We are now two-thirds of the way through 2014, and critical decisions are looming for companies and investors. Do they give central banks one more chance to stimulate growth? And are they prepared to trust policymakers to avoid a major geopolitical crisis in the Ukraine?
Or do they decide that ‘enough is enough’, and that they should develop new strategies for the future?
As the chart above shows, chemical prices since 2013 in the blog’s benchmark portfolio confirm the sense that a ‘tipping point’ has been reached:
- PTA prices in China are falling again due to weakness in cotton and the polyester chain (red)
- Benzene prices in Europe are also falling due to weakness in downstream demand (green)
- Brent crude oil (blue) and naphtha (black) are facing a “supply glut“
- Only US polyethylene prices appear strong (orange) but these are really nominal due to supply issues
This leaves only the financial markets showing strength.
In currency markets, the US$ is now moving higher versus the Japanese yen (brown). July’s fall in Japanese consumer spend has severely dented hopes that Abenomics might succeed in overcoming the major demographic headwinds created by its ageing population.
Similarly, the S&P 500′s rise to the 2000 level (purple) seems likely to prove at least a temporary peak unless more stimulus is created. The US also saw its consumer spending fall in July, with teenage apparel spend (15% of total retail) in a deep slump. Thus more forecasters have recently lowered GDP estimates back below 3% again.
Meanwhile the Eurozone is coming closer and closer to outright deflation, with inflation just 0.3% in August. Whilst even hosting the soccer World Cup couldn’t stop Brazil falling into recession in H1.
Plus, of course, in the background looms the growing geo-political crisis over the Ukraine. Western leaders still assume that Russia is bluffing when it threatens “gas wars”. And it will be too late to put in place proper emergency measures in mid-winter, if we then discover they were wrong. Yet as Reuters reported last November, this is clearly part of Russia’s gameplan:
“Moscow meanwhile had threatened retaliation for Kiev’s moves west, raising fears it could cut energy supplies in new “gas wars”.”
In the next few weeks, companies will be finalising their Budgets for 2015-17:
- Will they hope that more stimulus will finally return economies to SuperCycle growth levels? And will they assume that the threat of ‘gas wars’ in the Ukraine will remain just a newspaper headline?
- Or will they start to worry that current policies have opened ”fault-lines in a debt-fuelled ‘ring of fire’“, and that wishful thinking has obscured the risk to the 45% of Germany’s gas that is supplied by Russia?
Reorienting corporate strategy is never easy. But doing nothing may well turn out to be the bigger risk as we move into Q4.
WEEKLY MARKET ROUND-UP
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
Brent crude oil, down 6%
Naphtha Europe, down 4%. “Supply is long despite a wide-open arbitrage window to Asia”
PTA China, down 2%. ”Downstream demand in the polyester markets continued to be weak, with slower sales off-take”
US$: yen, down 1%
Benzene Europe, flat 0%. “Downward pressure from raw materials and bearish sentiment in both Europe and Asia are weighing down on the European styrene market”
S&P 500 stock market index, up 9%
HDPE US export, up 12%. “August prices in the US market settled flat for the sixth month in a row… Buyers who would previously have used PE for rigid containers starting to move to stand-up pouches, which use less plastic, and in some cases, steel containers rather than PE”
Markets have been remarkably calm ahead of Crimea’s planned Sunday referendum to leave Ukraine and join Russia. Yet as Associated Press has reported:
“The Group of 7 world leaders say they won’t recognize results of a referendum for the Crimea region to split from Ukraine and join Russia. A statement from the seven nations released from the White House on Wednesday calls on Russia “to cease all efforts to change the status of Crimea contrary to Ukrainian law and in violation of international law.” It says the referendum scheduled for this weekend “would have no legal effect” and the process is deeply flawed.
“The leaders said they would take further action, individually and collectively, if Russia tries to annex Crimea. The statement was from the leaders of Canada, France, Germany, Italy, Japan, Britain and the United States, along with the European Council and the European Commission.”
This calmness is probably because markets have forgotten that geopolitics matter. And as the old saying goes, “those who fail to learn from history, are doomed to repeat it”.
German Chancellor Angela Merkel used to live in East Germany, before German unification, and she hasn’t forgotten. She warned the European Parliament of potential “catastrophe” yesterday:
“We would not only see it, also as neighbours of Russia, as a threat. And it would not only change the European Union’s relationship with Russia. No, this would also cause massive damage to Russia, economically and politically.”
The Ukraine/Crimea dispute is thus just a first sign of the growing distance between the Have’s and the Have-nots. As the above slide from Branko Milanovic of the World Bank shows, there are 7 major global flashpoints today where this divide is already evident (red dots):
- “First to fourth world: Greece to Macedonia/Albania; Spain to Morocco; Malaysia to Indonesia
- “First to third world: US to Mexico
- “Borders mined or walled: N Korea to S Korea; Saudi Arabia to Yemen; Israel to Palestine”
These flashpoints matter because the key issue in income inequality today is not within countries, but between them. Where we are born and live explains 60% of the difference in personal incomes. Our parent’s income only explains 20% of the difference, as class distinction within countries has reduced in importance.
If we add a red line to Milanovic’s map to divide West and East Europe, we can easily see how his argument applies to the Crimea/Ukraine dispute:
- Europeans are relatively wealthy with GDP/capita averaging around $40k
- Russian GDP/capita is just a third of this at $14k
- Ukrainian GDP/capita is a third of Russia’s at $4k
Ukrainians and Crimeans might therefore easily see themselves in different camps:
- Those who live in Crimea and regard themselves as Russian might choose to join Russia
- Non-Russians living in Ukraine might instead choose to stay independent and hope to link up with Europe
Geopolitical issues like these were generally ignored during the economic boom of the SuperCycle. But now we are transitioning to the New Normal and economic growth has slowed. So geopolitical issues like these are therefore resurfacing and will become increasingly important once more. As Lithuania’s president warned last week:
“Russia today is dangerous. After Ukraine will be Moldova, and after Moldova will be different countries. They are trying to rewrite the borders after the Second World War in Europe.”
Today’s confrontations are probably only a taste of those to come. Relationships between the West and Russia are now clearly set to worsen as Merkel warned. Last week, for example, Russia’s President Putin claimed that Lithuania and Poland had helped to organise the unrest in the Ukraine.
In turn, it is likely that China will see today’s dispute as an opportunity to re-establish its former relationship with Russia. Its ambassador to Germany warned Wednesday:
“We don’t see any point in sanctions. Sanctions could lead to retaliatory action, and that would trigger a spiral with unforeseeable consequences. We don’t want this.”
We can have no idea of how the various strands will play out. But one thing is very clear. Many companies will suddenly wake up in shock one morning, having realised too late that their prized foreign plant is now on the ‘wrong side’ of the growing geopolitical divide.