By John Richardson
THE TOP chart shows that global chemicals industry operating rates fell to just 78.3% in November, even though companies up down the industry’s value chain were building inventory ahead of expected New Year price rises. This was in response to all the excitement generated by expectations of an OPEC-Russia deal to reduce output levels and talk of major oil price rises.
But even with this support, global operating rates have fallen in every month since January apart from June, when they temporarily stabilised at 79.3%. And these rates are at 1.3% above the March 2009 level, which marked the bottom of the sub-prime crisis in March 2009.
“The chemicals industry is normally around 8 – 12 months ahead of the wider economy due to its early position in the supply chain,” writes Paul Hodges in his latest PH report, from where the operating rate chart was borrowed.
The bottom chart, showing the movements in the S&P 500 since 2009, shows almost the complete opposite. We are now in the eighth year of a bull run that started after the Fed launched its quantitative easing programme in the hope that “trickle down” economics from a stock market rally would rectify the damage done by the Global Financial Crisis (GFC).
Now, though, the Fed, after all this wasted time, recognises that its policies might have been flawed because of the ageing of the Baby Boomers. It understands that repairing the damage from the GFC had all along been impossible via only a stock market boom. This reason is that the lack of young people entering the workforce is creating a demand deficit. The demand deficit for real things – -e.g. houses and autos etc. –is showing up in a deep analysis of the data. Short term blips aside, the trend here is decidedly downwards.
And those who voted for President Trump largely did so because they too have understood for a lot longer than the Fed that there is something fundamentally wrong with the US economy. The squeezed middle class voted for change.
If you are a Trump supporter, you may therefore argue that whereas strong equity markets before his election didn’t reflect the future of the real economy, they certainly do now because of his deregulatory and tax-cut policies. After brief declines immediately after the November vote, US equity and global indices have soared to new highs. The Dow Jones Industrial Average even recently went past the perhaps talismanic 20,000 mark.
But anyone who has been reading my blog over the last few months will not be surprised to hear me say that I don’t believe equities are the immediate risks ahead. In my post on Wednesday, I reached the difficult and painful conclusion that a global recession is almost inevitable in 2017.
President Trump’s policies may work in the long term, and let’s hope that they do, but it is hard to see anything but very negative short term effects on the real US and global economies. Stock market investors should thus be prepared for a potential major downward correction.
Reforming or Repealing Dodd-Frank
Alternatively, equities may get stronger and stronger, resulting in a growing disconnect with the real economy.
This could be the result of reforms, or even an outright repeal, of the Dodd-Frank financial regulations that were introduced after the GFC. President Trump, and many other people, argue that Dodd-Frank is impeding the flow of credit to small and -medium-sized businesses. Analysts have been arguing for years that US community and regional banks have been treated too harshly by these rules, and would lend more if they were less regulated.
That might be right. But I fear the problem is less the supply of loans than the demand for loans. This is the result of my argument on US, and also European, demographics Too much supply in finance, and also in manufacturing, is already chasing too little demand because of the retirement of the Baby Boomers. It is thus hard to see how making more loans available to US small businesses will, by itself, solve the problem.
And Dennis Mr Kelleher, CEO of the US non-profit organisation Better Markets says in this article:
Tens of millions of America’s families are still paying down debt, including more than a trillion dollars of student loan debt, due to the financial crash and too many are still dealing with un- or under-employment. That is the fundamental problem holding back real economic growth.
He adds that even eight years after the GFC, few Americans have had the home equity or creditworthiness for a personal guarantee to be able to start a small business.
He then warns that planned changes to Dodd-Frank that include deregulating derivatives trading and permitting banks to derivatives trading could lead to an even more inflated equities-market bubble.
Further, even if Dodd-Frank is not reformed or repealed, some critics suggest that President Trump’s proposals for cutting taxes would mainly benefit the rich. This might by itself add a lot of air to the equities bubble.
There is a lot of partisan noise out there because President Trump is doing exactly what he promised to do. He is radically departing from consensus thinking on everything from immigration to trade, to geopolitics and the environment.
I don’t want to add to this noise. The headline purpose of what I have written over the last few months has instead been this: Because what is being attempted has never been attempted before, there are major risks ahead – especially, as I again said on Wednesday, for the real US and global economies in 2017.
And as I have described above, there is another layer of risk. In summary:
- Stock markets might suddenly collapse as investors react to the almost inevitable 2017 global recession. Oil prices would of course go the same way.
- The equities bubble could instead continue as the real economy gets worse and worse, increasing the US middle class alienation that led to Donald Trump’s victory – and making victories by other populists in elections in France Holland, and possibly Italy, later this year more likely.
Ultimately, also, this new bubble would have to burst as all bubbles do – probably not this year, but in several years to come. The issue would then be whether a financial rescue on the scale of 2008 would be possible. It was that rescue, for all its flaws, that avoided a new Great Depression.