Boom, Gloom and the New Normal

January was not a great month for auto sales in the 3 major markets of the USA, EU and China. These amount to over 50% of global auto sales, and are a key indicator of underlying consumer demand.

As the chart shows, sales were just 3m (red square), down from 3.2m (green line) in 2011:

• China’s volumes were down 17% to 1.2m from 1.4m
• EU fell from 1.04m to 0.97k
• Only the USA saw a rise to 0.9m from 0.8m

Of course, China’s sales were much slower than last year due to the Lunar New Year taking place earlier than in 2011, and combining with the Spring Festival. But even so, China’s auto industry is only forecasting 8% growth this year – in line with the 6% seen in 2011. This is well down on the 33% and 49% increases seen during the stimulus period.

It is also difficult to be optimistic about EU sales, with auto companies forecasting sales declines of 6% or more this year. Whilst sales growth forecasts in the USA will be tested by today’s high gasoline prices.

This time last year, the petchem industry stood on the edge of an unseen precipice. Life seemed good. Prices were racing ahead and demand appeared buoyant. But in reality the buyers were only buying forward to protect margins, whilst end-user demand was slowing fast.

This year, the blog fears, we may be about to take one step forward.

As last year, the evidence comes from ICIS market reports. The highly experienced Linda Naylor last week reported buyers commenting as follows in European polyethylene and polypropylene markets:

“‘We expect an increase for ethylene in March, so we are buying our full contracted volumes in February, and also in January, even though our demand is poorer than we expected. That way, we won’t have to buy so much in March.”

“‘Our demand is below what we expected but we are taking our full contracted volumes to be able to have a buffer next month.”

Similar warning signs are reported by Becky Zhang in China’s ethylene glycol markets, and Helen Yan in Asian butadiene:

“‘The market is full of offers and this [has worsened the] bearish sentiment’, a major regional trader said. China’s port inventory reached a historic high of over 750KT, with increased import volumes arriving from all over the world. This is almost exceeding China’s maximum storage capacity of around 800KT.”

“‘BD prices are higher than BR and this is not sustainable,’ another synthetic rubber producer said.”

The chart shows how prices for the benchmark products have seen 3 major rallies since 2009. These followed the 3 major stimulus packages.

Today’s rally began with Q4′s US Federal Reserve’s $400bn Operation Twist programme. It is clearly much weaker than those which followed the March 2009 and August 2010 quantitative easing programmes.

Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 11%. “Offers for re-exports from China were heard at lower prices than offers from the US Gulf”
PTA China (red), down 11%. “The current supply and demand balance as well as volatile external markets did not support a solid upturn”
Naphtha Europe (brown dash), down 7%. “Vitol continued its naphtha buying spree, taking 5 cargoes after it bought eight cargoes last week”
Brent crude oil (blue dash), down 5%
Benzene NWE (green), down 4%. “Continued buoyancy on crude and energy numbers counterbalanced by lower demand.”
S&P 500 Index (pink dot), no change

China’s bank lending fell 7% in 2011, following a 17% decline in 2010. As the chart shows (red column), the government is clearly trying to stabilise the position, after the panic increase in lending in 2008/2009. (January lending, impacted by Lunar New Year, was down 29% vs 2011).

Electricity consumption growth (blue line) also seems to be stabilising. It is a lagging indicator, as it takes time to expand electricity production. But the ending of subsidies for rural home appliances helped to push their sales down 33% in January versus 2011.

The reason for the government’s caution is that food price inflation remains out of control. It was up 10.5% in January, reversing recent declines. In a country where 96% of the population earns less than $20/day, food prices matter a great deal.

Those analysts with a purely financial outlook seem to have missed this critical point. They have been forecasting further stimulus programmes for some months. But very little has yet happened. Instead, the government remains focused on maintaining social stability.

This is particularly important in the run-up to the major changes that will take place in politburo membership this year. Thus, instead of reductions in interest rates, the government has instead announced minimum wages will rise 13% a year until 2015:

• In Beijing, it is currently $200/month, and $140 in urban Chongqing
• The aim is for it to be at least 40% of average wages by 2015
• At present, it varies between 20%-30%, depending on region

This will boost domestic spending power. But, as we argue in our Boom, Gloom and the New Normal eBook, affordability will be the key factor. Those companies who focus on meeting the population’s basic needs for food, water, shelter, health and mobility should do very well indeed.

