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. 

The post The tide of global debt has peaked: 8 charts suggest what may happen next, as the tide retreats appeared first on Chemicals & The Economy.

Brexit a disaster for the UK, Europe and the world

Ring of fire Feb15

First, the good news.  It has long been recognised that the UK economy is over-dependent on financial services, and that its housing market – particularly in London – is wildly over-priced in relation to earnings.  The Brexit vote should ensure that both these problems are solved:

  • Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
  • There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
  • This will also undermine the London housing market by removing the support provided by these high-earners
  • In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”

This is probably not the result that most Leave voters expected when they voted on Thursday.  These voters will also soon find out that Thursday was not the Independence Day they were promised.  It is already obvious that Leave campaigners have no clear idea of what to do next.  They are even divided about whether to immediately trigger the 2-year departure period under Article 50 of the Lisbon Treaty.

Leave voters have more shocks ahead of them, of course:

  • Most believed that the UK would immediately be able to “take control of its borders” and dramatically reduce immigration.  But as I noted during the campaign, the majority of immigration has always been from outside the EU – and could already have been stopped, had the current or previous governments chosen to do this
  • Nor will the National Health Service suddenly benefit from the promised £350m/week ($475m) by stopping UK contributions to the EU.  For a start, more than half of this money already came back to the UK from the EU, and so can’t be spent a second time
  • Even more importantly, nothing is going to happen for at least 2 years whilst the Leave negotiations take place

This, of course, is where the bad news starts.  What will be the reaction of Leave voters as they discover they have been fed half-truths on these and other critical issues?  And what will happen as house prices begin to fall, and jobs in financial services – as well as manufacturing – begin to disappear as companies relocate elsewhere within the EU?

BREXIT VOTE WILL HIT EUROPE AND THE GLOBAL ECONOMY
The bad news is, unfortunately, not restricted to the UK.  Already, alarm has begun to spread across the rest of the EU.  There are strong calls for referendums to take place in 3 of the EU’s 6 founding members – France, Italy and The Netherlands.  It is hard to see how the EU could survive if even one of these votes resulted in a Leave decision.

In turn, of course, this is bound to draw attention once more to the unsolved Eurozone debt crisis.  Can anyone now really continue to believe the European Central Bank’s 2012 promise to do “whatever it takes” to preserve the euro, as set out by its President, Mario Draghi?

The simple fact is that the Brexit vote is the canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

THE BREXIT VOTE, LIKE THE 2008 CRISIS, WAS NOT A ‘BLACK SWAN’ EVENT
I am used, by now, to my forecasts being ignored by conventional wisdom.  The Brexit vote saw a repeat of the complacency that greeted my warnings in the Financial Times and here before the 2008 financial crisis.  Thus my March warning was again mostly ignored, namely that:

A UK vote to leave the European Union is becoming more likely”.

Instead, like the 2008 crisis, the Brexit vote is already being described as a ‘black swan’ event – impossible to forecast.  This attitude merely supports the status quo, as it means consensus wisdom does not have to challenge its core assumptions.  Instead, it takes comfort in the view that “nobody could have foreseen this happening”.

Critically, this means that the failure of the post-2008 stimulus programmes is still widely ignored.  Yet these have caused global debt levels to climb to more than 3x total GDP, according to McKinsey.  As the map above shows, they have created a debt-fuelled ‘ring of fire’, which now threatens to collapse the entire global economy:

  • China’s reversal of stimulus policies has led to major downturns in the economies of all its commodity suppliers
  • Latin America, Africa, Russia and the Middle East can no longer rely on exports to China to support their growth
  • Japan’s unwise efforts at stimulus via Abenomics have also proved a complete failure
  • Now Brexit will almost inevitably cause a major collapse in London house prices
  • And it will focus attention on the vast debts created by the Eurozone debt crisis
  • It will also unsettle US investors, who have taken margin debt to record levels in the belief that the US Federal Reserve will never let stock market prices fall

TIME FOR STRAIGHT TALKING ON THE IMPACT OF AGEING POPULATIONS ON ECONOMIC GROWTH
It is therefore vital that policymakers now make a new start, whilst there is still time to avoid total financial collapse. Once people begin to realise that all this debt can never be repaid, then interest rates will soar and many currencies collapse.  This is not being alarmist – this is just stating obvious facts.

