Boom, Gloom and the New Normal

Greece’s debt default saga seems never-ending. And it is tempting to hope that it only matters to those suffering in Greece and the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain).

But a look at auto sales trends since 2005 gives a different picture. As the chart shows, based on ACEA data, sales in the 5 PIIGS countries have seen a sharp decline since the crisis began:

• 4.8m autos were sold there in 2007, 31% of total EU sales (blue column)
• Only 2.9m were sold in 2011, a fall of 39%
• Italy’s sales (green line) were down 30% to 1.7m
• Spain’s (red) were down 50% to 0.8m
• Portugal’s (orange) were down 24% to 0.2m
• Greece’s (purple) were down 65% to 0.1m
• Ireland’s (brown) were down 52% to 0.1m

It is also clear that further declines are inevitable, as earlier stimulus such as ‘cash for clunkers’ is replaced by austerity programmes. Those losing their jobs in the public sector, or seeing their pensions reduced, will suffer a permanent loss of purchasing power.

Even more worrying is that a vicious circle is now underway. Jobs are starting to go in the private sector within the PIIGS, and amongst EU companies who supply there, further damaging the sales outlook:

• Italian auto maker, Fiat, sold 928k cars in 2011, versus 1.2m in 2007
• France’s PSA, the EU’s 2nd largest manufacturer, sold 1.6m versus 1.9m
• Renault COO, Carlos Tavares, has suggested current price wars could lead to a major bankruptcy
• He added “you cannot continuously be in the red. Somebody some day has to pay for it.”

Already PSA has announced 6000 job cuts, and said that production needs to be cut short-term to conserve cash-flow. Whilst
Fiat CEO Sergio Marchionne has warned that Europe needs to “cut 10% – 20% of its car manufacturing capacity”.

The US housing market was the original cause of the current financial crisis. It has gone quiet recently, but this does not mean that the problems are resolved. Quite the opposite, in fact.

True, foreclosures have slowed recently, due to legal issues. This is helping to boost consumer spending temporarily, as people stop paying their mortgage whilst they wait to be evicted. But there are still 14 million homes at risk, once the system starts working again. And prices have already begun to fall again.

Equally, the Federal Housing Agency has taken over the business of making risky loans, to help support the market. But according to Barrons, the US investment magazine, 18% of its loans are now missing one or more payments. And it only has $1.2bn of capital supporting $1tn of loan guarantees, so its finances look risky, to say the least.

The chart above shows the impact on housing starts (blue line) and on permits to build new houses (red), since records began in 1959. Quite clearly, the past 3 years have marked a completely different period:

• 2011 starts were just 607k, and permits 612k
• They were never before lower than 939k even in 1975

The issue is that the ageing of the BabyBoomers means that the rate of household formation has reversed. There are fewer young people in the Wealth Creator 25-54 age group to need new homes. And high youth unemployment means they cannot usually afford them.

So the new trend, as we describe in chapter 8 of ‘Boom, Gloom and the New Normal’, is for families to move back in together. 51% of Americans (17%) are now living in homes with two adult generations, up from 42 million in 2000:

• The ‘parent’ adults are worried about future medical bills, so don’t want to spend money on a home when prices are still falling
• The adult ‘children’ often have both parents working, so want to avoid the cost of childminders
• There is also a Shared Value aspect to the arrangements, as the grandparents have someone to look after them if they become ill, whilst they can monitor the children’s behaviour when the parents are working

Encouragingly as well, Lennar, the 3rd largest US housebuilder, has picked up on this trend. They are now marketing ‘Next Gen’ homes in 40 communities, under the slogan ‘the home within a home’.

These homes are not the traditional ‘granny flat’ where granny lives once her husband has died. They have separate cooking areas, and allow both sets of adults to be independent within the shared accommodation.

This is the New Normal in action. It is different from the 1982-2007 SuperCycle, and is not easy to navigate. But it provides excellent opportunities for those who are prepared to take the time and trouble to understand what is happening.

We hope the examples in Chapter 8, and our new strategy courses, will help companies go up the necessary learning curve as fast and profitably as possible.

Cars are now the largest single market for chemical sales, as housing markets have slowed globally. Each new US car is worth $3297, for example, according to the American Chemistry Council (ACC), making the US market worth $42bn in 2011.

2011 auto sales were ~59m, up 4% from 2010. The West (EU, USA, Japan) still dominates, with 50% of demand. Developing countries showed rapid growth until recently, but the BRICs (Brazil, Russia, India, China) are still only 35%.

