“What could possibly go wrong?”

I well remember the questions a year ago, after I published my annual Budget Outlook, ‘Budgeting for the Great Unknown in 2018 – 2020‘.  Many readers found it difficult to believe that global interest rates could rise significantly, or that China’s economy would slow and that protectionism would rise under the influence of Populist politicians.

MY ANNUAL BUDGET OUTLOOK WILL BE PUBLISHED NEXT WEEK
Next week, I will publish my annual Budget Outlook, covering the 2019-2021 period. The aim, as always, will be to challenge conventional wisdom when this seems to be heading in the wrong direction.

Before publishing the new Outlook each year, I always like to review my previous forecast. Past performance may not be a perfect guide to the future, but it is the best we have:

The 2007 Outlook ‘Budgeting for a Downturn‘, and 2008′s ‘Budgeting for Survival’ meant I was one of the few to forecast the 2008 Crisis.  2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year, as demand grows in line with a recovery in global GDP“.  Please click here if you would like to download a free copy of all the Budget Outlooks.

THE 2017 OUTLOOK WARNED OF 4 KEY RISKS
My argument last year was essentially that confidence had given way to complacency, and in some cases to arrogance, when it came to planning for the future.  “What could possibly go wrong?” seemed to be the prevailing mantra.  I therefore suggested that, on the contrary, we were moving into a Great Unknown and highlighted 4 key risks:

  • Rising interest rates would start to spark a debt crisis
  • China would slow as President Xi moved to tackle the lending bubble
  • Protectionism was on the rise around the world
  • Populist appeal was increasing as people lost faith in the elites

A year later, these are now well on the way to becoming consensus views.

  • Debt crises have erupted around the world in G20 countries such as Turkey and Argentina, and are “bubbling under” in a large number of other major economies such as China, Italy, Japan, UK and USA.  Nobody knows how all the debt created over the past 10 years can be repaid.  But the IMF reported earlier this year that total world debt has now reached $164tn – more than twice the size of global GDP
  • China’s economy in Q3 saw its slowest level of GDP growth since Q1 2009 with shadow bank lending down by $557bn in the year to September versus 2017.  Within China, the property bubble has begun to burst, with new home loans in Shanghai down 77% in H1.  And this was before the trade war has really begun, so further slowdown seems inevitable
  • Protectionism is on the rise in countries such as the USA, where it would would have seemed impossible only a few years ago.  Nobody even mentions the Doha trade round any more, and President Trump’s trade deal with Canada and Mexico specifically targets so-called ‘non-market economies’ such as China, with the threat of losing access to US markets if they do deals with China
  • Brexit is worth a separate heading, as it marks the area where consensus thinking has reversed most dramatically over the past year, just as I had forecast in the Outlook:

“At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.

“Today’s Populist politicians don’t seem to care about these risks. For them, the allure of arguing for “no deal”, if they can’t get exactly what they want, is very powerful. So it would seem sensible for executives to spend time understanding exactly how their business might be impacted if today’s global supply chains came to an end.”

  • Populism is starting to dominate the agenda in an increasing number of countries.  A year ago, many assumed that “wiser heads” would restrain President Trump’s Populist agenda, but instead he has surrounded himself with like-minded advisers; Italy now has a Populist government; Germany’s Alternativ für Deutschland made major gains in last year’s election, and in Bavaria last week.

The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better.  As a result, voters start to listen to Populists, who offer seemingly simple solutions to the problems which have been ignored by the elites.

Next week, I will look at what may happen in the 2019 – 2021 period, as we enter the endgame for the policy failures of the past decade.

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Boomer SuperCycle unique in human history – Deutsche Bank

“The 1950-2000 period is like no other in human or financial history in terms of population growth, economic growth, inflation or asset prices.”

This quote isn’t from ‘Boom, Gloom and the New Normal: How Western BabyBoomers are Changing Demand Patterns, Again‘, the very popular ebook that John Richardson and I published in 2011.  Nor is the chart from one of the hundreds of presentations that we have since been privileged to give at industry and company events around the world.

