The End of “Business as Usual”

In my interview for Real Vision earlier this month, (where the world’s most successful investors share their thoughts on the markets and the biggest investment themes), I look at what data from the global chemical industry is telling us about the outlook for the global economy and suggest it could be set for a downturn.

“We look at the world and the world economy through the lens of the chemical industry. Why do we do that? Because the chemical industry is the third largest industry in the world after energy and agriculture. It gets into every corner of the world. Everything in the room which you’ll be watching this interview is going to have chemicals in it. And the great thing is, we have very good, almost real time data on what’s happening.

“Our friends at the American Chemistry Council have data going back on production and capacity utilization since 1987. So 30 years of data, and we get that within 6 to 8 weeks of the end of the month. So whereas, if you look at IMF data, you’re just looking at history, we’re looking at this is what’s actually going on as of today.

“We look, obviously, upstream, as we would call it, at the oil and feedstocks markets, so we understand what’s happening in that area. But we also– because the chemical industry is in the middle of the value chain, you have to be like Janus. You have to look up and down at the same time, otherwise one of these big boys catches you out.

“And so we look downstream. And we particularly look at autos, at housing, and electronics, because those are the big three applications. And of course, they’re pretty big for investors as well. So we see the relative balance between what’s happening upstream, what’s  happening downstream, where is demand going, and then we see what’s happening in the middle of that chain, because that’s where we’re getting our data from.

“As the chart shows, our data matches pretty well to IMF data. It shows changes in capacity utilization, which is our core measurement. If if you go back and plot that against history from the IMF, there is very, very good correlation. So what we’re seeing at the moment– and really, we’ve been seeing this since we did the last interview in November— is a pretty continuous downturn.

“One would have hoped, when we talked in November, we were talking about the idea that things have definitely cooled off. Some of that was partly due to the oil price coming down. Some of that was due to end of year destocking. Some of that was due to worries about trade policy. Lots of different things, but you would normally expect the first quarter to be fairly strong.

“The reason for this is that the first quarter– this year, particularly– was completely free of holidays.  Easter was late, so there was nothing to interrupt you there. There was the usual Lunar New Year in China, but that always happens, so there’s nothing unusual about that.

And normally what happens is, that in the beginning of the new year, people restock. They’ve got their stock down in December for year end purposes, year end tax purposes, now they restock again. And of course, they build stock because the construction season is coming along in the spring and people tend to buy more cars in that period, and electronics, and so on.

“So everything in the first quarter was very positive. And one wouldn’t normally be surprised to start seeing stock outs in the industry, particularly after a quiet period in the fourth quarter. And unfortunately, we haven’t seen any of that. We’ve seen– and this is worth thinking about for a moment– we’ve seen a 25% rise in the oil price because of the OPEC Russia deal, but until very recently we haven’t seen the normal stock build that goes along with that.”

 

As we note in this month’s pH Report, however, this picture is now finally changing as concern mounts over oil market developments – where unplanned outages in Venezuela and elsewhere are adding to the existing cutbacks by the OPEC+ countries. Apparent demand is therefore now increasing as buyers build precautionary inventory against the risk of supply disruption and the accompanying threat of higher prices.

In turn, this is helping to support a return of the divergence between developments in the real economy and financial markets, as the rise in apparent demand can easily be mistaken for real demand. The divergence is also being supported by commentary from western central banks.  This month’s IMF meeting finally confirmed the slowdown that has been flagged by the chemical industry since October, but also claimed that easier central bank policies were already removing the threat of a recession.

We naturally want to hope that the IMF is right. But history instead suggests that periods of inventory-build are quickly reversed once oil market concerns abate.

Please click here if you would like to see the full interview.

Fed’s magic money tree hopes to overcome smartphone sales downturn and global recession risk

Last November, I wrote one of my “most-read posts”, titled Global smartphone recession confirms consumer downturn. The only strange thing was that most people read it several weeks later on 3 January, after Apple announced its China sales had fallen due to the economic downturn.

Why did Apple and financial markets only then discover that smartphone sales were in a downturn led by China?  Our November pH Report “Smartphone sales recession highlights economic slowdown‘, had already given detailed insight into the key issues, noting that:

“It also confirms the early warning over weakening end-user demand given by developments in the global chemical industry since the start of the year. Capacity Utilisation was down again in September as end-user demand slowed. And this pattern has continued into early November, as shown by our own Volume Proxy.