The critical need is to recognise that demographics, not monetary policy, drive economies.  A world with lots of young BabyBoomers in the Wealth Creating 25-54 age group will inevitably see strong growth.  And if more and more women return to the workforce after childbirth, this will turbo-charge an economic SuperCycle.

This is what happened between 1983 – 2007, when the world saw almost constant growth.  The US recorded just 16 months of recession in 25 years.  But last year saw global GDP decline by a record amount in current dollars, more than in 2009 – a clear warning sign of major trouble ahead.

The issue is very simple. Common sense tells us that the combination of a 50% increase in global life expectancy since 1950, and a 50% fall in fertility rates, means that the world has now reached the “demographic cliff“:

  • 1bn ageing Boomers are joining the low-spending, low-earning New Old 55+ generation for the first time in history
  • They will be more than 1 in 5 of the global population by 2030, twice the percentage in 1950

This is good news, not bad.  Who amongst us, after all, would not choose to have 20 years of life expectancy at age 65 instead of dying?  That is today’s position in the Western world.  And people in the emerging economies are catching up fast.  They can already now expect to live another 15 years at age 65.

The trade-off is lower, or negative growth.  People in this New Old 55+ age group already own most of what they need, and their incomes decline dramatically as they approach retirement.

But this simple fact of life has never been explained to voters.  Instead they have been told since 2008 that policymakers are confident of returning the economy to SuperCycle levels of growth.  No wonder they are growing restless, and starting to mistrust everything they are being told by the supposed experts.

CONCLUSION – TIME TO RESTORE TRUST WITH PLAIN SPEAKING
Policymakers and the media now have a grave responsibility, as do do all of us.

It is critically important that policymakers now recognise they must immediately reverse course on stimulus policies, and come clean with voters about the real economic situation.

Of course this will result in very painful conversations.  But the alternative, of ignoring the warning provided by the Brexit vote, is simply too awful to contemplate.

Simplicity the key goal for bank regulation

Leverage ratios Sept12.pngOver the past 20 years, the financial sector has captured an increasing share of the wealth created by the rest of the economy. At its peak before the Crisis, it accounted for 40% of all profits in the US corporate sector, allowing financiers to claim they were ‘masters of the universe’.

A key reason for this growth was their success in creating the illusion that finance was too complex for most people to understand.

Prior to 1990, very few people had heard of EBITDA, quantum, VAR or the host of other acronyms that now dominate finance-speak. Instead, bankers, companies and regulators cheerfully talked about financial issues in simple terms that everyone could understand:

• Companies tracked Operating Profit for individual businesses
• Shareholders monitored net Profit after tax and interest payments
• Regulators checked to see if a bank’s capital could support its lending

But gradually, it came to be believed that only ‘the brightest of the best’ could truly understand finance. Simple terms were replaced by jargon and complex algorithms.

The end-result of the change is shown in the graph above, from a paper by the blog’s favourite regulator, Andy Haldane of the Bank of England. It shows the leverage of major global banks in 2006 (before the Crisis):

• The banks on the left of the chart had the lowest amount of capital
• The banks on the right had most capital

It also shows which banks have since gone bust, and which survived:

• Banks which have gone bust are shown in red
• Those that have survived are shown in blue

The conclusion is simple:

• No bank with a capital ratio above 8:1 went bust
• Most banks with ratios of less than 5:1 did go bust

As Haldane comments:

“Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, it requires a regulatory response grounded in simplicity, not complexity.

“Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years. If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will.”

The Downturn arrives

D'turn 5Nov11.pngIt is 5 months since the blog launched its IeC Downturn Alert, using prices from 29 April. It wrote then that:

They don’t ring bells at market turning points. Otherwise, we could all retire to the Bahamas.”

But its argument was that a peak was likely, as crude oil had remained stable at $125/bbl for 4 weeks.

Buyers had previously bought forward as prices rose, to protect downstream margins. Now they would try to reduce this unwanted inventory. Equally, oil prices at April’s level had always led to recession in the past, and it was unlikely that ‘this time it may be different’.