It’s from the highly-respected Jim Reid and his team at Deutsche Bank in their latest in-depth Long-Term Asset Return Study, ‘The History (and future) of inflation’.  As MoneyWeek editor, John Stepek, reports in an excellent summary:

The only economic environment that almost all of us alive today have ever known, is a whopping great historical outlier….inflation has positively exploded during all of our lifetimes. And not just general price inflation – asset prices have surged too.  What is this down to? Reid and his team conclude that at its root, this is down to rampant population growth.” (my emphasis)

As Stepek reports, the world’s population growth since 1950’s has been far more than phenomenal:

“From 5000BC, it took the global population 2,000 years to double; it took another 2,000 years for it to double again. There weren’t that many of us, and lots of us died very young, so it took a long time for the population to expand.  Fast forward another few centuries, though, and it’s a different story.

“As a result of the Industrial Revolution, lifespans and survival rates improved – the population doubled again in the period between 1760-1900, for example. That’s just 140 years.  Yet that pales compared to the growth we’ve seen in the 20th century. Between 1950-2000,  a mere 50 years, the population more than doubled from 2.5bn to 6.1bn.”

Actually, it was almost certainly Jenner’s discovery of smallpox vaccination that led to the Industrial Revolution, as discussed here in detail in February 2015, Rising life expectancy enabled Industrial Revolution to occur’:

“Vaccination against smallpox was almost certainly the critical factor in enabling the Industrial Revolution to take place. It created a virtuous circle, which is still with us today:

  • Increased life expectancy meant adults could learn from experience instead of dying at an early age
  • Even more importantly, they could pass on this experience to their children via education
  • Thus children stopped being seen as ’little adults’ whose role was to work as soon as they could walk
  • By 1900, the concept of ‘childhood’ was becoming widely accepted for the first time in history*

The last point is especially striking, as US sociologist Viviana Zelizer has shown in Pricing the Priceless Child: The Changing Social Value of Children. We take the concept of childhood for granted today, but even a century ago, New York insurance firms refused to pay death awards to the parents of non-working children, and argued that non-working children had no value.

Deutsche’s topic is inflation, and as Stepek notes, they also take issue with the narrative that says central banks have been responsible for taming this in recent years:

“The Deutsche team notes that inflation became less fierce from the 1980s. We all think of this as being the point at which Paul Volcker – the heroic Federal Reserve chairman – jacked up interest rates to kill off inflation.  But you know what else happened in the 1980s?

“China rejoined the global economy, and added a huge quantity of people to the working age population. A bigger labour supply means cheaper workers.  And this factor is now reversing. “The consequence of this is that labour will likely regain some pricing power in the years ahead as the supply of it now plateaus and then starts to slowly fall”.”

THE CENTRAL BANK DEBT BUBBLE IS THE MAIN RISK

The chart above from the New York Times confirms that that the good times are ending.  Debt brings forward demand from the future.  And  since 2000 central banks have been bringing forward $tns of demand via their debt-based stimulus programmes.  But they couldn’t “print babies” who would grow up to boost the economy.

Today, we just have the legacy of the debt left by the central banks’ failed experiment.  In the US, this means that the Federal government is almost at the point where it will be spending more on interest payments than any other part of the budget – defence, education, Medicaid etc.

Relatively soon, as the Congressional Budget Office has warned, the US will face decisions on whether to default on the Highway Trust Fund (2020), the Social Security Disability Insurance Trust Fund (2025), Medicare Hospital Insurance Trust Fund (2026) and then Social Security itself (2031).  If it decides to bail them out, then it will either have to make cuts elsewhere, or raise taxes, or default on the debt itself.

THE ENDGAME FOR THE DEBT BUBBLE IS NEARING – AND IT INVOLVES DEFAULT
Global interest rates are already rising as investors refocus on “return of capital”.  Investors are becoming aware of the risk that many countries, including the USA, could decide to default – as I noted back in 2016 when quoting William White of the OECD, “World faces wave of epic debt defaults” – central bank veteran:

It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.

The next recession is just round the corner, as President Reagan’s former adviser, Prof Martin Feldstein, warned last week.  This will increase the temptation for Congress to effectively default by refusing to raise the debt ceiling.  Ernest Hemingway’s The Sun also Rises probably therefore describes the end-game we have entered:

“How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually and then suddenly.”

 

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London house prices slip as supply/demand balances change

London house prices are “falling at the fastest rate in almost a decade” according to major property lender, Nationwide.  And almost 40% of new-build sales were to bulk buyers at discounts of up to 30%, according of researchers, Molior.  As the CEO of builders Crest Nicholson told the Financial Times:

 “We did this sale because we knew we would otherwise have unsold built stock.”