The chart above shows performance in the 3 largest markets since 2007:

• China (blue column) remained in top spot at 14m. But its growth rate collapsed with the ending of stimulus spending – from 49% in 2009, and 30% in 2010, to just 5% in 2011. Q4 growth was only 1%, as the last subsidies were removed in September
• The EU (red) was 2nd at 13m, continuing its recent decline. Sales have now fallen for 4 successive years. Without Germany, whose sales rose 9% to 3.1m in 2011, the picture would be even worse
• The USA (green) remained 3rd with sales up 11% to 13m, hopefully having now bottomed, as the blog noted recently. But they are a long way from the 15 – 17m range enjoyed during the 1995-2007 boom years

• Japan was the next largest market at 4.2m, hit by 2011′s tsunami disaster. The other main markets are small by comparison – Brazil at 2.7m, Russia at 2.6m, India at 2m

Overall, growth in the 3 major markets weakened significantly last year.

2009 had equalled 2008 performance, as China’s massive stimulus balanced the US/EU slowdown. Then co-ordinated G20 stimulus led to 10% growth in 2010. But last year saw growth decline to 4%. Q4 growth was only 2%, versus 10% in Q4 2010.

The blog does not rule out a panic reaction by policymakers, as it becomes more apparent that the world has re-entered recession. Co-ordinated stimulus would work for a period, as it did in 2009/10. But the debt overhang afterwards would be even worse than today’s.

In the absence of further stimulus, it is hard to see much growth in 2012, particularly with oil prices at today’s record level:

• Germany’s economy is slowing fast, so EU volumes are likely to continue their decline
• China’s growth will remain slow, as its primary focus is now on controlling food price inflation, rather than boosting demand
• The USA will probably also see only slow growth, even with further stimulus ahead of the presidential election

It is not all bad news, however, as moves to reduce auto weight will boost chemical and polymer demand. The ACC estimates, for example, that 378lbs (172kg) of plastics and composites were used in the average light vehicle in 2010, up from 286lbs in 2000 and just 20lbs in 1960.

But clearly the days of steady SuperCycle growth are now behind us, as the Western BabyBoomers enter the New Old 55+ generation. With 29% of the Western population already in this cohort, their mobility needs now represent a new and potentially very attractive market opportunity.

We highlight these in more detail in Chapter 8 of ‘Boom, Gloom and the New Normal’, to be published next week.

December’s US auto sales provide a classic example of Kahneman’s illusion, discussed on Saturday.

Initially they appear encouraging to our System 1 minds. As the chart shows (red line), they were the 2nd highest of the year, and one of the few months to top 1.1m sales since the start of the Great Recession. But analysing them with a System 2 approach gives a different picture.

The past 3 years have seen buyers trying to avoid purchases:

• Owners have been hanging on to old cars for as long as possible
• Vehicle scrappage rates are now only 4% of the US fleet
• The average age of the US fleet is nearly 11 years, a record
• They are driving less, with vehicle miles down 1.7% versus 2007 levels

Yet there are limits to everything. Life without a car is very difficult in many parts of the USA, due to the lack of public transport and the vast distances. So it would appear that we have finally got to the point where today’s old cars simply can’t run any more.

As a result, industry estimates suggest we may well see 13.5m sales in 2012. This would better the 12.8m in 2011, but would still be well down on the 15 – 17m range seen in the boom years from 1995 – 2007.

These new purchases will come at a cost, however.

• Buyers are cutting expenditure in other areas, such as personal care
• Some are having to pay 16% interest on ‘near-prime’ loans (10% above normal rates)

None of these reasons provide much support for Wall Street’s System 1-type belief that recovery is finally underway. But they do highlight how companies need to conduct careful System 2 analysis, if they want to develop successful strategies for the transition to the NN.

Human beings are by nature optimistic. Otherwise our ancestors wouldn’t have bothered to climb out of the swamps, all those years ago, in the hope there was ‘something better’ to be found.

Equally, we don’t usually give up at the first sign that something has gone wrong. We assume that a way will be found to get past the problem. This means we don’t waste time on temporary problems.

But every now and then, the paradigm does shift. If we don’t recognise these moments, we will instead spend our time banging our heads against a brick wall. No matter what we do, our world will not return to how it was.

The blog strongly believes today is one of those moments.

