL SERVICES ARE PREPARING TO LEAVE LONDON
The CEOs of the world’s 2 largest investment banks have already warned of difficult times ahead.
JP Morgan CEO, Jamie Dimon, has warned: “The clustering of financials in London is hugely efficient for all of Europe. Now you’re going to have a declustering which creates huge duplicate costs which is expensive to clients, but we have no choice.”
Goldman Sachs CEO, Lloyd Blankfein, has highlighted the risks caused by uncertainty over the terms of the UK’s exit: ”Without knowing how things will turn out we have to plan for a number of contingencies,” Mr Blankfein said about possible job losses. “If there is no period of time to implement whatever changes are brought about in a negotiation, we may have to do things prematurely and we may have to do a range of things as a precaution and take steps.”
Unsurprisingly, buyers are starting to sit on their hands and waiting to see what happens, as The Guardian reports:
“London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a “burnt-out core.”
How much will prices fall, and how long will it take for prices to bottom? These are now set to become the key questions at London dinner-parties. Logic suggests prices will need to fall at least 50% to bring them back to more affordable levels. And the pain is likely to stretch out over years, as leading buying agent, Henry Pryor, has warned:
“In my 28 years in the property business, we have done this twice before, and each time it takes around five to seven years before things recover.”
We must all hope that May will use her potential landslide election win to quickly reverse her recent rhetoric, and return to the common sense positions she staked out before the Referendum. It is not too late for her to agree to remain in the Single Market, the Customs Union and accept the jurisdiction of the European Court of Justice.
Without such a move, London home owners will face a perfect storm as the financial services industry “de-clusters” to Frankfurt, Paris, Brussels, Dublin and Amsterdam next year.
Greed and fear are the primary emotions driving China’s housing and auto markets today, as China’s lending bubble hits new heights. For ordinary citizens, greed is the key driver:
Average home prices in Beijing rose an eye-popping 63% between October 2015 – February 2017
In Shanghai, one enterprising estate agent (realtor) has married 4 of his clients to enable them to buy a home
Mr Wang’s story highlights the bubble mentality that has taken over the market. As the Daily Telegraph reports, 30-year old Mr Wang:
“Married, and then quickly divorced 4 women to allow them to circumvent strict property laws which seek to cool prices in China’s booming cities, and pocketed more than £8000 ($10k) from each transaction. Once the paperwork is put through, Wang applies for a divorce and puts himself on the market again”.
This is just the latest phase of a market craze, as I noted in November, when one Shenzhen resident told the South China Morning Post:
“The only thing I know is that buying property will not turn out to be a loss. From several thousand yuan a square metre to more than 100,000 yuan. Did it ever fall? Nope.” He and his wife got divorced in February, in order to buy a 4th apartment in Shanghai for 3.6m yuan (US$530k) on the basis that “ If we don’t buy this apartment, we’ll miss the chance to get rich.”
A collective delusion has swept China’s Tier 1 cities, just as happened in the USA during the sub-prime bubble. Amazingly, China’s property bubble is even larger than sub-prime. Unremarkable pieces of land in Shanghai are now being sold at $2000/sq foot ($21500/sq metre), nearly 3 times the average land price in Manhattan, New York.
It is understandable in some ways, as Chinese buyers have never known a downturn, as I noted in September:
“It is also easy to forget that housing was all state-owned until 1998, and still is in most rural areas. Urban housing was built and allocated by the state – and there wasn’t even a word for “mortgage” in the Chinese language. Not only have home-buyers never lived through a major house price collapse, they have also had few other places to invest their money”.
The scale is also much larger, as UBS have reported:
“Chinese banks’ outstanding loans extended to the property industry were between Rmb 54tn – Rmb 72 tn in 2016 ($7.8tn – $10.4tn).”
The chart above confirms this analysis. In reality, the key driver for the bubble has been the growth in lending. As with the US subprime bubble, this has not only impacted housing markets, but also auto sales:
Q1 lending (Total Social Financing) averaged Rmb 2.4tn/month, 2.2x the Rmb 700bn/month level in Q1 2008
Q1 auto sales averaged 1.9 million, 2.06x the 733k/month average in Q1 2008
China’s GDP was only $11.2tn last year, meaning that its property sector loans are more than 2/3rds of GDP.
