Wall Street’s post-election rally suggests that many investors currently have the wrong idea about Donald Trump. They have decided he is a new Ronald Reagan, with policies that will deliver a major bull market.
But those promoting this narrative have forgotten their history. Both men certainly share a link with the entertainment industry. But Reagan took office towards the end of one of the worst recessions in the 20th century. By contrast, Trump takes office at the end of an 8-year bull market.
Prof Robert Shiller’s CAPE Index (based on average inflation-adjusted earnings for the past 10 years), provides the best long-term view of the US stock market, going back over a century to 1881. As the chart shows:
Ronald Reagan took office in January 1980, when the CAPE Index was 9.4
It fell to 6.6 in July/August 1981 at the bottom of the recession, when the S&P 500 was just 109
At the end of Reagan’s Presidency it was still only at 14.7, and the S&P 500 was at just 277
Today, Donald Trump takes office with the CAPE ratio at 28.5 and the S&P at 2271, after an 8-year rally
Is it really credible as a Base Case that the rally could continue for another 8 years? After all, Trump himself claimed back in September that the US Federal Reserve was being “highly political” in refusing to raise interest rates:
“They’re keeping the rates down so that everything else doesn’t go down. We have a very false economy. At some point the rates are going to have to change. The only thing that is strong is the artificial stock market.”
Common sense would also tell us that Trump is about to make sweeping changes in economic and trade policy. He made his position very clear in October with his Gettysburg speech. And his Inauguration Speech on Friday explicitly broke with the key thrust of post-War American foreign policy:
“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”
Change on this scale is never easy to achieve, and usually starts by creating major disruption. The expected benefits take much longer to appear. This, of course, is why “business as usual” is such a popular strategy. But it is clear that Trump is perfectly prepared to take this risk. As he said at the start of the speech:
“We will face challenges. We will confront hardships. But we will get the job done.”
Many companies and investors are still hoping nothing will change. But CEOs such as Andrew Liveris at Dow Chemical and Mark Fields at Ford have already realised we are entering a New Normal world:
Liveris told a Trump rally last month that jobs would be “repatriated” from outside the USA when Dow’s new R&D centre opened, adding as the Wall Street Journal reported “This decision is because of this man and these policies,” Mr. Liveris said from the stage of the 6,000-seat Deltaplex Arena here, adding, “I tingle with pride listening to you.”
Fields personally told Trump of their decision to cancel the Mexican plant and invest in Michigan, saying “Our view is that we see a more positive U.S. manufacturing business environment under President-elect Trump and the pro-growth policies and proposals that he’s talking about”.
The reversal of US trade policies will impact companies all around the world. The White House website has already confirmed the planned withdrawal from the TransPacific Partnership – and from NAFTA, if Mexico and Canada refuse to negotiate a new deal. China is certain to be targeted as well. Protectionism will start to replace globalisation.
This means that today’s global supply chains are set for major disruption. This will directly impact anyone currently selling to the US, and US companies currently selling overseas. It will also impact every supply chain that involves a final sale either to or from the US. The Great Reckoning for the policy failures since 2009 is now well underway:
The Dow Jones Industrial Average’s repeated failure to break the 20,000 level may well be a warning sign
Japan’s Nikkei Index was also poised to hit 40,000 when closing at 38,916 on 29 December 1989 – but never did
Sometimes, as US writer Mark Twain noted, “History doesn’t repeat itself, but it often rhymes”.
2016 saw the start of the Great Reckoning for the failure of stimulus policies.
Political and social issues are now beginning to dominate the landscape. As we saw in the UK’s Brexit vote to leave the European Union, voters no longer see economics as the sole issue in elections. This paradigm shift was then followed by Donald Trump winning the US Presidency and Italy voting against premier Renzi’s constitutional reforms.
Polls confirm this, as the Ipsos MORI chart above shows. Most people feel the current economic/political/social system is no longer working for them. Worryingly, given the votes due in 2017, the survey also highlights that French voters (89%), Italians (82%) and Germans (69%) are even more upset than American (63%) and British voters (60%).
