There are few real surprises in life, and President Trump’s decision to launch a full-scale trade war with China wasn’t one of them. He had virtually promised to do this in his election campaign, as I noted here back in September 2015:
“The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat. People no longer needed to argue over “who got what” as there seemed to be plenty for everyone. But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels.
“Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.”
Of course, I received major push-back for this view at the time, just as I did in 2007-8 when warning of a likely US subprime crisis. Most people found it very hard to believe that politics could trump economic logic, as one American commentator wrote in response to my analysis:
“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors”.
But, sadly or not, depending on your political persuasion, my conclusion after the election result was known seems to have stood the test of time:
“You may, or may not, approve of President-elect Trump’s policies. You may, or may not, think that these policies are destined to fail. But they do confirm that the world is moving into a New Normal, which will inevitably create Winners and Losers.
“The Winners are likely to come from those who accept that President Trump will at least try to introduce the policies proposed by Candidate Trump. And the Losers will almost inevitably include those who continue to believe he represents “business as usual”.”
Now, of course, we will start to see these Winners and Losers appear, as there is little the Western central banks can do to counteract the economic cost for the global economy of a US-China trade war.
One sign of this was Uber’s miserable performance on its stock market debut – despite having been priced at the low end of the planned range, it still fell further on its opening, in line with my suggestion last month that Uber’s $91bn IPO marks the top for today’s debt-fuelled stock markets.
But there will be many more serious casualties over the next few months and years:
- NE Asian countries such as Japan and S Korea are part of global supply chains which send a wide range of components to China, where they are incorporated into finished goods for sale to the USA
- Germany and the major European countries have relied on sales to China to boost economic growth, as domestic demand has stagnated, and clearly this support is now going to weaken
- The mining industry and other suppliers of commodities will also be hit – Rio Tinto, for example, depends on China for 45% of its revenue, and on the USA for 15%
- The petrochemicals industry has been dependent on China for its growth since the 2008 financial crisis, as I noted last summer, US-China tariffs could lead to global Polyethylene price war
Back in 2011-12, John Richardson and I wrote ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’ to give our view of the likely consequences of the major demographic changes underway in the global economy.
Unfortunately, the politicians of the time took the seemingly easy route out of the crisis. They decided that printing money was so much easier than having a dialogue with the electorate about the implications of ageing populations, or the fact that Western fertility rates have been below replacement levels for the past 45 years. Our warning is now coming true:
“The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.
“Companies will need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.
“We could instead decide to ignore all of this potential unpleasantness.
“But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.“
The chemical industry is easily the best leading indicator for the global economy. And thanks to Kevin Swift and his team at the American Chemistry Council, we already have data showing developments up to October, as the chart shows.
It confirms that consensus hopes for a “synchronised global recovery” at the beginning of the year have again proved wide of the mark. Instead, just as I warned in April (Chemicals flag rising risk of synchronised global slowdown), the key indicator – global chemical industry Capacity Utilisation % – has provided fair warning of the dangers ahead.
It peaked at 86.2%, in November 2017, and has fallen steadily since then. October’s data shows it back to June 2014 levels at 83.6%. And even more worryingly, it has now been falling every month since June. The last time we saw a sustained H2 decline was back in 2012, when the Fed felt forced to announce its QE3 stimulus programme in September. And it can’t do that again this time.
The problem, as I found when warning of subprime risks in 2007-8 (The “Crystal Blog” foresaw the global financial crisis), is that many investors and executives prefer to adopt rose-tinted glasses when the data turns out to be too downbeat for their taste. Whilst understandable, this is an incredibly dangerous attitude to take as it allows external risks to multiply, when timely action would allow them to be managed and mitigated.
It is thus critical that everyone in the industry, and those dependent on the global economy, take urgent action in response to BASF’s second profit warning, released late on Friday, given its forecast of a “considerable decrease of income” in 2018 of “15% – 20%”, after having previously warned of a “slight decline of up to 10%”.
I have long had enormous respect for BASF and its management. It is therefore deeply worrying that the company has had to issue an Adjustment of outlook for the fiscal year 2018 so late in the year, and less than 3 weeks after holding an upbeat Capital Markets Day at which it announced ambitious targets for improved earnings in the next few years.
The company statement also confirmed that whilst some problems were temporary, most of the issues are structural:
- The impact of low water on the Rhine has proved greater than could have been earlier expected
- But the continuing downturn in isocyanate margins has been ongoing for TDI since European contract prices peaked at €3450/t in May — since when they had fallen to €2400/t in October and €2050/t in November according to ICIS, who also reported on Friday that
“Supply is still lengthy at year end in spite of difficulties at German sellers BASF and Covestro following low Rhine water levels”
- The decline is therefore a very worrying insight into the state of consumer demand, given that TDI’s main applications are in furniture, bedding and carpet underlay as well as packaging applications.