The same phenomenon had occurred before the 2008 Crisis, of course, as described in The Crystal Blog.  I wrote regularly here, in the Financial Times and elsewhere about the near-certainty that we were heading for a major financial crisis. Yet very few people took any notice.

And even after the crash, the consensus chose to ignore the demographic explanation for it that John Richardson and I gave in ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’.

Nothing seems to change.  So here we are again, with the chart showing full-year 2018 smartphone sales, and it is clear that the consumer downturn is continuing:

  • 2018 sales at 1.43bn were down 5% versus 2017, with Q4 volume down 6% versus Q4 2017
  • Strikingly, low-cost Huawei’s volume was equal to high-priced Apple’s at 206m
  • Since 2015, its volume has almost doubled whilst Apple’s has fallen 11%

And this time the financial outlook is potentially worse than in 2008.  The tide of global debt built up since 2008 means that the “World faces wave of epic debt defaults” according to the only central banker to forecast the Crisis.

“WALL STREET, WE HAVE A PROBLEM”

So why did Apple shares suddenly crash 10% on 3 January, as the chart shows? Everything that Apple reported was already known.  After all, when I wrote in November, I was using published data from Strategy Analytics which was available to anyone on their website.

The answer, unfortunately, is that markets have lost their key role of price discovery. Central banks have deliberately destroyed it with their stimulus programmes, in the belief that a strong stock market will lead to a strong economy. And this has been going on for a long time, as newly released Federal Reserve minutes confirmed last week:

  • Back in January 2013, then Fed Governor Jay Powell warned that policies “risked driving securities above fundamental values
  • He went on to warn that the result would be “there is every reason to expect a sharp and painful correction
  • Yet 6 years later, and now Fed Chairman, Powell again rushed to support the stock market last week
  • He took the prospect of interest rate rises off the table, despite US unemployment dropping for a record 100 straight months

The result is that few investors now bother to analyse what is happening in the real world.

They believe  they don’t need to, as the Fed will always be there, watching their backs. So “Bad News is Good News”, because it means the Fed and other Western central banks will immediately print more money to support stock markets.

And there is even a new concept, ‘Modern Monetary Theory’ (MMT), to justify what they are doing.

THE MAGIC MONEY TREE PROVIDES ALL THE MONEY WE NEED

There are 3 key points that are relevant to the Modern Monetary Theory:

  • The Federal government can print its own money, and does this all the time
  • The Federal government can always roll over the debt that this money-printing creates
  • The Federal government can’t ever go bankrupt, because of the above 2 points

The scholars only differ on one point.  One set believes that pumping up the stock market is therefore a legitimate role for the central bank. As then Fed Chairman Ben Bernanke argued in November 2010:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

The other set believes instead that government can and should spend as much as they like on social and other programmes:

“MMT logically argues as a consequence that there is no such thing as tax and spend when considering the activity of the government in the economy; there can only be spend and tax.

The result is that almost nobody talks about debt any more, and the need to repay it.  Whenever I talk about this, I am told – as in 2006-8 – that “I don’t understand”.  This may be true. But it may instead be true that, as I noted last month:

“Whilst Apple won’t go bankrupt any time soon, weaker companies in its supply chain certainly face this risk – as do other companies dependent on sales in China. And as their sales volumes and profits start to fall, investors similarly risk finding that large numbers of companies with “Triple B” ratings have suddenly been re-rated as “Junk”:

  • Bianco Research suggest that 14% of companies in the S&P 1500 are zombies, with their earnings unable to cover interest expenses
  • The Bank of International Settlements has already warned that Western central banks stimulus lending means that >10% of US/EU firms currently “rely on rolling over loans as their interest bill exceeds their EBIT. They are most likely to fail as liquidity starts to dry up”.

I fear the coming global recession will expose the wishful thinking behind the magic of the central banks’ money trees.

CEOs need new business models amid downturn

Many indicators are now pointing towards a global downturn in the economy, along with paradigm shifts in demand patterns. CEOs need to urgently build resilient business models to survive and prosper in this New Normal world, as I discuss in my 2019 Outlook and video interview with ICIS.

Global recession is the obvious risk as we start 2019.  Last year’s hopes for a synchronised global recovery now seem just a distant memory.  Instead, they have been replaced by fears of a synchronised global downturn.