Mahathir Mohamad is one of the Grand Old Men of the Asian political establishment. He was Malaysian premier from 1981 – 2003, and led its rapid modernisation and economic growth. Over the period, which included the Asian financial crisis, the former colony’s economy grew four-fold in real terms, and it is now the 37th largest in the world.

His comments from an Asian viewpoint to the BBC on the problems facing Europe are thus well worth noting. He suggests that:

“Europe must face up to the new economic reality. Europe… has lost a lot of money and therefore you must be poor now relative to the past. In Asia we live within our means. So when we are poor, we live as poor people. I think that is a lesson that Europe can learn from Asia.”

“You refuse to acknowledge you have lost money and (that) therefore you are poor. And you can’t remedy that by printing money. Money is not something you just print. It must be backed by something, either good economy or gold. I think you should go back to doing what I call real business – producing goods, providing services, trading – not just moving figures in bank books, which is what you are doing.”Mahathir agreed “with a laugh” with the BBC, this was a tough message:

“We used to get tough messages from you before, remember? And now, what is the result? Sometimes you undermined our currency and we became very poor. Well, we learn from each other. We were Euro-centric before. I think it should be a little bit Asia-centric now.”

Short-term pressures have come to dominate financial markets in recent years. In turn, they have become dominated by high-frequency trading, which frequently accounts for over 60% of all market action.

Their trading is not based on careful analysis, but on extremely fast ‘black box’ computing, which generates ‘trading opportunities’ in micro-seconds. Their power is enormous, as Friday’s US market action showed in response to US jobless figures.

This is a pity, as the detail of the jobless figures themselves, and of those for personal income, provides valuable insight into the current state of the US economic recovery. As the chart shows:

• The number of US jobs (blue column) bottomed at 129m in Q4 2009
• It has since seen a slow but steady recovery, quarter by quarter
• But the current total of 132m jobs only matches that seen in 2001
• Disposable per capita income (red line) was $33.8k ($2005) in Q2 2008
• In Q4 2011 it was only $32.4k, and also lower than at the end of 2010

This is a completely different picture from anything seen in the past:

• Every 10-year period since 1939 (when jobs records began) has previously seen an increase in the number of jobs created. The past 10 years are the first time this has not happened.
• Similarly, every 2-year period since 1969 (when income records began), has previously seen a rise in real ($2005) disposable income. 2011 was the first time this has not happened.

Equally, the percentage of those unemployed for more than 6 months is at levels not seen since the Depression in the 1930s.

Of course, we can all hope that January’s rather modest jobs growth finally marks the start of a major upturn. But hope is not a strategy. It is certainly not a good reason for assuming that Friday’s euphoria means financial markets know something that the rest of us have missed.

The comparison with historical trends shows no sign of the strong job creation and rising disposable incomes that have powered economic recovery in the past.

Shipping markets are usually a good leading indicator of future economic activity.

They have their own supply/demand balances, of course. Not every uptrend or downtrend can be taken too seriously.

But the Baltic Dry Index of ocean freight costs has done a good job for the blog in the past.

So one cannot simply dismiss its message today.

It is an excellent proxy for world trade and activity in China, as it covers the heavy bulk products (iron ore, grains, coal). It was strong through 2007/8, before collapsing. Last March, it was the first indicator to signal the start of China’s slowdown.

As the chart shows, it has now been falling steadily for over a month. Day by day, every day. So far, it has fallen for 28 days in a row. This is quite remarkable behaviour for any market.

It is now back at the levels seen in December 2008.

Optimists who believe that China is about to see a renewed boom will continue to ignore the Index. They will argue its decline simply reflects the fact that too many ships were ordered at the height of the boom.

But this seems too simplistic a response. The recent price weakness is far too dramatic to be simply reflecting this already widely known fact. The blog suspects that the Index is also reflecting a serious slowdown in world trade. It is yet another sign that a new recession is probably underway.

UPDATE. The Index today fell 2.6% today, and is now at a 25 year low.

There is no arguing with markets when they are being driven by sentiment, either positive or negative. Last week’s news of China’s slower GDP growth gave rise to opposite interpretations in Asia and the West – but news media reported both were seen as firmly positive:

• In Asia, markets “jumped… after news that Q4 economic growth in China had beaten forecasts eased fears of a sharper slowdown there”
• Western markets “rose to a 10-week high…after China’s slowest economic growth in more than 2 years bolstered expectations for easier monetary policy”

News analysts, however, were more cautious, with CBS noting:

“This is the smallest GDP increase in a decade and the consensus opinion is that it indicates China is heading for a soft landing as its economy slows. That would be a reasonable conclusion if there was any chance this number wasn’t a complete fabrication. The actual number is certainly lower, quite possibly by a huge amount”.