- Even more worrying is the statement that:
“BASF’s business with the automotive industry has continued to decline since the third quarter of 2018; in particular, demand from customers in China slowed significantly. The trade conflict between the United States and China contributed to this slowdown.”
This confirms the warnings that I have been giving here since August when reviewing H1 auto sales (Trump’s auto trade war adds to US demographic and debt headwinds).
I noted then that President Trump’s auto trade tariffs were bad news for the US and global auto industry, given that markets had become dangerously dependent on China for their continued growth:
- H1 sales in China had risen nearly 4x since 2007 from 3.1m to 11.8m this year
- Sales in the other 6 major markets were almost unchanged at 23m versus 22.1m in 2007
Next year may well prove even more challenging if the current “truce” over German car exports to the USA breaks down,
INVESTORS HAVE WANTED TO BELIEVE THAT INTEREST RATES CAN DOMINATE DEMOGRAPHICS
The recent storms in financial markets are a clear sign that investors are finally waking up to reality, as Friday night’s chart from the Wall Street Journal confirms:
“In a sign of the breadth of the global selloff in stocks, Germany’s main stock index fell into a bear market Thursday, the latest benchmark to have tumbled 20% or more from its recent peak….Other markets already in bear territory are home to companies exposed to recent trade fights between the U.S. and China.”
The problem, as I have argued since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, again“, in 2011 with John Richardson, is that the economic SuperCycle created by the dramatic rise in the number of post-War BabyBoomers is now over.
I highlighted the key risks is my annual Budget Outlook in October, Budgeting for the end of “Business as Usual”. I argued then that 2019 – 2021 Budgets needed to focus on the key risks to the business, and not simply assume that the external environment would continue to be stable. Since then, others have made the same point, including the president of the Council on Foreign Relations, Richard Haas, who warned on Friday:
“In an instant Europe has gone from being the most stable region in the world to anything but. Paris is burning, the Merkel era is ending, Italy is playing a dangerous game of chicken with the EU, Russia is carving up Ukraine, and the UK is consumed by Brexit. History is resuming.”
It is not too late to change course, and focus on the risks that are emerging. Please at least read my Budget Outlook and consider how it might apply to your business or investments. And please, do it now.
You can also click here to download and review a copy of all my Budget Outlooks 2007 – 2018.
We are living in very uncertain times, where the only certainty is that there is no “business as usual” option for the future. One sign of this is that the extraordinary has become ordinary :
□ The FBI appear convinced Russia’s government targeted last year’s US elections: US President Trump and his former FBI head have since accused the other of lying about the issue
□ UK premier Theresa May has just lost an election she had expected to win by a landslide, and is now engaged in a probably futile attempt to remain in power
We have not seen political chaos on this scale since the 1970s. Yet unlike the 1970s, markets continue to bury their heads in the sand, in the mistaken belief that the central banks will always be able to ensure that prices never fall.
The problem is two-fold:
□ Most investors and company executives grew up during the BabyBoomer-led economic SuperCycle. They have never known a world where growth disappointed, and where political stalemate led to major economic crises
□ Central bank policies have made the underlying situation worse, not better. They have artificially boosted the value of financial assets (stocks, houses and commodities) whilst creating vast amounts of debt that can never be repaid
Even worse is that a generational divide has opened up in both the US and UK, as most assets are owned by older people. Younger people instead find themselves burdened by high levels of student debt, and facing a future where weekly earnings are no longer rising in inflation-adjusted terms.
KEY AREAS OF TRUMP’S AGENDA HAVE FAILED TO MOVE FORWARD
It was clear when President Trump came to power that we had reached the end of “business as usual“. He immediately set about creating major disruption in global trade patterns:
□ He cancelled the TransPacific Partnership which would have linked 11 Pacific countries with the USA
□ He also notified Congress of his intention to renegotiate the North American Free Trade Agreement
□ More recently, he announced his intention to withdraw from the Paris Climate Change Agreement, COP-21
Unsurprisingly, push-back is now developing against these dramatic changes. On COP-21, powerful opponents such as Michael Bloomberg have begun to co-ordinate moves by several key states, cities and companies to instead “do everything that America would have done if it stayed committed” to the Agreement.
Trump’s other major policy move – the lifting of restrictions on the development of fossil fuels – is also seeing push-back, this time from the markets. Oil prices are already back to pre-election levels, and are likely to go much lower as new US production comes online.
Trump’s position is also weakened by his failure to recruit a large team of highly skilled people, capable of promoting his agenda with all the relevant stakeholders. So far, he has only nominated 83 people to fill the 558 key positions in his Administration that require Senate confirmation. In the Dept of Commerce, only 7 of the 21 key positions have been nominated; in Energy, only 3 out of 22; in Treasury, only 10 out of 28.
