Its hard to be optimistic about the outlook for the global auto market. The chart above of the Top 7 markets, which account for around 2/3rds of global sales, highlights the growing uncertainty. It shows Q1 sales in 2015 (blue column) versus 2014 (blue). Overall, these were up just 1.9% at 15.8m. And although the 3 largest markets showed reasonable growth, there are growing questions about the underlying trends.
China’s market appears to have done well, up 7.6% at 5.2m. But Chinese data is constructed on a different basis to the rest of the world, as “sales” actually represent factory deliveries rather than retail purchases. And one sign of trouble is that a price war has broken out, with China Daily warning:
“China’s auto industry’s profits have been on a downward trend this year, plagued by a slowing market and plunging car prices”.
Analysts Macquarie add that “there has been almost no sales growth in recent months in certain segments”. And used car sales growth has already overtaken that for new cars, whilst China’s auto association is warning that:
The overall market downturn would push the auto industry to further polarize. Carmakers which have competitive products will continue to have decent profits, but those without competitive products will have meager profits and even losses,”
The US market is also giving off conflicting signals. Sales were up 5.6% at 3.9m, but March sales were flat at 1.5m. This seems to confirm my fears back in January that the end of the shale gas bubble would also start to reverse the recent recovery in auto sales (as well as housing starts).
4 out of 5 cars are now bought with credit or leased, with an average term of 5 1/2 years. This tactic essentially buys sales from the future, as a car sold today won’t be replaced before 2020. In addition, an increasing proportion of sales are now to subprime buyers, whose default rates are alarmingly high.
The European market also presents some puzzles. Sales were up 8.7% at 3.5m, but analysts EY note that purchases by private individuals are at the lowest levels since 1990. They warn there is:
“Significant concern over self-registrations, where dealers sell the cars to themselves to help shift vehicles and meet incentive targets. They continue to distort the true level of demand.”
In addition, of course, the European market also continues to see major discounting, with levels of 20% easily available in many countries.
The position in the other 4 BRIJ markets is clearly weak. Sales were down 15.5% at 3.1m, as I discussed last week, with the only positive signs in India.
Overall, therefore, Q1 data tends to support my view back in October that global auto sales have reached their ‘top of the mountain‘ moment. Suppliers to the industry, and investors, face a difficult outlook as these trends continue to develop.
Q1 showed little sign of improvement in the world’s second-tier auto markets – Brazil, Russia, India, Japan. In total, their sales used to equal those of the EU, the world’s 3rd largest market. But Q1 volumes saw a 16% decline versus 2014 levels, as the chart shows:
- Japan’s sales were boosted in 2014 (blue column) by buying ahead of April’s VAT rise. By now, premier Abe’s Abenomics strategy should have seen them moving higher again. But instead they were down 16% at 1.3m (red)
- Russia’s sales were simply awful, hit by the combination of the oil price and rouble’s collapse, and sanctions related to Ukraine. They were down 36% at only 0.4m, with March sales down an astonishing 43%
- Brazil was also very disappointing, with sales down 17% at 0.7m. Its economy should be buoyant, with the Olympics due next year, but most forecasts now expect it to remain in recession
- But India did see growth, with sales up 5% at 0.7m. And encouragingly, sales for India’s fiscal year April 2014-March 2015 also showed a 5% rise, after 2 years of decline, although they are still well below 2012′s peak levels
The key, of course, to the weak performance remains the combination of China’s New Normal policies and the failure of Japan’s Abenomics policy.
China is no longer buying commodities in vast quantities and at high prices from Brazil and Russia. And Japan’s attempt to devalue its way into growth, despite its demographic deficit, is now clearly failing.
So far, therefore, there is little change from the underlying position in these important markets since February. Japan’s sales seem likely to remain slow, especially if it returns to deflation, and Brazil’s sales also seem likely to continue to struggle. Russia is confirming the warning of a likely “bloodbath” from Renault/Nissan head Carlos Ghosn last December.
India could hold the most long-term promise, but sustainable increases in sales require concrete action by Premier Modi to improve basic living conditions and infrastructure. And interestingly, developments in Ford’s strategy for India now confirm our analysis in chapter 8 of Boom, Gloom and the New Normal when we wrote:
“Ford believes increased affordability is the key to meeting its goal of boosting global sales volumes by 50% by 2015. It has therefore developed a new 1 liter version of the Ecosport for sale in low-cost markets, and will manufacture it in India.”
As the Wall Street Journal noted last month:
“International brands such as Hyundai , Suzuki , Nissan, Volkswagen and Ford are now exporting hundreds of thousands of cars from India. In fact, in terms of passenger cars, India already exports more than China.
