G7 Summits began in the crisis years of the mid-1970s, bringing Western leaders together to tackle the big issues of the day – oil price crises, the Cold War with the Soviet Union and many others. Then, as stability returned in the 1980s with the BabyBoomer-led economic SuperCycle, they became forward-looking. The agenda moved to boosting trade and globalisation, supporting the rise of China and India, and the IT revolution.
This weekend’s 43rd Summit in Italy suggested we may be going back to earlier days. As the picture confirms, the leaders did all meet in the Italian city of Taormina in Sicily. But they clearly found it difficult to meet the challenge set by their hosts of “Building the Foundations of Renewed Trust”. One very worrying sign was that both the USA and the UK seem to have become semi-detached from the process. :
□ UK premier Theresa May left early, to “hold urgent talks with her election campaign chiefs” after new polls showed her lead dropping to single figure levels
□ President Trump refused to endorse the Paris Agreement, causing German Chancellor, Angela Merkel, to comment:
“The entire discussion about climate was very difficult, if not to say very dissatisfying. There are no indications whether the United States will stay in the Paris Agreement or not.”
There was some good news, with a compromise seemingly being agreed with US President Trump over his desire to dismantle the world’s open trading system, as the final statement noted:
“We reiterate our commitment to keep our markets open and to fight protectionism, while standing firm against all unfair trade practices. At the same time, we acknowledge trade has not always worked to the benefit of everyone.”
But it was a relatively weak statement, and nothing was said about the President’s withdrawal from the Trans-Pacific Partnership, or his decision to demand a formal review of the North American Free Trade Agreement. The change is even clearer by contrast with last year’s Summit in Japan, when the leaders committed:
“To fight all forms of protectionism ….(and) encourage trade liberalization efforts through regional trade agreements including the Trans-Pacific Partnership, the Japan-EU Economic Partnership Agreement, the Transatlantic Trade and Investment Partnership and the Comprehensive Economic and Trade Agreement.”
Sadly, the same lack of unity had been seen just before the Summit, when President Trump failed to endorse Article 5 (the fundamental principle of the NATO Alliance), which declares that an attack on one member state is an attack on all, and requires a mutual response. As the Financial Times noted:
“This was particularly galling given that he was attending a memorial for the September 11 terror attacks — the only time Article 5 has been triggered. It remains unclear why he equivocated.”
Even the Summit dinner saw a lack of unity, with US National Economic Council director Gary Cohn suggesting:
“There was a lot of what I would call pushing and prodding.”
This lack of a common purpose amongst Western leaders is deeply worrying. Of course, they were able to agree on strong words about terrorism and the role of social media. But their key role is to be pro-active, not reactive.
Collectively, their countries are responsible for nearly two-thirds of the global economy. Individually, none of them – not even the USA – can hope to successfully tackle today’s challenges. This was the rationale for the formation of the G7 in 1975, and it has since played a critical role in helping to spread peace and prosperity around the world.
Today’s G7 leaders seem to be in danger of forgetting their core purpose. They need to re-open their history books and focus on the lesson of the 1930′s, when “beggar-my neighbour” trade policies led directly to World War II.
If you want to know what is happening to the global economy, the chemical industry will provide the answers. It has an excellent correlation with IMF data, and also 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. The chart above confirms the extremely high correlation:
It shows annual GDP % growth figures from the IMF on the vertical axis from 2000, including the 2016 forecast
The horizontal axis shows the annual change in Capacity Utilisation % data for the global chemical industry
The correlation is remarkable at 88%. Nothing that I have ever seen comes anywhere close to this level of accuracy.
The logic behind the correlation is partly because of the industry’s size. But it also benefits from its global and application reach. Every country in the world uses relatively large volumes of chemicals, and their applications cover virtually all sectors of the economy, from plastics, energy and agriculture to pharmaceuticals, detergents and textiles.
We can also use the data to look forward, given its timeliness, as the ACC also produce detailed reports on the major Regions and countries. And as the second chart shows, the outlook is unfortunately not good:
N America’s recovery since 2014 has faded away, and is at -1%; Latin America is very weak at -3.9%
W Europe has also slowed to 1.6%; Asia has collapsed from 7.5% in 2014 to just 1.4%
The Middle East/Africa has halved from 5.3% to 2.7%; only Central/Eastern Europe has grown, from 1.9% to 4.4%
This rather negative picture is in complete contrast with the official views of forecasters such as the IMF. They currently suggest that global growth will rebound from 3.1% in 2016 to 3.4% in 2017, and then move higher. But sadly, their optimism has been wrong for the past few years, as I noted in my Budget Outlook in October.
They have forecast a similar recovery every year since 2011, but growth has continued to slow.
