Paradigm shifts create Winners and Losers

MY ANNUAL BUDGET OUTLOOK WILL BE PUBLISHED NEXT WEEK
Next week, I will publish my annual Budget Outlook, covering the 2020-2022 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.

LAST YEAR’S OUTLOOK WARNED OF KEY RISKS TO THE ECONOMY AND BUSINESS
My argument last year was that companies should be ‘Budgeting for the end of ‘Business as Usual‘:

A year later, this view is starting to become consensus:

  • Global auto markets are now clearly in decline, down 5% in January-September versus 2018, whilst the authoritative CPB World Trade Monitor showed trade down 0.8% in Q2 after a 0.3% fall in Q1
  • Liquidity is clearly declining in financial markets as China’s slowdown spreads, and US repo markets confirm: 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
  • “Bubble stocks” such as WeWork, Uber and Netflix have seen sharp falls in their valuations, leading at least some investors to worry about “return of capital”
  • The ongoing decline in global chemicals Capacity Utilisation, the best leading indicator for the global economy, suggests recession is close. This will lead to bankruptcies in over-leveraged firms and to major downgrades in the BBB corporate bond market

The rising risks in the US repo market confirm the concerns over the level of debt in global markets.

Developments over the past month suggest New York markets are now systemically short of overnight money, with the Fed’s balance sheet suddenly starting to expand again. It was $3.76tn on 4 Sept, but reached $3.97tn on 16 October, a $210bn rise in just 5 weeks.

It is therefore looking more and more likely that we are at the start of a  global debt crisis.

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.

Unfortunately, they also have a political dimension, as they encourage voters to listen to new voices, such as the Populists, who offer seemingly simple solutions to the problems which have been ignored by the elites.

The one redeeming feature of the 2008 Crisis was that global leaders did at least manage to come together to restore financial liquidity.  It is hard to be confident that this would happen again, if a debt crisis does begin.

Companies ignore the Perennials 55+ generation at their peril

Nearly a third of the the world’s High Income population are now in the Perennials 55+ generation.

Yet companies mostly ignore their needs – assuming that all they want are walking sticks and sanitary pads.  Instead, they continue to focus on the relatively declining number of younger people.

No wonder many companies are going bankrupt, and many investors are seeing their portfolios struggle.  As the chart shows:

  • The High Income group accounts for nearly two-thirds of the global economy
  • It includes everyone with an income >$12k/year, equal to $34/day
  • 31% of those in the world’s High Income population are now Perennials aged 55+
  • In other words, High Income Perennials account for a fifth of the global economy

This is a vast change from 1950, when most people still died around pension age.  But it seems very few people have realised what has happened.  When we talk about the global population expanding, we all assume this means more babies being born.  But in fact, 422m of the 754m increase in population between now and 2030 will be Perennials – only 120m will be under-25s.

It is therefore no surprise that central bank stimulus policies have failed.  Rather than focusing on this growth sector, they have instead slashed interest rates to near-zero.  But, of course, this has simply destroyed the spending power of the Perennials, as the incomes from their savings collapsed.

If the central banks had been smarter, they would have junked their out-of-date models long ago.  They would have instead encouraged companies to wake up to this new opportunity, and create new products and services to meet their needs.  Instead, companies and most investors have also continued to look backwards, focusing on the growth markets of the past.

The Perennials are the great growth opportunity of our time. Their needs are more service-based than product-focused – they want mobility,  for example, but aren’t so bothered about actually owning a car.  But it’s not too late to get on board with the opportunity, as the number of Perennials is going to continue to grow, thanks to the marvel of increased life expectancy.

I explore this opportunity in more detail in a new podcast with Will Beacham – please click here to download it.

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

Ageing Perennials set to negate central bank stimulus as recession approaches

The world’s best leading indicator for the global economy is still firmly signalling recession.  That’s the key conclusion from the chart above, showing latest data on global chemical industry Capacity Utilisation (CU%) from the American Chemistry Council.