“Companies in India have seen their passenger-car exports jump more than 60% in the last five years to a total of more than 620k in 2014. China trailed with 533k auto exports last year. Other countries like Japan, Korea and even Thailand exported more last year, but India is expected to start catching up.”
This decision to focus Indian production on the export rather than domestic market highlights the end of the 2009/10 euphoria around the Incredible India concept. This led to the widespread belief that India was somehow about to become ‘middle-class’ with incomes reaching Western levels.
Reality remains somewhat different, with average incomes in India still only around $1500/year.
Debt, debt, glorious debt,
Nothing quite like it for cooling the blood.
So follow me, follow, down to the hollow
And there let us wallow in glorious debt (apologies to Flanders & Swann)
It seems impossible today, but until the year 2000 most Western countries were reducing their debt burdens. Thus President Bill Clinton boasted in his 1998 State of the Union address that the US would see its first balanced budget for 30 years, and added “It is projected that we’ll then have a sizable surplus in the years that immediately follow.”
Unfortunately, 17 years later, this surplus has turned into debt. This is highlighted in the above chart for the G20 nations, which are almost four-fifths of the global economy.
It shows gross government debt per person in US$ on the vertical axis, and median age on the horizontal axis. The bubble represents the size of the country’s economy relative to the USA. This means the world can be segmented into 3 major groups, based on Bloomberg, IMF and UN Population Division data:
- Ageing & in Debt. Japan is in the worst position with debt of $100k per person, and a median age of 45 years. But other major Western countries are also burdened with serious levels of debt. The US has $59k, Canada $45k, France $42k, the UK $39k and Germany $36k
- Ageing & Solvent. This is a small group of 4 countries, who have median ages of <35 years and smaller levels of debt per capita. Australia has $18k, with a median age of 38 years. But as with Russia ($2k), it is now facing tougher times as the bonus from high commodity prices ends
- Young & Solvent. These 6 countries have median ages of <30 years, and very low debt levels. Brazil has the highest debt at $7k, whilst Saudi’s debt is just $687 per person
The Ageing & in Debt countries have a rocky road ahead, as high debt creates major headwinds for growth.
Essentially borrowing brings forward growth from the future. But now, the debt has to be repaid. This would be manageable, if their fertility rates had stayed the same as in the BabyBoom. But instead these have halved from an average of 2.8 babies/woman in 1950 to just 1.4 babies/woman today.
This is well below the replacement level of 2.1 babies/woman. It thus creates a further headwind, due to the lack of young people. These are critical to economic growth as the ages of 25-54 years are people’s high spending years
And, of course, these young people also have to support the retirement costs of the older generation via higher taxes, meaning they have even less to spend themselves.
The Young & Solvent and Ageing & Solvent countries have avoided this problem. But instead, many have high levels of corporate debt. To make matters worse, much of this borrowing has been in US$, not their local currency, as this offered much lower interest rates.
This means these companies face massive exchange rate risk, now that the US$ is breaking out of its 30-year downtrend. A must-read analysis by Jonathan Wheatley in the Financial Times highlights the problem this has created:
“A decade ago, the market for EM (Emerging Market) hard currency corporate bonds hardly existed. Today, it is bigger than the US high-yield corporate bond market, an asset class familiar to investors for decades, and more than four times the size of Europe’s high-yield bond market…
“The value of such bonds in the market has grown from $107bn then to more than $2tn today. But with Brazil’s economy imploding, China slowing and dark shadows over markets from Venezuela to Russia and Ukraine, some analysts worry that the party has gone on too long….
“The point of QE (Quantitative Easing) is to inflate the real economy” says Mr Oakley at Nomura. But instead of driving growth it is creating asset bubbles. The danger is that it will drive bubbles until they burst.”
There has been a lot of wishful thinking over the past 15 years about the BRIC countries (Brazil, Russia, India and China). The experts told us they were all going to become middle class overnight, and ensure that global growth continued to motor, even as the West slowed.
Reality has proved rather different, of course. This makes it all the more important that we keep a close eye on developments in these countries, which are home to 3bn people.
Auto markets are one key area. I looked at developments in China as well as the US and EU recently, so today I focus on the other 3 BRIC countries, plus Japan. These 7 markets are 80% of world sales.
Sales for Brazil, Russia, India and Japan (the BRIJ countries) are shown in the chart above:
- In total, their auto sales volume equal EU sales of 12.4m
- It has been static at this level since 2012, when President Xi was just about to take office in China
- Since his arrival, China’s move into the New Normal has changed trade patterns around the world
- Brazilian and Russian auto sales have felt the immediate pain, whilst Japan has plunged into Abenomics
- But the outlook for India could be quite promising, if Premier Modi carries through his reform programme
Japan is the largest market of the 4 (blue area). Its sales peaked at 4.7m in the mid-2000s, and were at this level again in 2014. But this was only due to an exceptional Q1, when 1.6m cars were sold ahead of April’s increase of VAT to 8%. Sales in the other 9 months were just 3.1m. Sales in 2015 will therefore probably stay slow this year, especially if Japan now heads back into deflation as I expect.