Voters are increasingly giving up on the “consensus wisdom” that ignores demographics, and which believes the world can somehow go back to the constant growth seen during the BabyBoomer-led SuperCycle. As I wrote in August:
“The critical issue is that central banks have been in denial about the changes taking place in demand patterns as a result of ageing populations and falling fertility rates. Their Federal Reserve/US-type forecasting models still assume that raising interest rates will reduce demand, and lowering them will release this pent-up demand. But today’s increasing life expectancy and falling fertility rates are completely changing historical demand patterns. We are no longer in a world where the vast majority of the adult population belongs to the Wealth Creator cohort of those aged 25–54, which dominates consumer spending:
□ Increasing life expectancy means people no longer routinely die around pension age. Instead, a whole New Old generation of people in the low spending, low earning 55+ generation is emerging for the first time in history. The average western BabyBoomer can now expect to live for another 20 years on reaching the age of 65
□ Fertility rates in the developed world have fallen by 40% since 1950. They have also been below replacement levels (2.1 babies per woman) for the past 45 years. Inevitably, therefore, this has reduced the relative numbers of those in today’s Wealth Creator cohort, just as the New Old generation is expanding exponentially
“You cannot print babies” should be the motto hanging on every central bankers’ wall. Unfortunately, it is too late to quickly reverse their demographic myopia. Instead, the Great Unwinding is now set to evolve into the Great Reckoning. Investors, companies and individuals must prepare for heightened levels of volatility, as markets continue their return to being based on the fundamentals of supply and demand, rather than central bank liquidity.”
2017 is therefore likely to be a difficult year, contrary to the optimism of Western stock markets, as the landscape becomes ever more uncertain. But the world has been through difficult years in the past. And in time, no doubt, the need to adapt to the positive impact of today’s demographic changes will become more obvious. The issue is simple:
Today, Western life expectancy is around 80, and is around 20 years at age 65. Due to the collapse of fertility rates, a G7 economy such as Italy has nearly as many people in the New Old 55+ cohort as in the Wealth Creator 25 – 54 cohort. Another new stage therefore needs to be added to our life cycle – whereby we are born, are educated, work, and then retrain in our 50s/60s, before working again until we retire and then die.
We need new leaders, with the vision and common sense required to help explain and manage this New Normal world, so that the benefits of the 100-year life are understood and welcomed.
The Brexit vote, and Donald Trump’s election, confirm that we are in a New Normal world. In the interview below with Will Beacham, Deputy editor of ICIS Chemical Business, I highlight some ideas about how industry needs to adapt.
BARCELONA (ICIS)–The global chemical sector needs to stimulate demand for innovative products and services in mature economies so that the benefits of globalisation are felt by people who have been left behind, a leading consultant says.
Globalisation is a very efficient method of production, but it shifts manufacturing to low-cost areas, leaving workers in mature economies at risk of under-employment. The chemical sector should adopt more service and solution-oriented business models which will boost demand and employment in high-cost regions, says International eChem chairman.
This innovative approach is particularly important for a country like the US where the election of Donald Trump has highlighted anger among voters about falling incomes and hostility to the effects of globalisation.
On 21 November, Trump confirmed that he plans to exit the proposed Trans-Pacific Partnership as soon as he is inaugurated. This indicates he does intend to follow through with a protectionist agenda which could result in higher tariffs against US-made chemicals and polymers if a trade war develops.
Hodges says the US industry can harness unmet domestic polymer demand to help swallow up the wave of new shale-based capacity due onstream over the next 2-3 years.
“It’s highly likely that all the new capacity will come onstream at a time when the US is pushing towards protectionism. This makes it critical for the US industry to move away from wishful thinking about selling all the new PE capacity into Asia and other foreign markets. They will have to refocus on creating domestic demand.”
Hodges believes it is critical to look at new opportunities in areas such as water and food; otherwise the industry will not be able to sell these new volumes. “Companies will move towards being designers of materials and solutions. There are opportunities as well as threats for people who can revise their business models. It’s critical for people to take decisions now.”
He highlights the example of California which has been in drought for the last five years. “Why not sell more PE pipes as we know that 40% of water is lost before it reaches the consumer. Why waste capital on new reservoirs when you are going to lose 40%?”
He also suggests developing materials for intelligent packaging to tell people when food is really out of date because 35% of food is currently thrown away.
“There must be a big focus on being efficient: these are enormous markets and the industry needs to become more demand-focused. Some of the new [wave of ethane-based] plants will struggle but in principal there is a lot of new demand that could be generated by taking a demand-orientated approach.”
Looking globally, a new political and trading power block will develop as a result of China’s “One Belt One Road” policy which includes countries representing 40% of global GDP, says Hodges. This strategy aims to boost cooperation and trade between China and around 60 countries including Russia, much of eastern Europe, Asia including India and Indonesia, and parts of North Africa and the Middle East.
Hodges also believes the chemical industry should adopt the use of smaller, leaner and more efficient manufacturing systems.
“In an uncertain world the biggest risk is that you can’t sell product: this was always the risk before and it is today. We need smaller, more flexible, cheaper production with units located next to customers, as well as a greater focus on sustainability in the plastics chain.”
“We won’t return to a world of unbridled production – services and solutions are the way smart companies will make money in the future.”
Imagine your government decided to shutdown most of the industry in two major cities for 2 weeks or more? Say Detroit and Chicago in the US, or Milan and Turin in Italy, or Leeds and Manchester in the UK. Now you will have some idea of the scale of the shutdowns being mandated in China for Shanghai and Ningbo ahead of the G20 Summit in Hangzhou on September 4-5.