They probably made a wise decision to take their profit and sell now.  There are currently 68,000 units under construction in London, and nearly half of them are unsold.  Slower moving builders will likely find themselves having to take losses in order to find a buyer.

London is a series of villages and the issues are different across the city:

Nine Elms, SW London.  This $15bn (US$20bn) transformation has been ‘an accident waiting to happen‘ for some time.  It plans to build 20000 new homes in 39 developments at prices of up to £2200/sq ft.  Yet 2/3rds of London buyers can only afford homes costing up to $450/sq ft – thus 43% of apartments for sale have already cut their price.

West End, Central London.  This is the top end of the market, and was one of the first areas to see a decline.  As buying agent Henry Pryor notes:

“Very few people want to buy or sell property in the few months leading up to our monumental political divorce from Europe next March, which is why 50% of homes on the market in Belgravia and Mayfair have been on the market for over a year. Yet there are people who have to sell, whether it be because of divorce, debt or death, so if you have money to spend I can’t remember a time since the credit crunch in 2007 when you could get a better deal.”

NW London.  Foreign buyers flooded into this area as financial services boomed.  Rising bonuses meant many didn’t need a mortgage and could afford to pay £1m – £2.5m in cash.  But now, many banks are activating contingency plans to move some of their highly paid staff out of London ahead of Brexit.  Thus Pryor reports buying a property recently for £1.7m, which had been on the market for £2.25m just 2 years ago.

W London.  Also popular with foreign buyers, even areas such as Kew (with its world-famous Royal Botanic Gardens) have seen a dramatic sales volume decline.  In Kew itself, volume is down 40% over the past 2 years.  And, of course, volume always leads prices – up or down.  Over half of the homes now on sale have cut prices by at least 5% – 10%, and the pace of decline seems to be rising.  One home has cut its offer price by 17.5% since March.

Outer London.  This is the one area bucking the trend, due to the support provided by the government’s ‘Help to Buy’ programme.  This provides state-backed loans for up to £600k with a deposit of just 5%.  As Molior comment, this is “the only game in town” for individual purchasers, given that prices in central London are out of reach for new buyers.

The key issue is highlighted in the charts above – affordability:

  • The first chart shows how prices were very cyclical till 2000, due to interest rate changes.  They doubled between 1983 – 1989, for example, and then almost halved by 1993.  In turn, the ratio of prices to average earnings fluctuated between 4x – 6x
  • But interest rates have been relatively low over the past 20 years, and new factors instead drove home prices
  • The second chart shows the impact in terms of first-time buyer affordability and mortgage payments.  Payments were 40% of take-home pay until 1998, but then rose steadily to above 100% during the Subprime Bubble.  After a brief downturn, the Quantitative Easing (QE) bubble then took them back over 100% in 2016

The paradigm shift was driven by policy changes after the 2000 dot-com crash.  As in the USA, the Bank of England decided to support house prices via lower interest rates to avoid a downturn, and then doubled down on the policy after the financial crash – despite the Governor’s warning in 2007 that:

“We knew that we had pushed consumption up to levels that could not possibly be sustained in the medium and longer term. But for the time being if we had not done that the UK economy would have gone into recession… That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out.”

  • The 2000 stock market collapse and subprime’s low interest rates led many to see property as safer than shares.  They created the buy-to-let trend and decided property would instead become their pension pot for the future
  • The 2008 financial crisis, and upheavals in the Middle East, Russia, and parts of the Eurozone led many foreign buyers to join the buying trend, seeing London property as a “safe place” in a more uncertain investment world
  • Asian buyers also flooded in to buy new property “off-plan”.  As I noted in 2015, agents were describing the Nine Elms development as: ” ‘Singapore-on-Thames’. Buying off-plan was the ultimate option play for a lot of the buyers [who are] Asian. You only need to put down 10% and then see how the market goes. A lot of buyers are effectively taking a financial position rather than buying a property”

But now all these factors are unraveling, leaving prices to be set by local supply/demand factors again.  Recent governments have taken away the tax incentives behind buy-to-let, and have raised taxes for foreign buyers.  As the top chart shows, this leave prices looking very exposed:

  • They averaged 4.8x earnings from 1971 – 2000, but have since averaged 8.7x and are currently 11.8x
  • Based on average London earnings of £39.5k, a return to the 4.8x ratio would leave prices at £190k
  • That compares with actual average prices of £468k today

And, of course, there is the issue of exchange rates.  Older house-owners will remember that the Bank of England would regularly have to raise interest rates to protect the value of the pound.  In 1992, they rose to 15% at the height of the ERM crisis.  But policy since then has been entirely in the other direction.