The problem is that everyone loves a bubble while it lasts. And so, as in the US during subprime, most analysts are keen to argue that “everything is fine, nothing to worry about here”.
In the US, we were told at the peak of the bubble in 2005 by then Federal Reserve Chairman, Alan Greenspan, that house prices would never fall on a national basis
Today, similar wishful thinking dominates, based on the myth that China has suddenly developed a vast middle class, with Western levels of incomes
The problem, of course, as the second chart shows, is that this is also not true. Annual disposable income for city-dwellers averaged just $5061 last year, whilst in rural areas it averaged only $1861. You really don’t buy many homes or cars with that level of income, unless a massive lending bubble is underway.
And this is why fear is the right emotion for everyone outside China. Its lending bubble has driven the “recovery” in global growth since 2009 – pushing up values of everything from homes to oil prices. So anyone who remembers the end of the US subprime bubble should be very scared about what could happen when – not if – China’s bubble bursts.
We can all hope that President Xi’s new policies will enable a “soft landing” to occur, and gently unwind the stimulus policies put in place by Populist Premier Li and his predecessor Premier Wen? But hope is not a strategy. And as the Guardian reported last month:
“Goldman Sachs is said to estimate the chance of a financial crisis in China this year at 25%, and in 2018 at 50%.”
It is 15 years since Goldman Sachs coined the word BRIC to highlight their argument that growth in the global economy would, in future, be led by the major emerging economies rather than the developed world. The core concept was that China and India would become the dominant suppliers of manufactured goods and services, whilst Brazil and Russia would become dominant suppliers of raw materials.
The idea was, of course, mainly a marketing venture for Goldman, who hoped to use it to stimulate investment activity at a time when many were in a state of shock after the 9/11 tragedy. And their timing was excellent, as the Note was published just before China joined the World Trade Organisation in December 2001:
China’s declared aim of becoming”the manufacturing capital of the world” provided good collateral for their argument
India’s 2002 launch of its “Incredible India” marketing campaign was equally supportive
With this support, the idea of Brazil and Russia moving closer to developed country status, via increasing their role as commodity suppliers, did not seem so far-fetched
The other great virtue of the BRIC concept, as a marketing venture, was that it was impossible to disprove the theory. Anyone who argued that these countries were too poor to really replace the G7′s economic leadership were simply told they “didn’t understand” or were “stuck in the past”. But 15 years is long enough to test the strength of the analysis, particularly in a key area such as autos. The chart above, showing January – August auto sales in the 4 countries since 2006, enables us to focus on some of the key issues:
China has been a qualified success. Its auto sales have risen more than four-fold from 3.2m in 2006 to 14.4m today. But it seems unlikely that this growth will continue in the future, as used cars are now set to become the main growth driver. This market has only developed recently, as auto quality was very poor before Western manufacturing techniques were introduced from 2009 onwards. It is also clear that government policy over the past 2 years has shifted to focus on increasing China’s self-sufficiency in auto production. The main tactic has been to halve the purchase tax on small cars (engines up to 1.6l), as these are primarily Chinese made. This tax reduction expires in October, but it has achieved its objective, boosting the market share for Chinese brands cars to 42.5%.
India has been successful on a smaller scale. Its auto sales have more than doubled from 800k in 2006 to 1.9m today, but the market for motor vehicles is still dominated by motorbikes – which have a 2/3rds market share, with cars at just 12%. Ford’s experience highlights the problem, as it has been forced to repurpose its major car manufacturing investment in India away from the domestic market into exports – which now account for 2/3rds of sales. Ford is also now moving away from pure manufacturing to become “an auto and mobility company”, with its investment in Zoomcar highlighting its new focus on becoming a “full service mobility company”
Brazil, unfortunately, has been a major disappointment. Its auto sales had doubled to 2.5m by 2012, but are back at 1.3m this year. 2013 was, of course, a turning point in the Chinese economy with the appointment of President Xi, and the subsequent development of his New Normal policies, which have taken the economy in a new direction. Xi’s policies are not based on China being the “manufacturing capital of the world”. Instead, he is focused on building a more service-driven economy, based on the mobile internet and greater self-sufficiency. As a result, Brazil is now left with an economy that is dangerously exposed to commodities, in a world where over-supply has become endemic.