The Washington Post added a more detailed warning:

“Real estate accounts for 13 percent of China’s economy, and it has been growing at ~20% a year…The run-up in real estate prices has allowed for massive government spending, as provinces and localities sell land and use land as collateral for large loans, raising the specter of a debt crisis similar to the debt crisis in the United States and Europe.”

Meanwhile petchem markets remained in their recent range. The current optimism in financial markets, even though these also remain range-bound, makes it prudent to restock inventories regularly.

The chart shows how markets have moved since 2009′s rally began, with the recent downturn highlighted in yellow. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. “Even with higher global prices, US prices were still too high to generate much interest”.
Naphtha Europe (brown dash), down 14%. “Some seasonal restocking, a recent open arbitrage to the US and the current loading of European vessels booked in December for Asia”.
PTA China (red), down 13%. “Transactions were subdued as most market players were away for the upcoming Lunar New Year holiday”.
Brent crude oil (blue dash), down 11%
Benzene NWE (green), down 5%. “Values buoyed by a firming Asian market as well as crude and energy gains”
S&P 500 Index (pink dot), down 4%

Pensions were one of the great inventions of the past century. Now the European Central Bank (ECB) has issued a ‘wake-up call’ on the affordability issues that lie ahead.

The reason is very simple. As we note in ‘Boom, Gloom and the New Normal’, pensions were introduced first introduced in Germany in 1889, and then in the UK in 1908. The idea was to provide a small amount of money to a small number of people for a small period of time:

• Life expectancy then was 30 years lower than today
• Pensions only went to those who lived 20 years longer than average

Since then, we have failed to index pension age to rising life expectancy. In addition, Westerners have come to assume that pensions are a ‘universal right’. We forget that younger people will have to pay the bill for this dramatic increase in costs.

The ECB’s report summarises the result. It calculates state-funded pension obligations in 19 EU countries where sufficient data exists:

• They have combined obligations of €30trn ($39trn)
• By comparison, total EU GDP in 2010 was only $12trn

The ECB is not supposed to intervene in political issues. So it cannot publically state the obvious conclusion. But most people reading the report will be in no doubt about what this means. Put simply, future pensioners are most unlikely to actually receive the money that has been ‘promised’ to them. Younger generations cannot, and will not, afford to pay the bill.

In turn, this has enormous implications for the type and cost of the products and services that older people will require. Affordability will be the key criteria for them in future years, not ‘value in use’.

Companies that grasp this challenge will not only help to cushion the transition for disappointed would-be pensioners. They will also build a robust platform for their own future growth.

Markets are worryingly quiet for the start of a New Year. There is some restocking underway, but the main interest lies in the crude oil market.

Since Brent peaked in April, there has been a clear pattern each month:

• Prices have peaked at the start of almost every month
• The only exceptions have been July and October
• They have then slipped lower by the end of the month

So players have been busy ‘talking up’ the market since New Year, to see if they can catch unwary buyers. If the pattern holds, they will then ‘talk down’ the market in the 2nd half of the month.

Actual price movements since April have been minimal – with a range of $103 – $118/bbl. So this type of tactic is the only way for players to earn a decent bonus. Their aim is simple – to buy at the end of each month, and then resell at the start of the next month.

Meanwhile, back in the real world of petchems, uncertainty rules.

Some hope that China will boost demand once Lunar New Year is over. Others, particularly in the USA, hope that consumer demand might be improving. But in Europe, there is little optimism. France and Austria lost their AAA ratings on Friday, and Greece moved closer to default.

The chart shows market developments over the past year. Product price changes since the 29 April peak, with ICIS pricing comments, are below:

HDPE USA export (purple), down 18%. “The delta between China and US prices was still too wide to generate much interest in US product”.
Naphtha Europe (brown dash), down 16%. “Low activity levels, with high prices still having an impact on demand”.
PTA China (red), down 14%. “Surging feedstock paraxylene (PX) prices supported PTA prices”.
Brent crude oil (blue dash), down 10%
Benzene NWE (green), down 9%. “Upward movement was primarily crude driven, as demand from key sectors such as styrene and phenol has so far remained sluggish to average “.
S&P 500 Index (pink dot), down 6%