Nobody knows whether what will happen next to the value of the pound.  But if interest rates do become more volatile again, as in 1971-2000, cyclicality might also return to the London housing market.

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Chemicals flag rising risk of synchronised global slowdown

Chemicals are easily the best leading indicator for the global economy.  And if the global economy was really in recovery mode, as policymakers believe, then the chemical industry would be the first to know – because of its early position in the value chain. Instead, it has a different message as the chart confirms:

  • It shows changes in global production and key sectors, based on American Chemistry Council (ACC) data
  • It highlights the rapid inventory build in H2 as oil and commodity prices soared
  • But since then, all the major sectors have moved into a slowdown, and agchems into decline

As the ACC note:

“The global chemical industry ended the first quarter on a soft note.  Global chemicals production fell 0.3% in March after a 1.0% drop in February, and a 0.6% decline in January. The last gain was 0.3% in December.

This, of course, is the opposite of consensus thinking at New Year, when most commentators were confident that a “synchronised global recovery” was underway. It is therefore becoming more and more likely, as I warned in January, that policymakers have been fooled once again by the activities of the hedge funds in boosting “apparent demand”:

“For the last 6 months, everyone who buys oil or other commodity-related products has been busy building as much inventory as they could afford. In turn, of course, this has made it appear that demand has suddenly begun to recover. At last, it seems, the “synchronised global recovery” has arrived.

Except, of course, that it hasn’t. The hedge funds didn’t buy 15 days-worth of oil to use it. They bought it to speculate, with the OPEC-Russia deal providing the essential “story” to support their buying binge.”

This downturn is worrying not only because it contradicts policymakers’ hopes, but also because Q1 volumes should be seasonally strong:

  • Western companies should be restocking to meet the surge of spring demand
  • Similarly, China and the Asian markets should now be at peak rates after the Lunar New Year

HIGHER OIL AND COMMODITY PRICES ARE CAUSING DEMAND DESTRUCTION
The problem is that most central bankers and economists don’t live in the real world, where purchasing managers and sales people have bonuses to achieve.  As one professor told me in January:

“Economists would tend to be skeptical about concepts such as “apparent demand”. Unless this a secret concept (and it doesn’t seem like it is), other investors should also use it, and then the oil price should already reflect it. Thus, there wouldn’t be gains to be made (unless you’re quicker than everyone else or have inside information)…”

But in the real world, H2’s inventory build has now been replaced by destocking – whilst today’s higher oil prices are also causing demand destruction.  We have seen this many times before when prices have risen sharply:

  • Consumers only have limited amounts of spare cash
  • When oil prices jump, they have to cut back in other areas
  • But, of course, this is only confirmed afterwards, when the spending data is reported
  • Essentially, this means that policymakers today are effectively driving by looking in the rear-view mirror

RISING DEBT LEVELS CREATE FURTHER HEADWINDS FOR GROWTHNew data from the US Federal Reserve Bank of St Louis also highlights the headwinds for demand created by the debt build-up that I discussed last week.  As the chart shows:

  • US borrowing was very low between 1966-79, and $1 of debt created $4.49 in GDP growth
  • Borrowing rose sharply in the Boomer-led SuperCycle, but $1 of debt still created $1.15 in GDP growth
  • Since stimulus programmes began in 2000, however, $1 of debt has created just $0.36 of GDP growth

In other words, value destruction has been taking place since 2000.  The red shading tells the story very clearly, showing how public debt has risen out of control as the Fed’s stimulus programmes have multiplied – first with sub-prime until 2008, and since then with money-printing.

RISING INTEREST RATES CREATE FURTHER RISKS
Last week saw the yield on the benchmark US 10-year Treasury Bond reach 3%, double its low in June 2016.  It has risen sharply since breaking out of its 30-year downtrend in January, and is heading towards my forecast level of 4%.

Higher interest rates will further slow demand, particularly in key sectors such as housing and autos.  And in combination with high oil and commodity prices, it will be no surprise if the global economy moves into recession.