As a result, the US now seems likely to face political stalemate. Trump clearly has a mandate to push through his changes. But every day that passes makes it less likely that his key policy objectives – healthcare/tax reform and infrastructure spending – can be implemented.
The problem is simple – every new President has only a short “window of opportunity” to implement his policies, as their post-election momentum soon starts to disappear. By Labor Day (4 September), legislators are refocusing on next year’s mid-term elections. Their ability to make the compromises necessary for major legislation soon disappears, once the “losers” from any change make their voices heard.
MAY’S ELECTION FAILURE CREATES AN OPENING FOR CORBYN
Last Thursday’s election result confirmed my analysis back in October that:
“In the UK, where most pundits regard the populist Labour Party leader, Jeremy Corbyn, as unelectable due to his radical socialist and pacifist agenda, it would only take a breakdown in the Brexit negotiations for his chances of gaining power to rapidly improve.”
The breakdown duly occurred with May’s decision to adopt a “hard Brexit”. May, like Trump, relied on a small group of advisers and failed to recruit the team needed to push through her ambitious agenda of total EU withdrawal. The result, as I noted last month, was that the “UK risked crashing out of EU after election without a trade deal“.
This stance created fertile ground for Corbyn as he mobilised large numbers of young people to vote for the first time. They quickly realised that their future was at stake, given that the Brexit negotiations are due to start on June 19.
May will clearly try to hang on – but she is unlikely to succeed for very long. Corbyn’s move to propose giving EU citizens full rights after Brexit could easily be the straw that brings May down, as leading Tories such as Ken Clarke and others would no doubt vote with him.
As in the US, political stalemate is likely to develop. Brexiteers no longer have a mandate for a “hard Brexit”, where the UK would leave the EU without access to the Single Market and Customs Union. But neither can Remainers easily reverse the formal EU exit process, which will see the UK leave the EU by March 2019.
MARKETS ARE IN A METASTABLE STATE
Markets cannot continue to ignore these developments for much longer. They are in what scientists would call a metastable state. The detail of the next move is uncertain – and the only certainty is that the status quo is untenable:
□ There is no going back to the SuperCycle: the Western world faces a demand deficit due to its ageing population
□ Equally, there is no obvious and easy route forward, until policymakers focus on the “impact of the 100-year life”
As a result, markets will soon be forced to rediscover the negative impact of political stalemate. Probably Winston Churchill’s famous comment after the Allies’ victory at El Alamein in 1942 best describes the position:
“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”
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.
Until recently, the job description for a UK (and most Western) politician has been fairly simple – look good on television, and only say something when it has been approved by a focus group. The reward was the ability to jet off to important sounding meetings of the G7 and G20, and have agreeable dinners at Summit meetings.
There was no sense that, as was the case before the economic SuperCycle, that politicians needed to have a clear view about economic policy, and what they wanted to achieve. Instead, this “detail” was the responsibility of the central banks, with their seemingly magical powers to guide a global economy of 7.3bn people by printing money and reducing interest rates. Most senior politicians in Europe, the USA and Japan clearly still believe in this presumed ability of their central banks to implement NICE policies that create Non-Inflationary Constant Expansion.
One case study for this behaviour has been the UK Conservative Party, where schoolboy politics has instead come to dominate. Historians will focus on the Brexit debate as the great example. Neither David Cameron for Remain, or Boris Johnson and Michael Gove for Leave, had any understanding of the dark forces around the immigration issue that they unleashed during the campaign. They all assumed a Remain vote was inevitable, and saw the vote itself as simply a proxy for the really interesting battle (for them at least) to be prime minister.
This meant that neither side bothered to prepare a Plan to handle a UK vote to leave the European Union. As a result, Cameron was forced to tell his 27 fellow EU leaders last week that he had no plan at all for dealing with a Brexit vote. Similarly, Johnson simply ducked the issue and went off to play cricket after the result, whilst Gove’s wife has revealed he went to bed whilst the votes were being counted.
Tragedy is always close to farce, and we can see that in the events of the past week, since the Brexit vote. Gove’s comment, “Gosh, I suppose I had better get up!” summarises the shallowness of the preparation for an event which could completely change the course of British history, as well as Europe and the world.
The writing is now on the wall for this wishful thinking. The world’s demographic deficit means the global economy has a demand deficit. Even central bankers are starting to realise they cannot possibly deliver on the expectations they have created. As the Governor of the Bank of England, Mark Carney, clearly stated last week:
“The future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of monetary policymakers.”
Unfortunately, the Brexit vote means that the UK is effectively going to be a test-bed for what happens next, now that the “cult of the central banks” is drawing to a close. And who therefore knows whether Dutch premier Mark Rutte (a long-time UK friend) over-stated the risks with his warning last week:
“England has collapsed politically, monetarily, constitutionally and economically.”