The problem is that their models ignore the influence of demographics, and today’s ageing populations, on demand. The result, as the deputy chairman of the US Federal Reserve, Stanley Fischer, observed in 2014 is that:
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”
Clearly, it is encouraging that economists such as Andy Haldane at the Bank of England now recognise that demographics “have been under-emphasised for too long“. We can certainly hope that future forecasts may start to take account of the fact that older people do not consume as much as when they were young.
But in the meantime, it seems wise to take the chemical industry data very seriously.
It is clearly suggesting that the global economy is moving into a downturn. And whilst we must all hope this turns out to be wrong, hope is not a strategy. We also cannot ignore the major upheavals now underway in economic policy in both the USA and the UK, with President Trump taking office and the UK starting to leave the European Union.
These developments may well produce good results in the longer term. But in the short-term, they create major uncertainty. And if we look across the G20 countries – such as China, Russia, Brazil, India, S Africa, Saudi Arabia and Turkey – many are experiencing from similar political and economic uncertainty.
Uncertainty usually makes everyone – companies and consumers – more cautious in their spending. And lower spending inevitably means less growth.
Its hard to be optimistic about the outlook for the global auto market. The chart above of the Top 7 markets, which account for around 2/3rds of global sales, highlights the growing uncertainty. It shows Q1 sales in 2015 (blue column) versus 2014 (blue). Overall, these were up just 1.9% at 15.8m. And although the 3 largest markets showed reasonable growth, there are growing questions about the underlying trends.
China’s market appears to have done well, up 7.6% at 5.2m. But Chinese data is constructed on a different basis to the rest of the world, as “sales” actually represent factory deliveries rather than retail purchases. And one sign of trouble is that a price war has broken out, with China Daily warning:
“China’s auto industry’s profits have been on a downward trend this year, plagued by a slowing market and plunging car prices”.
Analysts Macquarie add that “there has been almost no sales growth in recent months in certain segments”. And used car sales growth has already overtaken that for new cars, whilst China’s auto association is warning that:
The overall market downturn would push the auto industry to further polarize. Carmakers which have competitive products will continue to have decent profits, but those without competitive products will have meager profits and even losses,”
The US market is also giving off conflicting signals. Sales were up 5.6% at 3.9m, but March sales were flat at 1.5m. This seems to confirm my fears back in January that the end of the shale gas bubble would also start to reverse the recent recovery in auto sales (as well as housing starts).
4 out of 5 cars are now bought with credit or leased, with an average term of 5 1/2 years. This tactic essentially buys sales from the future, as a car sold today won’t be replaced before 2020. In addition, an increasing proportion of sales are now to subprime buyers, whose default rates are alarmingly high.
The European market also presents some puzzles. Sales were up 8.7% at 3.5m, but analysts EY note that purchases by private individuals are at the lowest levels since 1990. They warn there is:
“Significant concern over self-registrations, where dealers sell the cars to themselves to help shift vehicles and meet incentive targets. They continue to distort the true level of demand.”
In addition, of course, the European market also continues to see major discounting, with levels of 20% easily available in many countries.
The position in the other 4 BRIJ markets is clearly weak. Sales were down 15.5% at 3.1m, as I discussed last week, with the only positive signs in India.
Overall, therefore, Q1 data tends to support my view back in October that global auto sales have reached their ‘top of the mountain‘ moment. Suppliers to the industry, and investors, face a difficult outlook as these trends continue to develop.
Q1 was very difficult for many companies and investors. They had wanted to believe since 2009 that central banks could somehow control the global economy:
- The oil price would always be $100/bbl
- The US $ would always remain weak
- Central banks would always be able to stimulate growth in the economy
- Stock markets would always go up in the US and other major economies
But instead, volatility increased quite dramatically. The chart above of Brent oil prices and the US $ Index since the Great Unwinding of central bank policies began in mid-August highlights the issue:
- Brent oil averaged $57/bbl in the first week of January, and $56/bbl last week (blue line)
- Yet prices fell 14% within the quarter, and rose 25%, as pricing volatility returned to the markets with a vengeance
- In currency markets, the $ gained 6% over the quarter against the world’s major currencies (red)
- This was an astonishing move, which hit trade flows, debt markets, company profits and national economies
- Its volatility also rose: it was up by 10% in mid-March, before falling 4% in just 3 weeks
It is thus becoming clearer with every day that passes that central bank policies are simply wishful thinking.
Companies also have their own self-inflicted wounds to deal with. As I discussed last week, too many failed to spot the oil price fall in H2 last year, and only reacted in January. They thus destocked at exactly the wrong moment – just before the brilliantly successful ‘SuperBowl coup’ pushed oil prices up 22%.
Since then, they have been seeking to rebuild inventory as we enter the seasonally strongest-demand period of the year. This has caused price rises in some most unlikely areas – China’s PTA markets, for example. Genuine shortages are also now occurring in some markets, such as European polyethylene and polypropylene.
