Boom, Gloom and the New Normal

EU auto sales are back at early 2009 levels. This was the height of the slump that followed the start of the financial crisis. But today, unlike then, it seems unlikely that politicians can afford another €2500 ($3.25k) ‘cash for clunkers’ programme.

As the chart shows, 2012 sales (red square) fell 10% in February versus 2011 (green line). This followed a 7% fall in January. Cumulatively, they are now just 2% above 2009′s level (blue).

There was no good news, according to ACEA, the industry association. They noted that February “demand for new cars dropped in all major markets, except Germany where registrations remained stable”. Equally, on a year to date basis:

• Sales were down 21% in France and down 18% in Italy
• Spain, the UK and Germany were all slightly negative

It also seems unlikely that coming months will see much improvement. Austerity is replacing stimulus programmes in most countries. Whilst Germany’s economy may well slow as activity weakens in China, its main export market.

If something seems to be too good to be true, then it generally is. That appears to be the learning from China’s auto market in recent months.

February sales jumped, as the Lunar New Year holiday took place in January this year. But total sales in January/February were down 5% versus 2011 at 2.37m versus 2.5m.

This is quite different from the 2008 – 10 period when;

• Sales fell 4% in Q4 2008, as the Crisis hit China’s economy
• Then they jumped 53% in 2009, and 33% in 2010
• But this was only due to the government’s panic reaction
• It doubled bank lending, and added stimulus worth 13% of GDP

The blog has always argued this growth could not be sustained.

The reason is simple. 96% of China’s population earns less than $20/day, according to Asian Development Bank data. This means they would be living below the poverty line in any Western economy.

So cars are a luxury item for many people, and only really affordable when the government helps to pay the bill.

As regular readers know, the blog regards benzene as an excellent leading indicator for petchem markets and the global economy. Its track record since the start of the crisis in 2008 has continued to be strong.

The reason is probably two-fold:

• It is one of the oldest, and widely used, chemicals. In many ways it is therefore a proxy for industrial production.
• It is close to the feedstock end of the value chain. So it also responds to ‘correlation trade’ activity by the high speed computers that now dominate financial markets

As the chart shows, it provided early warning in December (yellow highlight) that another feedstock price surge was underway. This drove up other petchem markets as cost increases began to be passed through. The correlation trade also led to a major rally in global stock markets.

But the crucial issue with bear-market rallies is that the volume of trading usually fails to increase as prices rise. Instead of more and more buyers jumping into the market, activity remains subdued.

This has been the pattern of recent weeks. Equally, both crude oil and the US S&P 500 have stalled at the top of their trading range. Brent is still at $124/bbl, and the S&P 500 is at 1370. Neither has found new buyers willing to support the rally.

Meanwhile, ICIS pricing reports continue to suggest that end-user demand is slowing. Buyers seem to be simply protecting downstream margins by buying forward. There is no surge of new demand.

Thus benzene’s price fall last week (second highlight) is worrying. So are the reports from China on PTA demand. It never recovered after the Lunar New Year holiday, and now seems to have slowed further.

The blog would like to be wrong. It may be that this week’s slowdown will be quickly reversed. But for the moment, it suggests that – just as in 1973/4, 1979/80, 1990/1 and 2007/8 – today’s sustained high level of oil prices is leading to demand destruction on an increasing scale.

ICIS pricing comments and price changes since the IeC Downturn Monitor launch on 29 April are below:

PTA China (red), down 10%. “PTA demand is likely to drop as a number of downstream polyester yarn/fibre chip producers in China have either shut their plants or lowered their operating rates by 5-20%, starting from last week, to ease high inventory pressure and balance weak demand”
Benzene NWE (green), down 8%. “The market has grown increasingly detached from oil and energy movements, with supply/demand dynamics playing a larger role in driving direction”
HDPE USA export (purple), down 5%. “US Gulf export offers were higher, as producers continue to try to implement an increase of about 3 cents/lb for March. However, traders said they are purchasing very little material, because the prices are too high to work in other regions”
Naphtha Europe (brown dash), down 2%. “Demand for naphtha remains unexceptional, with no shortage of offers but little in the way of bids.”
Brent crude oil (blue dash), no change
S&P 500 Index (pink dot), no change

The past few years have seen an increasing number of countries and major companies moving to ban or reduce the use of plastic bags. Now Austin, state capital of Texas, and the 14th largest US city has voted to introduce criminal penalties for any retailer breaking its new law.