Chemicals is providing the vital early warning of the risks ahead.  But as usual, it seems policymakers prefer to wear their rose-coloured spectacles.  And then, of course, as with subprime, they will all loudly declare “Nobody could have seen this coming”.

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The tide of global debt has peaked: 8 charts suggest what may happen next, as the tide retreats

The results of the central bankers’ great experiment with money printing are now in, and they are fairly depressing, as the charts above confirm:

  • On the left are the IMF’s annual forecasts from 2010 – 2018 (dotted lines) and the actual result (black)
  • Until recently, the Fund was convinced the world would soon see 5% GDP growth, or at least 4% growth
  • The actual outcome has been a steady decline until 2017 and this month’s forecast sees slowing growth by 2020

As the IMF headlined last week,current favorable growth rates will not last”.

  • On the right, is the amount of money the bankers have spent on money printing to achieve this result
  • China, the US, Japan, the Eurozone and the Bank of England printed over $30tn between 2009-2017
  • So far, only China – which did 2/3rds of the printing, has admitted its mistake, and changed the policy

The chart above shows what happens if you spend a lot of money without getting much return in terms of growth.  Again from the IMF, it shows that total global debt has risen to $164tn.  This is more than twice the size of global GDP – 225%, to be exact, based on latest 2016 data.  The IMF analysis also highlights the result of the money printing:

“Debt-to-GDP ratios in advanced economies are at levels not seen since World War II….In the last ten years, emerging market economies have been responsible for most of the increase. China alone contributed 43% to the increase in global debt since 2007. In contrast, the contribution from low income developing countries is barely noticeable.”

It doesn’t take a rocket scientist to work out the result of this failed policy, which is shown in the above IMF charts:

  • Global debt to GDP levels are higher than in 2008 and in the financial crisis; only World War 2 was higher
  • Debt ratios in the advanced economies are at their highest since the 1980s debt crisis
  • Emerging market ratios are lower (apart from China), but this is because of debt forgiveness at the Millennium

CAN ALL THIS DEBT EVER BE PAID PACK?  AND IF NOT, WHAT HAPPENS?
As everyone knows, borrowing is easy.  Almost all governments and commentators have lined up since 2009 to support the money-printing policy.  But the hard bit happens now as it starts to become obvious that the policy has failed.

We now have all the debt, but we don’t have the growth that would enable it to be paid off.

It would be easy to simply end here, and point out that John Richardson and I set out the reasons why money-printing could never work in 2011, when we published Boom, Gloom and the New Normal: How the Ageing of the BabyBoomers is Changing Demand Patterns, Again.  Our conclusion then was essentially based on common sense:

Central bankers simply confused cause and effect: demographics drive the economy, not monetary policy. 

Common sense tells us that young populations create a demographic dividend as their spending grows with their incomes.  But today’s ageing Western populations have a demographic deficit: older people already own most of what they need,and their incomes decline as they enter retirement.

But having been right in the past doesn’t help to solve today’s problem of excess debt and leverage:

  • Common sense also tells us that leverage equals risk – if it works out, everything is fine; if not…..
  • If you have a lot of debt and the world moves into recession, it becomes very hard to repay the debt

Financial markets are doing their best to warn us that the problems are growing.  Longer-term interest rates, which are not controlled by the central banks, have been rising for some time. They are telling us that some investors are no longer simply chasing yield.  They are instead worrying about risk – and whether their loan will actually be repaid.

Essentially, we are now in the and-game for stimulus policies.  Major debt restructuring is now inevitable – either on an organised basis, as set out by Bill White, the only central banker to warn of the 2008 Crisis – or more chaotically.

This restructuring is going to be painful, as the chart above on the impact of leverage confirms.  I originally highlighted it in August 2007, as the Crisis began to unfold – unfortunately, it now seems to have become relevant again..

PLEASE DON’T FIND YOURSELF SWIMMING NAKED WHEN THE TIDE OF DEBT GOES OUT 
Leverage makes people appear to be geniuses on the way up.  But on the way down, Warren Buffett’s famous warning is worth remembering: “Only when the tide goes out do you discover who’s been swimming naked”.

 

*Return on Equity is the fundamental measure of a company’s profitability, and is defined as the amount of profit or net income a company earns per investment dollar. 