Capacity Utilisation in the global chemical industry is the best leading indicator that we have for the global economy.  And latest data from the American Chemistry Council confirms that the downtrend is now well-established.  It is also clear that key areas for chemical demand and the global economy such as autos, housing and electronics moved into decline during the second half of 2018.

In addition, however, it seems likely that we are now seeing a generational change take place in demand patterns:

  • From the 1980s onwards, the demand surge caused by the arrival of the BabyBoomers into the Wealth Creating 25 – 54 cohort led to the rise of globalisation, as companies focused on creating new sources of supply to meet their needs
  • At the same time the collapse of fertility rates after 1970 led to the emergence of 2-income families for the first time, as women often chose to go back into the workforce after childbirth. In turn, this helped to create a new and highly profitable mid-market for “affordable luxury”
  • Today, however, only the youngest Boomers are still in this critical generation for demand growth. Older Boomers have already moved into the lower-spending, lower-earning 55+ age group, whilst the younger millennials prefer to focus on “experiences” and don’t share their parents’ love of accumulating “stuff”

The real winners over the next few years will therefore be companies who not only survive the coming economic downturn, but also reposition themselves to meet these changing demand patterns.  A more service-based chemical industry is likely to emerge as a result, with sustainability and affordability replacing globalisation and affordable luxury as the key drivers for revenue and profit growth.

Please click here to download the 2019 Outlook (no registration necessary) and click here to view the video interview.

Global smartphone recession confirms consumer downturn


Q3 smartphone sales data show the global market in recession, as Strategy Analytics confirmed:

The global smartphone market has now declined for four consecutive quarters and is effectively in a recession.

The warning signs began in Q1, when the market plateaued for the first time, as discussed here in May:

“The global smartphone market has finally gone ex-growth as China’s slowdown continues. In turn, the market is starting to polarise – with Apple pushing further up-market whilst Chinese brands such as Xiaomi focus on volume. Samsung’s middle market positioning looks increasingly under threat.”

The chart highlights the key issues:

  • Samsung’s market share has declined from a third in 2013 to a fifth today, as its mid-market positioning leaves it without a clear value proposition for consumers
  • China’s Top 3 players have meanwhile soared from just a 12% market share to 29% today, powered by their low-cost positioning
  • Apple’s market share has remained very stable, as it has focused on the top end of the market, prioritising price over volume
  • “Others”, also usually without a clear value proposition, have seen their share drop to just 36% from a peak of 46% in Q3 2016


China remains the world’s largest smartphone market, with 103 million phones sold in Q3. But its volume was down 8% compared to Q3 2017, as the stimulus programmes continue to slow. As the Counterpoint chart shows, the market is now consolidating around a few winners:

  • Huawei are emerging as the market leader with a 23% share
  • Vivo and Oppo remain key challengers at 21%
  • But “Others” have dropped to 13%, and Samsung has almost disappeared at just 1%

As Counterpoint note, the top 5 brands now hold 86% of the market:

“The Chinese smartphone market is saturated with accelerated market consolidation. The competition in 2018 is almost a zero-sum game for the top five players. It is challenging however, even for the leading brands to create clear product differentiation. In Q3, only Huawei and vivo managed to achieve positive YoY growth among the top 5 brands.”

Meanwhile, of course, Apple continue to dominate the premium segment after the launch of the new iPhones in September.

This divergence between low-cost and premium will no doubt spread across the rest of the global market as the downturn continues.  And the main growth is likely to be in the low-cost area.

India, for example, saw volume grew 5% versus Q3 2017.  But with average per capita income less than $2000, price is all-important.  Reliance Jio’s ultra-low pricing strategy has been critical in making bandwidth affordable, and there are now over 400 million smartphone users in the country.

But iPhone sales are actually falling, and will be down by a third to just 2 million this year.  Functional phones in the $150-$250 price segment are driving sales growth, via online sales.  Q4 is expected to see these grow 65% to reach 50 million, due to their 50%-60% discounts.


The smartphone market thus continues to confirm that the BabyBoomer-led SuperCycle is over. As the chart shows, this created a new and highly profitable mid-market from the mid-1980s:

  • Before then, companies had competed on the basis of price or perceived value
  • But from the mid-1980s onwards, the mid-market became the most profitable sector
  • Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again

Instead, the market is segmenting again on the basis of price or perceived value. Chinese players compete on price, while Apple focuses on profit and is moving up-market. this means that previously profitable market leaders such as Samsung are slowly disappearing along with the mid-market segment that they supplied.