Brazil was the 2nd largest market in 2014 at 2.6m, down from its 2.9m peak in 2012. It failed to diversify its economy during the boom years of buoyant commodity and other sales to China, and is now close to recession. Its sales fell 7% in 2014, and 19% in January after the government reinstated a 4.5%-7% tax to help boost its weak finances. Dealer inventories are also high, suggesting sales will continue to struggle in 2015.
Russia was the 3rd largest of the four markets in 2014 at 2.5m, down from its 2.8m peak in 2012. It is used to volatility, with its sales halving to 1.5m in 2009 versus 2008, before rebounding. January sales fell 24%, and this slowdown looks more serious, with oil and commodity prices weakening, the value of the rouble collapsing, and sanctions in place over many parts of the economy due to Ukraine. Renault/Nissan CEO Carlos Ghosn halted their sales in December, warning of a potential “bloodbath” in 2015 due to the currency crisis.
India was the smallest of the 4 in 2014 at 2.5m, down from a peak of 2.6m in 2012, but may well hold the most long-term promise. Unlike China, it has underspent on infrastructure over the past 10 years. But unlike the others, it has a relatively young population, and could gain a ‘demographic dividend’ if it focused on improving basic living conditions. But these things are easier said than done, and so we will have to wait to see if the promise of Premier Modi’s election campaign is fulfilled.
Overall, recent developments in the 7 major markets do nothing to change my view in October that we have reached “peak car” moment for global auto markets.
More and more commentators are beginning to recognise that deflation is becoming inevitable in many major economies:
- China’s producer prices fell -4.3% last month, and its consumer prices rose just 0.8%
- Eurozone consumer prices fell in December to -0.2%, and are likely to have fallen further in January
- US prices rose just 0.8% in December and are also likely to have fallen further in January
- Japan’s prices have already fallen by a third from their 3.7% peak in May, after last year’s VAT increase to 8%
This is hardly a surprise to anyone but the central banks. The world has an ageing population, and there is a growing shortage of people in the peak spending age range of 25 – 54 years, due to the halving of global fertility rates to just 2.5 babies/woman since 1950.
My concern is not about deflation. It is about the enormous debt created by the central banks since 2007, in their vain attempt to compensate for the lack of babies by printing money.
They had assumed that they could create a ‘wealth effect’ by boosting stock prices. But fewer people own stocks than houses. So the US subprime housing bubble should have been a warning that they were doomed to fail.
And as McKinsey’s report highlighted yesterday, they have instead only succeeded in raising global debt to 3x GDP.
Debt, of course, becomes more expensive with deflation. So unfortunately, the central banks have done exactly the wrong thing by adding debt. Major defaults are now becoming almost inevitable, as we move through the Cycle of Deflation.
CHINA’S CHANGING MARKET FOR PLASTICS HIGHLIGHTS KEY ISSUES
As so often, developments in chemical markets are a leading indicator of what lies ahead. The chart shows the changes taking place in China’s demand for the 3 main plastics – polyethylene (PE), polypropylene (PP) and PVC between 2012 – 2014:
- All 3 markets show demand growth slowing, whilst China’s own production increases at the expense of imports
- The reason is the adoption by the new government of its New Normal policies which reverse previous stimulus
- It had realised the stimulus had “wasted $6.8tn” – around the size of its own economy
- PVC shows this development very clearly, as its growth was based on the development of the property bubble
- The new policies means China is now a net exporter, when it had been the world’s largest importer in 2012
Of course, this reverse-course is creating major problems for countries which had built vast new complexes to supply ever-increasing amounts of plastic to China. Instead, these producers find themselves in an over-supplied market.
They are thus forced to cut prices to gain orders, creating yet more deflation. As the charts also show:
- The big losers are NE Asia (NEA) and North America (NAFTA), whose exports have fallen sharply
- NAFTA has done particularly badly, despite its temporary cost advantage with shale gas versus oil
- China clearly prefers to buy its limited import needs from the Middle East (ME) and SE Asia (SEA)
And so the plastics market highlights how deflation is set to continue, particularly as oil prices return to more normal levels below $50/bbl.
As China has discovered, central banks are essentially pushing on the proverbial piece of string. Adding more stimulus only creates more over-capacity.
Could Japan actually go bankrupt at some point in the future? This was the question left hanging in the air after Friday’s panic at the Bank of Japan, when its Governor forced through his new stimulus policy on a 5 – 4 vote.