The lesson of the period since August is that volatility is on the rise. Companies who wish to survive must therefore follow the time-tested motto of the Scouts – “Be Prepared”. They need to ignore consensus views, and instead develop robust Scenarios against which to test out their strategies.
Slowly but surely, the economic impact of today’s ageing global population is now moving us kicking and screaming into the world of the New Normal.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 50%. “The market was quiet ahead of the monthly contract settlement”
Brent crude oil, down 46%
Naphtha Europe, down 42%. “Olefins and polyolefins markets are relatively tight in Europe.”
PTA China, down 40%. “Majority of market participants were concern that high stockpiles might result in a drastic decline in prices in the near term, especially with the settlement for physical delivery of PTA futures cargoes coming in May.”
HDPE US export, down 23%. “US export prices remained unchanged this week”
¥:$, down 17%
S&P 500 stock market index, up 6%
The blog’s 6-monthly review of global stock markets highlights the narrow nature of the advance since September 2008, when the blog first began analysing developments. It shows their performance since the pre-Crisis peak for each market, and the performance of the US 30-year Treasury bond.
Remarkably, only the US, India, Germany and the UK stock markets are in positive territory, along with the 30-year bond. Japan, Brazil, Russia and China remain well below their previous peaks:
- The 30-year bond remains the best performer, as investors fear that a sustained economic recovery remains as far away as ever (purple line)
- The US had been the best stock market performer till now, driven by the US Federal Reserve’s belief that a strong stock market would spur economic recovery (green)
- India has now become the best performer, due to hopes for broad economic reform from the new Modi government (black)
- Germany is next, supported by hopes the European Central Bank will continue to follow the Fed’s low-cost money approach (orange)
- The UK has just slipped into positive territory, also supported by Bank of England stimulus (pink)
A number of major markets remain in negative territory:
- Japan strengthened in 2012 as the Abe government followed the Fed’s policy, but has recently seen a slowdown as GDP fell in Q2 (blue)
- Brazil had weakened, despite the World Cup and 2016 Olympics stimulus, but recent polls lead investors to hope for a change of government next month (brown)
- Russia’s recovery also ended rather early, despite the boost from high oil and commodity prices, and Ukraine developments have caused it to move sideways (red)
- China’s market has never seen a recovery, as investors have preferred to speculate in the housing bubble, where prices have been doubling every 2 – 3 years (blue)
All-in-all it is hard with the benefit of hindsight to argue with September 2008′s conclusion, as the storm began to break:
“This pattern seems to confirm the blog’s long-standing concern that we may now be facing a multi-year global slowdown, as the financial excesses of the 2003-7 boom are unwound.”
Those markets where there has been little direct central bank stimulus have found it very hard to recover. This is quite contrary to the pre-2008 experience, when ‘a rising tide lifted all ships’.
The blog will look in more detail at the US equity market next week, as it concludes its mini-series on the Great Unwinding of stimulus policy now underway.
The Cycle of Deflation has taken another lurch forward. The reason was India’s decision to veto last year’s Bali deal to streamline customs procedures. Almost certainly, this will prove the dying effort of the World Trade Organisation, which sponsored the proposal.
The blog is particularly sad at this outcome. It has always believed that free trade provides the best possible basis for improving global living standards.
The problem, of course, is that compromise becomes increasingly difficult as the economic outlook worsens:
Thus WTO’s ‘Doha Round’ began in 2001 in Doha, and has since gone nowhere.
It was hoped in Bali that a small deal, allowing everyone to benefit from easier customs procedures, might restore momentum. But India refused to agree this without guarantees that it could continue with its food subsidies.
This of course, is an unrelated issue. But it is very important to the new Modi government, anxious to be seen as champions of the poor. Thus India’s Trade Minister argued:
“We cannot wait endlessly in a state of uncertainty while the WTO engages in an academic debate on the subject of food security. Issues of development and food security are critical to a vast swath of humanity and cannot be sacrificed to mercantilist considerations”.
Other major global trade deals look equally unlikely to deliver real progress:
The reason is simple – politicians are failing to spell out potential benefits and are instead leading from behind.
Thus as the blog warned back in February, protectionism is gaining ground around the world. As the chart suggests, we have moved through the period of devaluation and have now arrived at the period of competitive devaluation, where everyone tries to out-compete their rivals.
This process began more than a decade ago, when companies and policymakers failed to recognise that demand would inevitably slow as global populations aged, and the Boomers joined the New Old 55+ generation. Even today, major expansions are underway in many industries, regardless of the fact that demand growth is already very weak.
Once the money is spent, countries will close their borders to protect jobs. Only then, when too late, will we all look back and wonder what we could have done differently.