These very different strategies highlight the new world ahead for consumer markets and those who supply them.

Apple, Xiaomi squeeze smartphone mid-market as sales plateau

The global smartphone market has finally gone ex-growth as China’s slowdown continues.  In turn, the market is starting to polarise – with Apple pushing further up-market whilst Chinese brands such as Xiaomi focus on volume.  Samsung’s middle market positioning looks increasingly under threat:

  • The chart shows Q1 sales for Samsung, Apple, the 3 top Chinese brands and Others (Strategy Analytics data)
  • The 3 Chinese brands (Huawei, OPPO, Xiaomi) have collectively taken top position with 27% of the market
  • Samsung has slipped into 2nd place with 23%, whilst Apple is at 15%
  • Total volume at 345m was down 2% versus 2017 and back at 2015 levels, as Strategy Analytics note:

“Samsung is holding steady in its core markets of North America, Western Europe and South Korea, but the company is facing intense competitive pressure in China and India from rivals such as Xiaomi. Apple volume grew 3%.

“Huawei grew 14% despite headwinds in North America (whilst) Xiaomi doubled marketshare versus 2017 as its growth soared 125%. Xiaomi is expanding like wildfire across Asia, particularly in India.  OPPO has been hit hard by Xiaomi’s rapid retail expansion and Huawei’s much-improved Android device portfolio.

CHINA’S PREVIOUSLY HOT MARKET HAS GONE COLD

The key to Q1’s decline was the collapse in China’s market, where sales fell 19% to 91m, and were back at 2013 levels according to Canalys data.  And as the chart shows, the 4 main players are consolidating their position:

  • Huawei grew market share to 24% from 18%; OPPO grew from 17% to 19%
  • Vivo grew from 15% to 17%, whilst Xiaomi jumped 8% to 13%.  And as Canalys note:

“There is a sense of fatigue in the market. The level of competition has forced every vendor to imitate the others’ product portfolios and go-to-market strategies.  But the costs of marketing and channel management in a country as big as China are huge, and only vendors that have reached a certain size can cope.”

Xiaomi’s growth is due to its focus on the sub-RMB1000 level ($160).  Its recent launch of cheap up-market phones will put more pressure on competitors and further drive consolidation in the market.

SMARTPHONE MARKET’S POLARISATION CONFIRMS THE GLOBAL TREND

It is, of course, no accident that China’s downturn has ended global market growth.  Its vast stimulus programme after 2008’s financial crisis meant that it became the growth engine for the global economy.  But now President Xi’s resolve to make “deleveraging” one of his “3 tough challenges” is changing the rules of the game, again:

  • As the chart shows, the Boomer-led SuperCycle created a new and highly profitable mid-market
  • Before then, companies had competed on the basis of price or perceived value
  • But from the mid-1980s onwards, the mid-market became the most profitable sector
  • Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again
  • The vastly different strategies of Apple and Xiaomi highlight the new world ahead

Apple CEO, Tim Cook, has deliberately turned his back on the mid-market, positioning the new iPhone X at the $1000 price point, where it has consistently outsold the cheaper iPhone 8 and iPhone 8Plus. In turn, this led profits to jump 25%.  As a result, Apple is the clear leader in the high-end sector with its relatively niche products and high margins. As the Financial Times reports:

“iPhone unit sales of 52m were up only 3% by volume but the product’s revenues jumped 14%, as the iPhone X drove its average selling price up by $73 compared with a year ago, to $728.

Apple’s performance highlighted the new strategy:

  • Its China revenues rose 21% and the iPhone X was the top selling smartphone
  • It also benefits from the growth of the used-phone market, now around 10% of the total
  • Around a quarter of US consumers sold their old smartphone when upgrading last year
  • iPhones will likely hold their value well, making them more valuable when resold

Similarly, Xiaomi’s success in China highlighted the opportunity in the mass-market.  Its market share jumped to 13% as it aimed to make a net profit margin of just 5% on its $100 – $160 phones.