Russia has also unfortunately proved a disappointment. Its auto sales doubled from 900k in 2006 to 2m in 2009, but then collapsed back to 1m after the financial crisis. China’s stimulus programme then took them to 1.9m. But 2015 saw a major decline to 1.1m, and 2016 has been worse, with sales back at 900k again.
2 key conclusions seem to stand out from this analysis:
The BRIC concept only appeared to work when China was operating as the “manufacturing capital of the world” following WTO entry. And even then, its success was more apparent than real, as Western demand for its production was inflated by the subprime policies pursued in the West – which then led to the 2008 Financial Crisis. China hasnow recognised under President Xi that this policy has reached its sell-by date, as the ageing of the BabyBoomers means that Western demand for manufactured goods has gone ex-growth
Ford’s experience highlights how India’s future is not going to be as a “China lookalike” focused on manufacturing. Instead, it will be more focused on services – not only due to reasons of affordability and sustainability, but also because of the new opportunities opened up by the mobile internet, as Mukesh Ambani has highlighted. The arrival of the smartphone is a paradigm shift, which will completely change demand patterns due to its ability to enable the “sharing economy”, and more localised producttion on demand via 3D printing.
The BRIC example is thus another powerful example of the dangers created by building an unthinking consensus on the basis of clever marketing by a major player. Goldman have done very well out of the BRIC thesis, as have those companies and investors who were agile enough to play the trend for their own benefit.
But others, who let their judgement be swayed by consensus thinking have, like Ford, made some expensive mistakes. Today, after all, it is very clear that Goldman’s core thesis was simply wrong. Emerging economies have not taken over economic leadership from the G7, and and are unlikely to do so in the foreseeable future.
Suddenly, far too late, the world is catching up with reality. Goldman Sachs and others yesterday halved their forecast for Brent oil to $42/bbl from $80/bbl. But this isn’t forecasting, this is simply catching up with events long after they happened. Brent, after all, opened at $45/bbl this morning.
As readers will remember, I forecast back in August that Brent oil prices were about to fall to “at least $70/bbl and probably lower“. I coupled this with a forecast in early September that the US$ was about to see a “strong move upwards“ as the Great Unwinding of stimulus policies began. Then in October, I published my original forecasts in a Research Note, and also highlighted the key issues in the Financial Times.
Then, when the $70/bbl level was reached in early December, I published a new Research Note highlighting the potential for further major falls:
“Astonishingly, most commentators remain in a state of denial about the enormity of the price fall underway. Some, failing to understand the powerful forces now unleashed, even believe prices may quickly recover. Our view is that oil prices are likely to continue falling to $50/bbl and probably lower in H1 2015, in the absence of OPEC cutbacks or other supply disruption. Critically, China’s slowdown under President Xi’s New Normal economic policy means its demand growth will be a fraction of that seen in the past.
“This will create a demand shock equivalent to the supply shock seen in 1973 during the Arab oil boycott. Then the strength of BabyBoomer demand, at a time of weak supply growth, led to a dramatic increase in inflation. By contrast, today’s ageing Boomers mean that demand is weakening at a time when the world faces an energy supply glut. This will effectively reverse the 1973 position and lead to the arrival of a deflationary mindset….
“Asian producers and traders now have large inventories of almost every oil-related product. Buyers have simply stopped buying in recent weeks as prices have collapsed. So the question is whether China’s demand will now increase in January, before markets close for Lunar New Year in mid-February. A lot of money is now riding on this issue.
If these hopes prove false, and the West enjoys a mild winter, there would seem little to stop prices heading back towards historical levels of $25/bbl – $40/bbl. This would be good news long-term, as $25/bbl is an ‘affordable’ price for the global economy, at 2.5% of GDP.
But it would be very bad news for investments based on the two myths that (a) oil will remain at $100/bbl forever and (b) China’s demand will increase exponentially as it becomes middle class. Equally important is that a sustained price fall will mean deflation becomes inevitable in the Eurozone and Japan, irrespective of any further QE initiatives.”