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Economy faces slowdown as oil/commodity prices slide


Oil and commodity markets long ago lost contact with the real world of supply and demand. Instead, they have been dominated by financial speculation, fuelled by the vast amounts of liquidity pumped out by the central banks.  The chart above from John Kemp at Reuters gives the speculative positioning in the oil complex as published last Monday:

  • It shows hedge fund positioning in terms of the ratio of long to short positions across the complex
  • The ratio had been at a near-record low of 1.55x back in June last year, before the rally took off
  • On 30 January it had risen to a record 11.9x – far above even the 2014 and 2017 peaks

The size of the rally has also been extraordinary, as I noted 2 weeks ago.  At its peak, the funds owned 1.5bn barrels of oil and products – equivalent to an astonishing 16 days of global oil demand.  They had bought 1.2bn barrels since June, creating the illusion of very strong demand.  But, of course, hedge funds don’t actually use oil, they only trade it.

The funds also don’t normally hang around when the selling starts. And so last week, as the second chart shows, they began to sell their positions and take profits.  The rally peaked at $71/bbl at the end of January, and then topped out on 2 February at $70/bbl.  By last Friday, only a week later, Brent was at $63/bbl, having fallen 11% in just one week.

Of course, nothing had changed in the outlook for supply/demand, or for the global economy, during the week.  And this simple fact confirms how the speculative cash has come to dominate real-world markets.  The selling was due to nervous traders, who could see prices were challenging a critical “technical” point on the chart:

  • Most commodity trading is done in relation to charts, as it is momentum-based
  • The 200 day exponential moving average (EMA) is used to chart the trend’s strength
  • When the oil price reached the 200-day EMA (red line), many traders got nervous
  • And as they began to sell, so others began to follow them as momentum switched

The main sellers were the legal highwaymen, otherwise known as the high-frequency traders.  Their algorithm-based machines do more than half of all daily trading, and simply want a trend to follow, milli-second by milli-second.  As the Financial Times warned in June:

“The stock market has become a battlefield of algorithms, ranging from the simple – ETFs bought by retirees that may invest in the entire market, an industry, a specific factor or even themes like obesity – to the complex, commanded by multi-billion dollar “quantitative” hedge funds staffed by mathematicians, coders and data scientists.”

JP Morgan even estimates that only 10% of all trading is done by “real investors”:

“Passive and quantitative investors now account for about 60% of the US equity asset management industry, up from under 30% a decade ago, and reckons that only roughly 10% of trading is done by traditional, “discretionary” traders, as opposed to systematic rules-based ones.”

Probably prices will now attempt to stabilise again before resuming their downward movement.  But clearly the upward trend, which took prices up by 60% since June, has been broken.  Similar collapses have occurred across the commodity complex, with the CRB Index showing a 6% price fall across major commodities:

  • Typically, inventory build ahead of price rises can add an extra month of “apparent demand” to real demand
  • This inventory will now have to be run down as buyers destock to more normal levels again
  • This means we can expect demand to slow along all the major value chains
  • Western companies will now see slow demand through Easter: Asia will see slow demand after Lunar New Year

This disappointment will end the myth that the world is in the middle of a synchronised global recovery. In turn, it will cause estimates of oil demand growth to be reduced, further weakening prices.  It will also cause markets to re-examine current myths about the costs of US shale oil production:

  • As the charts from Pioneer Natural Resources confirm, most shale oil breakeven costs are below $30/bbl
  • Pioneer’s own operating costs, typical of most of the major players, are below $10/bbl
  • So the belief that shale oil needs a price of $50/bbl to support future production is simply wrong

PREPARE FOR PROFIT WARNINGS AND POTENTIAL BANKRUPTCIES BY THE SUMMER
Over the summer, therefore, many industrial companies will likely need to start issuing profit warnings, as it becomes clear that demand has failed meet expectations.  This will put stock markets under major pressure, especially if interest rates keep rising as I discussed last month.

Smart CEOs will now start to prepare contingency plans, in case this should happen.  We can all hope the recent downturn in global financial markets is just a blip.  But hope is not a strategy.  And the risk of profit warnings turning into major bankruptcies is extremely high, given that global debt now totals $233tn, more than 3x global GDP.

 

FORECAST MONITORING
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.

Since January, I have also been monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book. Today’s forecast for oil prices to fall initially to $50/bbl is therefore now added to those on ethylene/polyethylene and the US 10-year interest rate. I am also increasing the confidence level for the interest rate forecast to 70%, and will continue to update these levels when circumstances change.

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