The reason is the need to improve air quality during the summit, as I noted last month.
Hangzhou itself is China’s 4th largest city, with a population of 21m. And as the map shows, it is bordered by Shanghai (with 24m people), and Ningbo (8m people). Together, they are one of the biggest industrial conurbations in the world.
Now, as ICIS news reports, more details are starting to emerge of the scale of the likely disruption:
“Hangzhou is home to major polyester producers, which are expected to implement the prescribed temporary measures to curb pollution until after the summit, market sources said.
“For Shanghai, the production cuts and shutdowns will take effect from 24 August to 6 September, according to a document published on the Shanghai Environment Protection Bureau website. Other industries such as steel, coking and cement sectors in Shanghai are also being required to restrict production for a prescribed period, based on the document.
“In Ningbo City, a number of industries were likewise given orders to help out in the efforts to reduce pollution in preparation for the G20 summit. Cement, non-ferrous metal, chemical fibre companies are due to shut down their plants during the summit, while refining and chemical companies must reduce operation more than 50%, according an official statement obtained by ICIS.”
More information will obviously follow in the next few weeks. But already details have begun to emerge on the scale of the planned shutdowns in Ningbo:
- In the polyester sector, Yisheng Petrochemical will shut 5 million tonnes of PTA capacity
- In polyurethanes, Wanhua Chemical will shut 1.2 million tonnes of MDI capacity
- There will also be 1.2 million tonnes of propylene capacity shutdown
- In addition, production of at least 16 major petrochemicals will be disrupted including PVC, ethylene, styrene. ethylene glycol, acrylic acid and polypropylene
- CNOOC’s Ningbo Daxie refinery complex will also be operating at reduced rates
These closures/cutbacks will obviously have a very disruptive impact on a whole range of supply chains. Some companies will lose their raw material supplies – others will lose their customers for finished product. So there will be no easy answers for managements – and even if their immediate suppliers or customers are still operating, there may well be closures or disruption in another part of the value chain.
Companies outside China, whether suppliers or customers, will clearly also be impacted, given the importance of this region in global markets. My suggestion would be that you need to check as soon as possible with your business partners to gain their insights into the likely outcome, now that details of the plans are becoming clear. Then you will have time to work out alternative options.
One other important conclusion is clear. No government would lightly create this level of disruption, particularly at a time when the domestic economy is already under pressure. The fact that President Xi Jinping is taking these major steps, is a sign of the severity of China’s pollution problems. The country simply cannot go back to the Old Normal way of doing things – the New Normal policies are here to stay.
US home ownership is back at levels seen briefly in the mid-1980s, and before that in the mid-1960s. One key issue today is that while the US population is still growing, the younger population has quite a different profile from the Boomer generation, as the Pew Institute have reported.
- In 1980, only 1 in 10 young Boomers were still living at home with parents
- But today we are “going back to the future”, with 1 in 5 young adults living at home with their parents, due to economic pressures
In addition, there is a growing trend for retiring Boomers to reverse the “flight to the suburbs” that they undertook in the 1960s/1970s, and instead return to apartment living in the cities.
As the second chart confirms, these trends are steadily reducing the demand for single family homes. Multi-family units are now (as in the pre-Boomer SuperCycle era) around one-third of total housing starts, and are likely set for further increases. This is not good news for industries or companies focused supplying the housing industry, as it means they are being hit by 2 adverse trends:
- Contrary to policymaker promises, housing starts have not bounced back quickly to subprime highs. In fact, they are continuing to disappoint as the support for new home building from shale gas and oil-related development disappears as migrant workers return to their home state. This is a major reversal for petrochemical demand as the average new home uses around $15,000 of petrochemical products. At its peak (when housing starts reached 2.1m in 2005) the US housing market was worth $31bn to the industry
- Even worse from the demand viewpoint is that the SuperCycle trend towards single family homes has sharply reversed. Starts for apartment living have doubled as a percentage of the total back to around a third, equal to levels seen 40 years ago. This trend towards apartment living further reduces potential chemical and polymer demand. Although no detailed analysis yet exists on this factor, due to its relatively recent appearance, estimates suggest each apartment only uses around 50% of the materials required for a single-family home.
The combination of these factors has had a major impact on US home-ownership rates. These were given a major boost under President Clinton in 1995, when he introduced his major housing initiative as follows:
“The goal of this strategy, to boost home ownership to 67.5% by the year 2000, would take us to an all-time high, helping as many as 8 million American families across that threshold”.
This target was maintained by President George W Bush. And in the subprime bubble, home ownership rose beyond Clinton’s target to reach 69.2% in 2005. But it has since fallen back to pre-1995 levels and the current figure of under 64% equals 1964 levels.