INVESTORS NEED TO WATCH FOR BANKRUPTCIES AS CONSOLIDATION REVS UP
The free money provided by the central banks since 2008 has had two key effects:

  • It has prolonged the reign of the mid-market as consumers have been able to borrow cheaply
  • It has allowed mid-market companies to borrow heavily and build up major debt

Now, both of these trends are reversing.  Consumer spending is increasingly being driven by income, rather than borrowing.  Companies are seeing interest rates rise on their debt: even worse, those who borrowed to take advantage of low US rates are seeing repayments rise as the US$ rises again.

Investors need to be very careful about where they place their bets for the future.  And companies need to check out their business partners’ strategies.  Falling volumes and higher interest/debt costs will lead to a wave of bankruptcies.

Most analysts are ignoring the changes underway in China.  As with subprime, they will soon argue that “nobody could have seen this coming”.  But in reality, there are always warning signs.  The global smartphone market has been the great success story of the stimulus era.  Its paradigm shift is highlighting the likely “surprises” that lie ahead.

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Global smartphone sales slide 9% in Q4, as China tumbles 16%

Global smartphone sales have seen major growth until recently as consumers fell in love with going mobile, as the chart shows:

  • In the critical Q4 period they jumped from 290m in 2013 to 380m in 2014, 405m in 2015 and 439m in 2016
  • But they then fell 9% in Q4 last year, according to Strategy Analytics data.  They note that:

“It was the biggest annual fall in smartphone history (and) …. was caused by a collapse in the huge China market, where demand fell 16% annually due to longer replacement rates, fewer operator subsidies and a general lack of wow models.”

Even more revealing was that only Xiaomi of the Top 5 vendors increased their volume. Apple lost 1m sales, Samsung lost 3m, Huawei lost 4m, whilst even OPPO only managed to maintain its volume.  And Xiaomi only did well because they were recovering from their 2016 collapse, when their share crashed to just 3.35% from 5% in Q4 2015.

Chinese companies were, however, the real winners during 2017 as the price war intensified, as the second chart confirms:

  • China’s top 3 vendors now supply a quarter of the global market – compared to less than a tenth in 2013
  • Samsung have been the main loser, with their share falling from over a third of the market to less than a fifth
  • They did well to recover from the Galaxy Note 7 problems, but seem unlikely ever to reclaim their dominance

The rise of the Chinese vendors is great news for consumers, but very bad news for their competitors, as the third chart confirms.  It highlights how revenues are now being squeezed for most vendors as the Chinese ramp up their volume.  Only Apple has avoided the carnage by heading defiantly up-market, with its average handset price now close to $800.

The issue is the very different nature of the smartphone market in the major emerging economies, where incomes are much lower than in the West and it is very rare for carriers to subsidise handset sales over the life of the contract.  In India, for example, the typical smartphone sells for less than $200, whilst Apple has less than 2% of the market.

2017 therefore marked a crucial turning point in the market, as I forecasted when reviewing 2016 data a year ago:

“The issue is that 3.1bn people now own smartphones, and the other 4.2bn can’t afford them. So inevitably, the market is going to focus more and more on price. Of course, millions of people will still want to own an iPhone or Galaxy. But price will become the deciding feature for many people.”

2018 seems likely to see pricing pressure intensify, now that the Chinese market has gone ex-growth.  India is likely to be a critical battleground after Xiaomi’s success there in 2017, which was key to its nearly doubling global sales.  As analysts IDC noted:

“Brands outside the Top 5 struggled to maintain momentum as value brands such as Honor, Vivo, Xiaomi, and OPPO offered incredible competition at the low end.”

OPPO is likely to be particularly aggressive as it saw no growth in 2017 after doubling its sales in 2016, whilst Xiaomi is unlikely to risk a second slip-up on volume.  In turn, this makes it likely that Samsung’s mid-market positioning will come under major pressure from Chinese competition in key markets such as China and India.

Apple must now intensify its efforts to move into application-based markets such as healthcare and other services.  It has been building its position over the past 3 years, and has a vast cash-pile from its smartphone profits to fund the necessary shift away from hardware sales.  Samsung’s future looks less rosy, however, given that Chinese vendors have been able to produce smartphones for as little as $20 for the past 2 years.

And as I noted back in May 2015:

“The smartphone market is not alone is facing these New Normal challenges. They are coming to the online and High Street stores near all of us, if they haven’t already arrived.

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