By John Richardson
WHAT for you is the most important chart, the one on the left or the one on the right? If you are a chemicals producer rather than stockmarket investor, I would suggest it is the one on the right.
The chart on the left shows the rise of the Dow Jones Industrial Average up until five days ago. Since then, the rally has continued. Yesterday, the index was closing in on 20,000, which has never been reached before.
But the chart on the right, just a small sample of the excellent work carried out by the American Chemistry Council, tells a very different story:
- Capacity utilisation (CU), or operating rates, fell to just 78.4%, despite October being seasonally one of the four strongest months of the year. This is worrying as customers are normally running at full rates after the summer holidays, and are keen to maximise output ahead of the Christmas holidays.
- It has fallen by nearly two percentage points since October last year.
- CU has fallen in every month since January, with the exception of June when it temporarily stabilised at May’s level of 79.3%.
- The October level was only just above the lowest reading ever seen, of 77% at the bottom of the sub-prime crisis in March 2009.
The chemicals industry is an excellent indicator of wider economic activity, as of course chemicals and polymers go into a very broad range of finished goods.
The Dow Jones is supposed to tell us about the future, as are all equities. You might as a result believe that the some $1 trillion added to US share valuations since Donald Trump’s success in the US presidential election is a pointer towards a bright economic future.
Alternatively, you might instead see the latest ACC estimate of historic global chemicals production as a better future indicator. The ACC is in my view a much more reliable barometer of the future economic climate because it reflects a secular decline in demand.
The reason for this decline should be obvious to most people by now. Recently, far too belatedly, the reason became obvious to the Fed. It is of course demographics. As Paul Hodges writes in his November 2016 PH report, demographic forces will make it very difficult for Mr Trump to achieve his target of 4% GDP growth:
The number of US families in the higher-earning, higher-spending Wealth Creator cohort was virtually unchanged between 2000 – 2015 at around 65m.
Meanwhile, the number of those in the lower-earning and lower-spending New Old 55+ cohort rose by nearly 50% to 53m, and is still rising
Equally important is that the increase seen in average spending by the New Olders over the period (from $43k to $50k) was only a short-term phenomenon, caused by the fact that even the oldest Boomers (born in 1946), were still in the relatively prosperous 55 – 64 cohort until 2011.
But since then, as the Pew Institute has reported, every day has seen 10,000 American Boomers reach the age of 65. And this trend will continue until 2030, given that the US BabyBoom lasted between 1946 – 1964. Equally important from the growth perspective is that current US Social Security projections suggest that a man aged 65 can expect to live on average until age 84.3, and a woman to age 86.6. They also expect a quarter of 65-year-olds to live past 90, and a tenth past 95.
Consumer spending is 70% of US GDP and is heavily age-related. This means that the long-term trajectory for New Older spending is inevitably downwards. Spending clearly peaks by the age of 55, as people already own most of what they need, and their incomes decline as they enter retirement. Thus spending by the over-75s is down by nearly a half compared to the peak level.
Fiscal stimulus is trying to replace babies that haven’t been born by building more bridges, roads and digging more shale-oil wells etc. There is a risk that this will be as much a mistake as the Fed’s efforts to replace lost babies by printing more money, and by so doing devaluing the dollar and lowering global interest rates.
What is worse is that the move to fiscal stimulus threatens to raise global interest rates to the point where much of the debt built-up during monetary stimulus become unpayable.
The other knock-on effect is a stronger dollar that would result from higher borrowing costs. What then would be the growth prospects be for emerging markets who have over-borrowed in dollars? Not good, I fear. Of equal concern is how the Yuan might further weaken, and what this would do to trading relationships between the US and China. A global trade war is a strong possibility.
My base case for 2017 is that US fiscal stimulus won’t work as intended, and risks creating more problems than it solves. This is feeding into my work on oil prices and chemicals demand growth.
Any sensible chemicals company needs to into account these risks in their Scenario Planning, even if they to differ from me on their base-case outcomes.