Evidence that a Downturn is now underway is all around us:

• European cracker operators are mostly at 70-75% operating rates
• A major naphtha surplus has developed in India and the Middle East
• Crackers in Japan, Taiwan and parts of SEA are running at 80-90% rates, with S Korea set to join them
• The US Federal Reserve is forecasting GDP growth of just 1.6%, half its June estimate

Coincidentally, as the chart shows, financial markets such as the US S&P 500 Index also peaked on 29 April, although their decline has so far been less dramatic. The high frequency traders who dominate these markets, have no interest in the fundamentals of supply and demand.

Today, however, the only question is ‘how long will the downturn last, and how deep will it be?’ Mario Draghi, the new head of the European Central Bank, forecasts “a mild recession” in Europe. We can all share this hope, but hope is not a strategy. Sensible Boards will develop scenarios that also include a worst case of a sustained and deep recession.

The blog was in a small minority when it launched its Downturn Alert.

Having run major businesses in the past, it knows that buyers always give seemingly convincing reasons when cancelling or deferring orders. It therefore felt it might be helpful to present a global overview, covering benchmark products and regions, to highlight that the problems were general, and not specific.

The industry’s current laser-like focus on year-end inventories means that we should avoid the problems seen in Q4 2008, when inventories piled up around the world. Instead, lower operating rates will mean that buyers occasionally find themselves short of product, as has happened this week in China on polyethylene.

But these short-term issues should not be confused with the potential for a quick recovery.

The Downturn Alert has hopefully helped the industry to navigate the last few difficult months. It will now be renamed the IeC Downturn Monitor, to reflect its new role of charting the problems that lie ahead.

ICIS pricing comments this week, and price movements since the IeC Downturn Alert launched on 29 April, are below:

Benzene NWE (green), down 29%. “Demand remains subdued for the current month”.
HDPE USA export (purple), down 24%. “Prices were rising, as global buyers began to restock, including in China and S American markets.”
Naphtha Europe (brown dash), down 20%. “The market continues to suffer soft demand, and has lengthened from the previous week.”.
PTA China (red), down 18%. “Most players were worried that the downturn may extend into the rest of the year because of the poor demand for polyester in China, India and parts of SEA.”
Brent crude oil (blue dash), down 12%.
S&P 500 Index (pink dot), down 8%

Investors prefer JUUGS to PIIGS

JUUGS Nov11.pngFinancial markets have become increasingly nervous in recent weeks, since the blog last reviewed developments in global bond markets.

Its conclusion then was that investors are worrying more about return of capital, than return on capital, as we transition to the New Normal. This is because 272 million westerners are now over 55 years old, and they need security of income as they prepare for retirement.

The chart above updates market moves in the JUUGS (Japan, UK, USA, Germany, Switzerland) and the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Since August (blue column), the 2 groups have seen very different interest rate trends for 10-year government bonds (red line):

• Rates in the JUUGS have been extremely stable. UK and Swiss rates have edged down 0.1%, whilst German rates moved up 0.1%. US and Japanese rates are unchanged.
• The PIIGS have been much more volatile. Greece is now paying 34% vs 22% in August: Portugal’s rate is 12% vs 11%: Italy’s is 6.4% vs 5.7%: Spain’s is 5.5% vs 5.3%: only Ireland’s reduced, from 8.8% to 8.3%.

This suggests Portugal will also need to default on its debts, alongside Greece. Otherwise the burden of interest payments will simply become too large, particularly as austerity programmes lead to recession.

Italy, of course, is the real problem child. It is a rich and large G7 country. But its interest rate is now also close to being unaffordable. Two key questions are looming on the horizon:

• Will it really now allow the IMF to dictate its economic policy?
• What will happen to French and German banks if investors start to question Italy’s ability to repay its debt?

Italy currently owes $416bn to French banks, and $162bn to German banks. It owes a total of $788bn to European lenders. This is the concept of ‘contagion’:

• If Italy’s rates move into the 6.5%-7% area, and remain there, then its default becomes almost certain.
• France, another G7 member, would then be in the firing line.
• Its 3.3% interest rate is already 50%+ higher than those of the JUUGS. This suggests underlying nervousness amongst investors.

The blog will continue to monitor the situation closely.