ICIS’ Joe Kamalick notes that “the Austin bag ban law also requires that retailers post signs informing customers that they must bring their own multi-use bags, any failure to post such signs could be subject to the misdemeanour criminal penalty”.

The maximum penalty is $2000, although the ban “includes exemptions for plastic bags used by laundries and dry cleaners, newspaper delivery bags and some other single-use plastic bags provided by specific vendors such as pharmacies and for restaurant carry-out foods”.

The blog remains fully supportive of such bans, although it regrets any criminalisation measures. The video above, first posted last May, highlights the enormous environmental damage caused by these single-use bags. They are simply too light, and cannot be properly contained during or after use.

The situation seems to parallel other occasions where products have been withdrawn after it was found they produced unintended, and unwelcome, side effects. Nobody today, for example, would advocate adding lead to gasoline to boost octane, now we know about its health hazards.

The polymer industry would boost its public image, and lose very little in terms of total sales volume, if single-use bag manufacturers were to voluntarily stop production.

The Wall Street Journal carried an interesting opinion piece on Friday, assessing current market conditions from the viewpoint of the film character, Forrest Gump. Gump’s key insight is that “Stupid is as stupid does”. Thus the Journal noted:

“Oil staged its last price surge along with other commodity prices when the Fed revved up its second burst of “quantitative easing” (QE) in 2010-2011. Prices stabilized when QE2 ended. But in recent months the Fed has again signaled its commitment to near-zero interest rates first through 2013, and recently through 2014. Commodity prices, including oil, have since begun another surge.” And it went on to add:

“Fed officials….want to take credit for easy money if stock-market and housing prices rise, but then deny any responsibility if commodity prices rise too, causing food and energy prices to soar for consumers. They can’t have it both ways, as not-so-stupid Americans intuitively understand when they buy groceries or gas. This is the double-edged sword of an economic recovery “built to last” on easy money rather than on sound fiscal and regulatory policies.”

ICIS’ Truong Mellor sums up the consequences as far as petchem markets are concerned when he notes with regard to benzene that:

“The push and pull of opposing factors – the upstream bullishness versus the slower end-use demand as well as the sense that the market is currently overheated – is also adding to the confusion.”

Europe and the USA are not the only regions where the Fed’s QE policies are destroying demand. China has record retail prices for gasoline and diesel, and ICIS reported a polyester producer commenting this week:

“General demand is not recovering as well as expected. We are at a very difficult position now: sales are slipping while inventory are increasing”.

All the key sentiment indicators are telling us that financial markets are at a cross-roads. The critical number is 1370 on the US S&P 500. This was the peak of the last rally, and coincided with the blog’s launch of its Downturn Alert on 2 May. Friday’s close was 1366. A rise above 1370 would also mark a recovery to market levels not seen since June 2008.

The chart shows product price changes since then, with ICIS pricing comments below. It shows how stock and oil markets continue to move together, whilst downstream markets have proved increasingly unable to pass through the higher prices due to demand destruction:

HDPE USA export (purple), down 11%. “PE prices were stable in Asia, amid weak demand and high feedstock costs”
PTA China (red), down 11%. “Mounting polyester inventories have restricted the purchasing power of polyester makers in the physical and futures markets”
Benzene NWE (green), down 5%. “Sentiment has softened this week with lower demand from the phenol and cumene sectors.”
Naphtha Europe (brown dash), down 4%. “Reduced supply, resulting from refinery maintenance and shutdowns, is easily able to meet soft demand”
Brent crude oil (blue dash), down 2%
S&P 500 Index (pink dot), no change

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.