The regular IeC Boom/Gloom Index chart above is a small illustration. It shows:

• The Index (blue column) remains in negative territory
• It is back at levels seen when the crisis began to develop in 2008-9
• The reading for Austerity (red line) continues to climb

Change is not necessarily a bad thing. It may be uncomfortable at the time, but it also brings opportunities. And there are major opportunities ahead:

• 29% of the rich Western population are now in the New Old generation of 55+ years. Yet just a century ago, Western life expectancy was only 46 years. It was still only 66 years in 1950. Today, these 272 million people can expect to live until they are 80.
• Billions of people in the developing world are emerging from poverty for the first time. They need the essentials of life – food, water, hygiene, shelter and transport. A century ago, their life expectancy was just 26 years. It was only 44 years in 1950. Today, it is 64 years, and still rising.

The blog’s New Year outlook is very simple. It believes it is a waste of time and energy to keep hoping that things will ‘return to normal’ in another 6 months. They won’t, and we might as well recognise this.

Instead, as we discuss in ‘Boom, Gloom and the New Normal’, demographics drive demand and the global economy.

The Western BabyBoomers (those born between 1946-70) drove the Boom years as they moved into the Wealth Creator 25 – 54 age group. But now they are leaving it. The average Boomer will be 54 this year.

Nor can we expect China or India to easily replace their demand. Their ‘middle classes’ have an income of just $2-$20/day. They would be below the ‘poverty line’ in the West.

This is why the paradigm has changed.

Yet very few companies have recognised this shift. Even fewer have begun to develop products and services for Westerners in the New Old generation, or for those emerging from poverty in the developing countries. These two groups of people are dramatically under-served in today’s economy.

Great companies focus on the future, not the past. This enables them to survive wars, depressions and periods of near-disaster. The blog passionately believes that the great companies of tomorrow will be those who focus on these new opportunities.

November (red line) was a mixed month for auto sales, as the above chart shows. It updates the state of the world’s 3 largest markets:

• China remained the largest market with sales of 1.3m. Its Year To Date (YTD) sales are up 6% at 12.5m
• Europe is the 2nd largest market with sales of 1.03m, but YTD was down 2% at 12.1m
• The USA is 3rd, with sales of 1m, and YTD up 11% at 11.6m

In terms of total volumes, YTD 2011 was up 5% versus 2010 at 36.2m. This is a slowdown versus the 9% growth seen in 2010. But it is still respectable.

Interestingly, the USA is now leading the recovery, as both China and Europe have slowed. But its volumes are still a long way from the 15m-17m annual sales which were seen routinely until 2007.

China’s growth has slowed very sharply. Its sales were up 49% in 2009, and 30% last year. But the ending of the stimulus programmes has reduced demand growth very sharply.

Europe, however, is the weakest link. Its volumes have been lower every year since 2007. And it has become dangerously reliant on Germany:

1. Sales there were up 3% in November, as its economy continued to benefit from China’s demand.
2. But in the other major markets, the UK was down 4%, Spain down 6%, France down 8% and Italy down 9%.

Autos are a critical market for the chemical industry. They also provide an important insight into the wider state of consumer demand. Currently they are flashing an amber warning light that difficult times may lie ahead in all the main regions.

Many analysts have argued that demand in India could easily replace volumes lost due to a slowing Western economy. Sadly, this week has provided further evidence of why this is merely wishful thinking.

As the chart shows, India’s GDP is the same size as Canada’s. But India’s 1.4bn people means its GDP/capita is only $1371, compared to Canada’s $46303. This matters, as it means India’s needs are much more basic than those of the wealthy Western nations.

Equally, India’s development is increasingly being held back by politics:

• Currently, 40% of India’s food rots on the way to the consumer
• Last week, India’s premier Singh announced major retail reforms
• Foreign retailers would have been able to own 51% of Indian companies
• This could have opened the door to major improvements in food supply
• It could also have increased polymer demand for storage etc

But this week, Singh was forced by his own party and the opposition BJP to withdraw the proposals.

It used to be said that progress in India came ‘with two steps forward, one step back’. This week suggests the model has instead become ‘one step forward, two steps back’. Not only will India’s food continue to rot. But this failure will reduce the chances for reforms in other areas.

Equally, this will reduce still further India’s ability to compensate for slowing Western demand.

Western banks now demand higher deposits when lending to first time buyers. The Bank of England expects this to increase the average age at which first-time buyers buy a home, and reduce home ownership.