Financial markets’ first reaction was to assume this was a coup de théâtre on his part, meant to ‘shock and awe’. But central banks typically try to be as boring as possible, and very predictable. Also, Japan is the land of consensus.
Clearly something is not right. And Governor Kuroda’s press conference spelt out the issue – the return of deflation
“We are at a critical moment. There is a risk that victory over deflation may be delayed.”
Nor is it difficult to see why Japan might be about to topple back into deflation. As the chart shows:
- It has been in deflation for 2/3rds of the period from 1995 – 2013, 150 months out of 19 years
- It was only out of deflation very briefly during this period – in 1996-8, 2006 and 2008
- The latest increase, to 3.4%, took place in April this year, after sales tax was increased from 5% to 8%
- Already the rate is turning down, and the impact of the sales tax will disappear from the index next April
Against this background, it would only take one “shock” for Japan to move back into deflation. And, of course, just such a shock has occurred with the collapse of oil prices and other commodities over the summer:
- Japan is the world’s 2nd largest importer of fossil fuels, after China
- The Fukushima tragedy means it has been the world’s 3rd largest oil consumer and importer since 2012
- Since June 16, the oil price has fallen 26% from $116/bbl to $86/bbl on Friday
- On its own, this is highly likely to push Japan back into deflation
In addition, of course, the whole Asian region is seeing slower growth as China leads the Great Unwinding of policy stimulus. There is little that Premier Abe or Governor Kuroda can do about either of these external developments.
ABE-KURODA’S ’3 ARROWS’ POLICY IS HIGHLY RISKY FOR THE ECONOMY
The problem for Japan is that the Abe-Kuroda policies are highly risky for its economy, as I discussed last December:
- It has the oldest population in the world, with a median age of 46 years
- According to the OECD, 42% of the adult population are over 65, and this percentage is rising
- One in two adults are in the New Old 55+ generation, when spending declines quite sharply
There is therefore no chance that the new policies, known as Abenomics, could work.
The OECD also calculate that Japan’s net relative pension level equals only 38% of net average earnings, so the drop in spending power on retirement is profound. In addition, the collapse in fertility rates since 1955 means Japan’s population is already declining, from 127m today to 108m by 2050 according to UN Population Division forecasts.
So its GDP must now be on a declining trend, especially as Japan’s consumer spending is nearly 2/3rds of GDP.
Even worse, however, is that the so-called ’3rd arrow’ of Abenomics policy – structural reform in the economy – has never been fired. For example, female employment levels are just 63%, far lower than in other rich countries, and Abe has done nothing to change this. Instead, he has focused on the other two arrows:
- Massive monetary easing to push up stock market prices and create a ‘wealth effect’
- Major government spending increases to try and boost demand
- One key aim has been to devalue the currency to boost exports and create inflation
- The yen has thus fallen 47% versus the US$ since Abe took office, from Y76 in January 2012 to Y112 on Friday
Friday’s announcement was more of the same. The Y127tn ($1.14tn) Government Pension Investment Fund (GPIF) has been told to increase its stock market holdings by Y34tn, and to sell Y30tn of its government holding to the Bank of Japan. The news led to an astonishing 3% fall in the value of yen versus the USD, from Y109 to Y112.
Kuroda’s policy announcement also showed he was aware of the bankruptcy risk. Clearly no foreign investor would buy Japan’s government bonds – interest rates are near 0%, and they face a near-certain exchange rate loss. This must be why the Bank of Japan will be buying the GPIF’s bonds.
But this type of manoeuver is essentially sleight of hand – Japan’s borrowing was in real yen, and will have to be repaid in real yen. Similarly, its growing army of pensioners cannot live on electronic money. They need real cash each week if they are to eat and to keep their homes warm in the winter.
And when deflation returns, it will increase the real value of the debt created by Abe-Kuroda, and so create a further headwind for economic growth. Japan’s debt was already $80k for every man, woman and child back in March. Abe-Kuroda’s policies are increasing this level on a daily basis.
Japan has not yet got to the point where bankruptcy has become a real risk. But time is running out for it to accept demographic reality. It needs to return to the sensible policies of Kuroda’s predecessor as Governor, Masaaki Shirakawa. He understood very well the threat posed by current policies when warning in 2012:
“The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices.”
WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
PTA China, down 24%. ”End-users who are in the re-export business were seeking cargoes”
Naphtha Europe, down 21%. “Naphtha supplies lengthened further this week, with petrochemical buyers continuing to opt for LPG”
Brent crude oil, down 18%
Benzene Europe, down 13%. “Sluggish derivative demand meant that some length was growing.”
¥:$, down 10%
HDPE US export, flat. “Traders said prices need to drop at least 10 cents/lb more to compete with China and Asian values”
S&P 500 stock market index, up 3%