However, although it may be too late, some change does finally seem to be underway, as the photos illustrate:
- We appear to be seeing the end of the schoolboy politics that has dominated for too long
- Instead, it appears that Teresa May, currently Home Secretary, is favourite to become UK prime minister
- Nicola Sturgeon is already First Minister of Scotland, and Arlene Foster of N Ireland
These women appear to be more prepared to take responsibility for the impact of their actions.
May’s first campaign promise was that she would not trigger the start of negotiations to leave the EU “until next year at the earliest“. She clearly understands that nobody on either side has any idea of how to conduct these discussions, let alone what they should cover. This wise decision immediately sets her apart from her schoolboy predecessors, who thought 43 years of economic and legal union could be replaced more or less overnight.
Will May be successful in returning the UK to the world of grown-up politics? Will she get ambushed on the way, as Michael Gove ambushed his supposed friend and colleague Boris Johnson on Thursday? Or will the crisis now facing the UK and EU economies make it impossible for rational debate to take place?
We cannot know the answer.
But we can hope that the events of the past 10 days have begun to change the nature of political debate, at least in the UK. It even seems possible that the schoolboy socialist, Jeremy Corbyn, could soon be replaced as leader of the opposition Labour Party – in which case, the government might also start to be properly held to account for its actions.
But whatever happens now, difficult times still lie ahead for the UK and the world economy:
- As The Telegraph confirms, the UK has hardly anyone with experience of global trade negotiations – nor, indeed, the lawyers to turn their agreements into law. Even the job of assessing what to do about the 12,295 EU Regulations now part of UK law will take years rather than months to resolve
- Similarly, nobody in the world has any experience of a situation where its 5th largest economy suddenly decides to tear up its past 43 years of history, and start again with a clean sheet of paper – as the UK did 2 weeks ago
No adult politician would ever have risked putting their country into such a absurd and potentially risky situation.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 53%
Naphtha Europe, down 52%. “The European naphtha market is seen as fairly weak, balanced to long, with demand of light virgin naphtha said to be low.”
Benzene Europe, down 55%. “Higher US pricing supports Europe”
PTA China, down 39%. “Buying sentiment was thin in the week, as buyers took into account the volatile upstream energy prices and stayed on the sidelines”
HDPE US export, down 33%. “Increased supply across most other grades caused prices to slip by a few pennies”
US$ Index, up 17%
S&P 500 stock market index, up 8%
Global chemical industry sales are around $3tn a year, close to 5% of global GDP. They are even larger when converted into all the products that we actually use on a day-to-day basis such as plastics, coatings, fibres, agrochemicals etc. And thanks to the American Chemistry Council, we have near real-time data of core trends such as capacity utilisation (CU%).
This is why the industry is the best leading indicator that we have for the global economy.
The chart above confirms the clear picture of weakness that has re-emerged over the past year:
- The post-2008 Crisis recovery was relatively weak, with the CU% peaking at just 85.7% in March 2011
- This was below anything seen in the 1987 – H1 2008 period, when the lowest CU% level was 86.3% in H1 2002
- Even more worrying is that CU% has been in a renewed decline for the past year
- It is now down at 79.3% versus 81% a year ago in May 2015
The drop is even more worrying when one remembers that consumers have generally been building inventory over the past few months – seeking to buy forward ahead of price increases caused by the rising oil price. Without this support, the CU% would presumably have been even lower. And of course, the unwinding of this inventory will now have a negative impact on CU% in H2, unless the oil price rises further for some reason.
The performance in the main Regions adds further cause for concern:
- N American production rose just 1.3% in May, despite the ramp-up of new shale gas based capacity
- Latin America kept falling and was down 5.6%, whilst W Europe was up just 0.3%
- Central/Eastern Europe was up just 2.6% versus 3.4% in January, although Russia was up 5.1%
- India was up only 0.8% versus 6.4% in December (that’s not a typo)
- Japan was up only 2.5%, nearly halving from December’s 4.6%
- Only China and the Middle East are on an improving trend – China is up 6.4% as it boosts its self-sufficiency; whilst the Middle East is up 7.1% as it boosts exports and Iran returns to global markets
The key question, of course, is whether H2 sees any improvement? This seems unlikely following the Brexit vote, which is already having an impact on confidence within and outside Europe. Plus there is the uncertainty over the outcome of the US Presidential election, which has clearly set nerves on edge around the world.
This is the New Normal world, unfortunately, where political and social issues assume equal or even greater importance than economic issues. It is very hard to adjust to these changed priorities, particularly as the pace of change keeps increasing.
Who would have thought a year ago, for example, that in the UK both major political parties would now be holding leadership elections? Or that a man of the moment would be Nigel Farage of the UK Independence Party – who had failed once again in May 2015 to win a seat in Parliament?
Truth is indeed proving stranger than fiction. And who knows what shocks are yet to come, as we move into H2?