This will hit demand for home furnishings and appliances, unless companies change their approach to the market.

The Bank’s conclusions apply to other western countries. The reason is that 5 years ago, most banks were offering mortgages worth 95% of property values. So new buyers only had to save for a 5% deposit. This took them 4 years if the home cost 4 times their annual income.

Now, however, banks are typically demanding deposits of 20% – 25%. As the Bank’s chart above shows, this means people have to wait longer before they can buy. On the assumption that people typically begin to plan for home purchase at the age of 28, the average age of first purchase:

• Was 32 years (red line) in the mid-2000s. Buyers began saving at 28 years, and achieved the 5% deposit after 4 years
• Will rise to 44 years with a 20% deposit. It takes 16 years of saving
• Will rise to 36 years (green dot) even if they double their savings rate to 10%. It still takes 8 years of saving

Home ownership rates thus fall from 71% to 52% (at 5% saving) or to 65% (at 10% saving). And the Bank notes that in the short-term “the flow of buyers falls very sharply”. Instead, rental demand increases.

This shift also reduces demand for home furnishings and appliances.

Landlords are much less likely to replace these items than homeowners. They value their profit more than a tenant’s comfort. Equally, young people saving for a higher deposit will have less spare cash to buy such items themselves.

This is yet another example of the dramatic changes in demand patterns that are taking place as we transition to the New Normal.

Consumption dominates chemical demand. Chapter 7 of our new ‘Boom, Gloom and the New Normal’ eBook therefore looks at the changes taking place in consumer markets. These provide vital insight into how chemical markets are likely to develop in the New Normal.

The key learning is that companies are re-adapting their business models. The great companies of tomorrow will build their businesses by providing products that are of genuine benefit to society.

We therefore highlight three case studies to help companies develop their thinking in this critical area. They provide concrete examples of the changes being made by far-sighted businesses in different regions:

• Procter & Gamble, the world’s largest consumer products company, is now following a ‘white space’ strategy to reposition itself for future growth.
• We also look at the lessons to be learnt from the launch by India’s Tata Motors of the world’s cheapest car, the Nano.
• Plus we highlight the new business and technical innovation models being successfully developed by the Bill Gates-funded Meningitis Vaccine Project in sub-Saharan Africa.

All three examples highlight the opportunity for companies to grow sustainably and profitably as we enter the New Normal. They also support the new concept of Shared Value developed by Professor Michael Porter.

As Porter summarises the position:

“Firms have focused on enticing consumers to buy more and more of their products. Facing growing competition and shorter-term performance measures from shareholders, managers resorted to waves of restructuring, personnel reductions and relocating to lower-cost regions, while leveraging balance sheets to return capital to investors.

“The results were often commoditization, price competition, little true innovation, and no clear competitive advantage….Companies have overlooked opportunities to meet fundamental societal needs….Our field of vision has simply been too narrow.”

We argue that doing nothing, and hoping that yesterday consumer-led boom will reappear, is no longer the low-risk option for companies, as profits and growth levels slip.

‘Who dares wins’ might instead be a good motto to post on every boardroom wall. This, after all, is how today’s great companies built their franchises in the past, through world wars, depressions and many other equally uncertain times.

FREE DOWNLOAD OPTIONS FOR CHAPTER 7
Click here to download a 2 page summary of the Chapter .
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2011′s final International eChem/ICIS training course takes place in Singapore next week. It aims to help attendees with detailed implementation issues. Please click here for further details.

Autos are now the single biggest market for petchem sales. They are also reported very quickly. So October’s EU auto sales provide the best real-time picture of the downturn now underway. As the chart shows:

• October’s sales (red square) were the lowest in recent years
• Total sales since January are also the lowest
• They are 16% below the 2007 peak

It is not difficult to write the script from here. People in the weaker economies such as Spain or Italy will not be buying many new cars in the next few months. Austerity programmes and rising unemployment do not encourage purchases of high cost items.

Equally, as Petromatrix report, consumers are cutting back on their driving, as they worry about high fuel costs. Germany’s diesel demand was down 6% in September versus 2010, whilst gasoline demand was down 3%. Data for the other 4 main markets (France, UK, Italy, Spain) shows similar trends.

Already the auto makers are starting to respond. GM said its results were “not sustainable and not acceptable”, adding that it was looking at ways to reduce costs. Others such as Peugeot have already announced production cuts and layoffs.

Q1 could be very difficult indeed, if current trends continue.