A major part of the problem is simple affordability. Younger people are the key demographic for home buying, as they constitute the critical first-time buyer group. But Pew data shows that 92% of recent population growth has been in minority communities, whose earnings are generally less than those of the white population.
US Bureau of Labor Statistics data show that while average annual US earnings were around $42,000 in 2015, there was a wide variation between the main racial groups:
- Whites earned $43,000 on average, and Asians $51,000
- But Blacks earned $32,000 on average and Hispanics $31,000
This means that the average ratio of house prices to earnings of 9.0x disguises a wide variation. Whites are close to the average at 8.7x, while Asians are below it at 7.4x. But for the younger Black and Hispanic populations, which are critical for driving first-time home buyer sales, the ratio rises to 11.6x for Blacks and 12.0x for Hispanics, based on US Census Bureau data for new home prices.
Unsurprisingly, latest National Association of Realtors data show the share of first-time home buyers is now at its lowest level since 1987 at just 32%, having fallen for the past 3 years.
What are companies and investors to do? As the infographic below describes, they have a clear choice ahead:
- They can either hope that somehow new stimulus policies will succeed despite past failure
- Or, they can join the Winners who are now starting to develop new revenue and profit growth by adopting demand-led strategies
These are the issues that we focus on in the Demand – the New Direction for Profit study. And since we published this just 2 months ago, it has become clear that the risks of assuming stimulus programmes will deliver their promised results are rising all the time.
“Within 20 years, we will be an economy that doesn’t depend mainly on oil“.
With that one statement, deputy Crown Prince Mohammed bin Salman (pictured above), changed the outlook for oil and energy markets. The world’s major oil producer, with the lowest cost, was signalling that the kingdom will no longer be supply-driven, focused on maximising oil revenue over the long term. And as the Prince told Bloomberg:
“We don’t care about oil prices—$30 or $70, they are all the same to us. This battle is not my battle.”
Thus the government’s new Vision statement is based on the assumption of a $30/bbl oil price in 2030 – in line with the long-term historical average. And one key element of this policy is the flotation of 5% of Saudi Aramco, the world’s largest oil company. Estimates suggest it is worth at least $2tn, meaning that 5% will be worth $100bn. And as I suggested to the Wall Street Journal yesterday:
“The process of listing will completely change the character of the company and demand a new openness from its senior management“.
Equally important is that the aim is to use the IPO to create the world’s largest sovereign wealth fund, which will not only include Aramco itself, but also real estate and other newly-privatised companies. This Public Investment Fund will have a value of between $2tn – $3tn, as the chart shows – meaning it could potentially buy the 4 largest public companies in the USA – Apple, Alphabet (Google), Microsoft and Berkshire Hathaway.
And the aim of this Fund will be to:
“Invest half its holdings overseas, excluding the Aramco stake, in assets that will produce a steady stream of dividends unmoored from fossil fuels”.
Why is this happening? Part of the answer, at least, is due to the financial crisis that engulfed Saudi this time last year. As the Prince’s financial adviser, Mohammed Al-Sheik, has explained, the post-2009 period of $100/bbl oil prices meant Saudi spending went:
“Beserk…with between 80 to 100 billion dollars of inefficient spending every year, about a quarter of the entire Saudi budget….At last April’s spending levels, Saudi would have gone completely broke by early 2017″.
It is clear from the Vision and the Prince’s interviews that this crisis was the catalyst for major change because:
“An oil price of 30-40-50 dollars spurs reforms (and enables Saudi) …to focus on the non-oil economy”
And now this change is underway. Saudi has already begun to boost its market share, selling on a spot basis (outside contract) to a Chinese refiner. And as the Prince has explained, Aramco in the process of being:
“Transformed from an oil and gas company to an energy/industrial company…We’re targeting many projects. Most important is building the first solar energy plant in Saudi Arabia. Aramco is now the biggest company in the world and it has the capability of controlling the shape of energy in the future and we want to venture into that from today.
Also, we want to develop the petrochemicals market that depends on oil and the services provided by some of the oil derivatives as well as some of the industries that we might create given the size of Aramco. For example, we could create a huge construction company under Aramco that will also be offered to the public and that services projects other than Aramco’s projects in Saudi. So all these projects that we announce will be how we transform Aramco from an oil and gas company to an industrial and an energy company.”
In their own way, therefore, these new policy statements are likely to be as critical for the global economy as President Xi Jinping’s speech to China’s economic policy conference in November 2013, which effectively abandoned the previous stimulus policy and prepared the way for his New Normal economic direction.
As I wrote then, “we cannot know if he will succeed in moving the economy towards a more sustainable future“. And the same is true, today, for Prince Mohammed’s new policies. But what is clear, is that anyone who still believes that oil prices will “inevitably” return to $100/bbl are fooling themselves, just as were those who argued in 2013 that President Xi would “inevitably” continue with “business as usual” policies.