Budgeting for paradigm shifts and a debt crisis

It is now 8 years since John Richardson and I published our 10-year forecast for 2021 in Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’. Remarkably, its core conclusions are very relevant today, as the summary confirms.

Unfortunately, as we feared, policymakers refused to junk their out-of-date models, despite the lesson of the 2008 financial crisis. Instead, they doubled down on their failed stimulus policies.

  • Yet nearly 1/3rd of the world’s High Income population are in the Perennials 55+ age group and are a replacement economy
  • As a result, and as we suggested in 2011, central bank policies have not, and cannot, produce sustainable growth or inflation

As a result, they have created record levels of government, corporate and individual debt – which can never be repaid. Even the IMF has now started to recognise the timebomb that has been created:

“We look at the potential impact of a material economic slowdown – one that is half as severe as the global financial crisis of 2007-08. Our conclusion is sobering: debt owed by firms unable to cover interest expenses with earnings, which we call corporate debt at risk, could rise to $19tn. That is almost 40% of total corporate debt in the economies we studied.”

Already we are starting to see the unwinding of some of the most extreme examples of the bubbles that have been created in asset prices:

And if the IMF are right, which is almost certain, we must expect major bankruptcies to take place over the next few years.  Over-leveraged businesses go bust very quickly when profits decline, as they can no longer pay their interest bills.

As with the run-up to the 2008 crisis, the signs of trouble are already building. The Fed has had to provide $200bn of support to overnight money markets in New York over the past 6 weeks, and is having to add another $60bn/month into next year.

Companies now face a binary choice as they finalise their Budgets for 2020-2022.

They can choose to ignore what is happening in the real world and continue to hope ‘business as usual’ will continue? Or they can start contingency planning by working through the implications of our forecasts for their Downside Scenario?

One key issue is that our 2021 predictions included paradigm shifts as well as economic forecasts. And as the chart above shows, the transitions associated with paradigm shifts are now accelerating:

  • It took decades for the telephone, electricity, autos and even the radio to reach most Americans
  • But it took only years for the microwave, computer, cellphone and internet to become mainstream

It is clear that a whole series of major paradigm shifts are now underway, as I noted 2 weeks ago:

  • Climate change is finally being taken seriously by legislators and many companies
  • This will lead to dramatic declines in the use of fossil fuels for both transport and petrochemicals
  • It highlights how sustainability is now the key issue for corporate strategy, replacing globalisation
  • Affordability is also moving up the agenda, and will become critical as the debt crisis starts to impact

The problem is that incumbents, as we have seen with central banks, are usually very slow to notice what is happening in the real world outside their office or factory.  The reason is simple – they forget what they have discussed with their friends and family once they go to work. Group-think instead takes over, and everyone goes blindly on believing their own propaganda until it is too late.

German car company VW was a classic example of a blinkered strategy. As top executives now recognise, it was only the “dieselgate” emissions disaster that enabled new management to introduce the Transform 2025 strategy based on a transition to Electric Vehicles.

Most companies don’t face the near-death challenge faced by VW in 2015. But they do face major challenges over the next 2-3 years, which will require them to implement major shifts in their strategy if they want to continue to grow revenue and profits in the future.

The good news is that these challenges can be turned into opportunities with hard work and imagination.  Please let me know if I can help you to achieve the necessary transformation.

Markets face major paradigm shifts as recession approaches

Major paradigm shifts are occurring in the global economy, as I describe in a new analysis for ICIS Chemical Business

Over the past 25 years, the budget process has tended to assume that the external environment will be relatively stable. 2008 was a shock at the time, of course, but many have now forgotten the near-collapse that occurred. Yet if we look around us, we can see that a number of major paradigm shifts are starting to occur in core markets – autos, plastics and others – which mean that ‘business as usual’ is highly unlikely to continue.

In turn, this means we can no longer operate a budget planning cycle on the assumption that demand will be a multiple of IMF GDP forecasts. Our business models will have to change in response to today’s changing demand patterns. Of course, change on this scale is always uncomfortable, but it will also create some major new opportunities.

Chemical companies in particular are clearly best placed to develop the new products and services that will be needed in a world where sustainability and affordability have become the key drivers for market success.

The transition periods created by paradigm shifts are never easy, however, due to the level of risk they create. The table gives my version of the key risks – you may well have your own list:

■ Global auto markets are already in decline, down 5% in January-August versus 2018, whilst the authoritative CPB World Trade Monitor showed trade down 0.7% in Q2 after a 0.3% fall in Q1

■ Liquidity is clearly declining in financial markets as China’s slowdown spreads, and Western political debate is ever-more polarised

■ The US$ has been rising due to increased uncertainty, creating currency risk for those who have borrowed in dollars; geopolitical risks are becoming more obvious

■ Some of the main “bubble stocks” such as WeWork, Uber and Netflix have seen sharp falls in their valuations, leading some investors to worry about “return of capital”

■ Chemical industry capacity utilisation, the best leading indicator for the global economy, has been in decline since December 2017, suggesting recession is close, and that bankruptcies among over-leveraged firms will inevitably increase

AUTOS PARADIGM SHIFT

The paradigm shift now underway in the global auto industry typifies the scale of the potential threat to sales and profits. Hundreds of thousands of jobs will likely be lost over the next 5-10 years in auto manufacturing and its supply chains as consumers transition to electric vehicles (EVs). The issue is that EVs have relatively few parts . And because there is much less to go wrong, many servicing jobs will also disappear.

The auto industry itself was the product of such a paradigm shift in the early 19th century, when the horse-drawn industry mostly went out of business. Now it is seeing its own shift, as battery costs start to reach the critical $100/kWh levels at which EVs become cheaper to own and operate than an internal combustion engine (ICE) on a total cost of ownership basis.

China currently accounts for two-thirds of global EV sales and sold nearly 1.3m EVs in 2018 (up 62% versus 2017). They may well take 50% of the Chinese market by 2025, as the government is now focused on accelerating the transition via the rollout of a national charging network. Importantly, though, Europe is likely to emerge as the main challenger to China in the global EV market.

VW is likely to be one of the winners in the new market. It plans to spend €80bn to produce 70 EV models based on standardised motors, batteries and other components. This will enable it to cut costs and accelerate the roll-out:

■ Its new flagship ID.3 model will go on sale next year at a mid-market price of €30k ($33k)

■ Having disrupted that market segment, it will then expand into cheaper models

■ And it expects a quarter of its European sales to run on battery power by 2025

The risk for suppliers to the auto industry is that the disruption caused creates a new playing field. Those who delay making the investments required are almost certain to become losers. The reason is simple – if today’s decline in auto sales accelerates, as seems likely, the investment needed for EVs will become unaffordable for many companies.

Nothing lasts forever. ‘Business as usual’ was a great strategy for its time. But it is clear that future winners will be those who recognise that the disruptive paradigm shifts now underway require new thinking and new business models. Companies who successfully transition to focus on sustainability and affordability will be the great winners of the future.

Please click here if you would like to read the full analysis