That was published a month ago, not yesterday. Today it is clear there has been no increase in China’s demand ahead of Lunar New Year, and the West is having a mild winter. So the price is now highly likely to return to historical levels of $25 – $40/bbl.
All these experts who have missed the obvious for so long need to look at themselves in the mirror, and ask the simple question, “How did we get this so wrong“? And more importantly, “What are we going to do now, to help those who believed our forecast and now face bankruptcy“?
Equally, Western central banks must now give up on the myth that printing money can somehow create demand and inflation. They are primarily responsible for this looming earthquake by creating the ‘correlation trade’ in the first place. As the chart shows, this caused oil (red line) and stock market prices (blue) to rise exponentially together.
They too need to look in the mirror, and focus urgently on the real task ahead – “How do we position the global economy to survive the deflation shock that is now about to hit?”
When was the last time you told your customers that they would have to wait 570 days for delivery of material for which they have already paid?
You’ve never done this? Well, you need to take lessons from those super-smart people who own the aluminium warehouses, such as Goldman Sachs (pictured above by Reuters). As the blog has noted before, they have created a situation where warehouse stocks now represent enough metal to build 2 years’ supply of cars.
Finally, however, the world’s largest buyer, Novelis, has gone public with its complaints to the Financial Times. They argue that the shortage is “temporary and artificial”, and that the market remains in large surplus with 10m – 15m tonnes of metal stored in warehouses around the world.
They are also upset by a second tactic now common in the market. If you want to obtain prompt material to use today, and you can’t obtain your own material from the warehouse until the end of 2015, you instead have to pay a “prompt premium”. And this isn’t small change. Last week, buyers were paying about $450/t in premium, 26% above the supposed ‘cash price’ at the London Metal Exchange.
Clearly, ‘enough is now enough’ for Novelis. As their chief supply officer, Nick Madden, notes:
“There is more than enough metal to meet the higher consumption levels, but it continues to be held off-market by those who benefit from financing deals and the appreciation in premiums. This increase in costs ultimately does flow down through the supply chain to the end consumer.”
Aluminium is thus another market, like crude oil, where the market is completely failing in its primary role of price discovery. There have been no shortages in either market since 2009 to justify today’s high prices. And the short-sighted greed of those creating these high prices is clearly having major negative effects on those of us who live in the real world:
- Aluminium is used in a wide range of applications, from beverage cans to car bodies
- Its higher prices therefore have to be passed on to consumers
- Equally, caustic soda demand has been artificially inflated by the aluminium stock build-up
- When finally the bubble bursts, chloralkali producers will be the innocent victims as demand disappears
This moment may now be approaching quite quickly. Demand for new cars has begun falling in major markets, as the blog discussed yesterday. And this could well be the trigger for a price collapse, if it continues.
In the meantime, the moral of the aluminium story is clear. As in virtually every area impacted by the Crisis, most regulators and policymakers have let down the people they were supposed to protect.
The blog is awarding itself and fellow-blogger John Richardson a pat on the back this morning. The reason is that investment bank Goldman Sachs, the largest player in commodity markets, has completely reversed its analysis of oil markets. They now accept our view that there is no fundamental reason for oil prices to be at today’s high level.
The blog discussed this issue at length in its January 2011 White Paper, Budgeting for Uncertainty, and has maintained its view ever since. This has sometimes been a lonely position, as Goldman’s voice is very strong in the markets. However, on Thursday, Goldman revealed they had changed their mind:
“The U.S. shale oil boom, which saw the country’s oil production rising to multi-decade highs, caught many industry watchers and specialists by surprise and has dramatically reshaped the global oil flows over the past few years”
By coincidence, the blog has this week published another article on the subject in ICIS Chemical Business, which includes the sentence:
“In oil markets, there have been no major shortages of product on the scale of the 1979 OPEC embargo, or similar, to cause prices to rise. And production has actually been rising. US output, for example, has reversed years of decline, and is now back at 1996 levels. Similarly, inventories in the US and elsewhere have often been at near-record levels.”
The blogs are delighted that that their readers have been forewarned of the real position all along. They cannot change the course of events. But at least, as with the collapse of Bear Stearns, the 2008-9 recession and September 2008 financial collapse, China’s slowdown and other major issues, they can keep readers ahead of the game.