The logic behind the indicator is compelling:

  • Chemicals are one of the world’s largest industries, and also one of the most diverse
  • Every country in the world uses relatively large volumes of chemicals
  • And their applications cover virtually all sectors of the economy
  • They include plastics, energy and agriculture as well as detergents and textiles

If you want to know the outlook for the global economy, the chemical industry will provide the answers.

It also has an excellent correlation with IMF data, and benefits from the fact it has no “political bias”. It simply tells us what is happening in real-time in the world’s 3rd largest industry.

And now it is telling us that the CU% is continuing to fall. It was down at 83.1% in January, well below the long-term average of 86.5%.  In fact, it has fallen sharply from that level since December 2017.

Ironically, it was exactly a year ago that the world’s major central banks were congratulating themselves on the success of their policies. “Yes”, they said, “it had taken longer than expected, but we can finally declare victory for our post-2008 stimulus policies”.

Unfortunately, however, this confidence was misplaced as the second chart suggests.

It shows there was a brief rebound in 2010 after the 2008 Crisis as the first round of stimulus took place. But then growth fell back again.

Instead of learning the lesson, the banks decided to do more of the same.  But repeating the same action in the hope of a different result is not terribly sensible.  And so it has proved.

Next month will see the IMF’s new estimate for 2018’s GDP growth (black line). Chemical industry CU% data (the red line) suggests it will have to be revised downwards, once again.

Already, it seems, the central banks are preparing their next round of stimulus. They have finally recognised the slowdown underway in the key areas of the economy such as autos, housing and electronics:

  • China has already panicked, with January seeing record levels of loans
  • Similarly the US Federal Reserve has promised it will go slowly with any further interest rate rises, or might even reduce them
  • The Bank of Japan’s former deputy governor has warned of recession as global demand weakens
  • Most recently, the European Central Bank has completely reversed course, after suggesting as recently as December that strong growth meant further stimulus was unnecessary

As the 3rd chart shows, the key aim for the western central banks is simply to support stock markets such as the S&P 500. They are determined to keep them moving steadily upwards, in the belief this will stimulate growth. But this, of course, is wishful thinking.  As the Financial Times reported last week, the combined result of stimulus and President Trump’s tax cuts has been that:

“US companies handed their shareholders a record-shattering $1.25tn through dividends and buybacks last year, lifting the post-crisis bonanza to nearly $8tn.”

And as the independent Pew Research Center reported last year:

“Today’s real average wage (that is, the wage after accounting for inflation) has about the same purchasing power it did 40 years ago. And what wage gains there have been have mostly flowed to the highest-paid tier of workers.”

YOU CAN’T PRINT BABIES – AND IT IS PEOPLE THAT CREATE DEMAND

The final chart highlights the “problem” for the central banks.  Their financial models, and all their thinking, are based on the experience of the post-1945 BabyBoomer SuperCycle.

The vast numbers of babies born between 1946-70 first created massive inflation in the 1960s-70s, as demand outstripped supply. But then they created more or less constant growth as the Boomers moved into the workforce. They turbo-charged demand as Western women stopped having enough children to replace the population after 1970, and instead went back into the workforce – creating the two-income family for the first time in history.

But after 2000, this growth began to weaken as the oldest Boomers moved out of the Wealth Creator 25 – 54 age group, when consumption peaks along with earnings.  And today’s “problem” is really that, wonderfully, we now have a entirely new generation of Perennials aged 55+.

They will soon be over one-fifth of the global population, double the percentage in 1950.  In the developed western economies, they are already a third of the population, due to the collapse of fertility rates.  This is great news for us as individuals. But it is bad news for economic growth as Perennials already own most of what they need, and their earnings reduce as they retire.

The S&P 500 and other asset markets are already rising due to central bank promises of more support.

But one thing is certain. Third time around, the main result of more stimulus will again be to increase today’s already high levels of debt and inequality.  It cannot return us to SuperCycle levels of growth.