Chemicals & The Economy

The blog has worried in the past about the way that official statistics seem to be increasingly manipulated to provide a rosy view of the economy. Barrons, the leading US investment magazine, provides another example this week, in connection with the report that US GDP grew at 3.3% in Q2.

Barrons notes that this is supposed to be a 'real' figure, ie after adjusting for inflation. This leads them to question why the inflation rate used by the statisticians was just 1.33%? And they comment, 'maybe it did -- but not in the good old U.S. of A', adding that this would have been the lowest inflation rate in 5 years. It is also a major discrepancy with official figures for consumer price inflation, which was reported at 8.8% for Q2.

Barrons suggests that if a realistic inflation estimate had been used, the US economy would instead have been shown to have contracted by 2.9%. Quite a difference!

There seems no end to the losses being revealed by the world's major banks. The total has now reached $514bn. 110 banks and investment firms have now posted writedowns. CitiGroup, the largest US bank, tops the list with $55.1bn of losses, closely followed by Merrill Lynch with $51.8bn. Then comes UBS of Switzerland with $44.2bn.

Back in April, the IMF forecast losses of at least $1 trillion, and warned this could lead to recession. New York professor Nouriel Roubini, who has been consistently bearish, but accurate, on the size of the problems, now forecasts the total could reach $2 trillion. That would be equivalent to almost 15% of the output of the US economy.

Roubini is also forecasting that US personal consumption will fall, now the impact of the government's Q2 $100bn stimulus package has passed. This has not happened since 1990. If Roubini is correct, 2009 could be a very difficult year for the chemical industry.

A trend seems to be developing amongst the world's policy makers. Last month saw China and the UK's finance ministries warning of bad times to come. Yesterday, France's finance minister joined the chorus, saying that she had 'underestimated the spillover from the US financial and housing market turmoil'. Even more significantly, her boss, French prime minister Francois Fillon, announced a cut in the government's 2008 growth forecast to just 1%, and warned that the world was facing 'A very, very serious global economic slowdown'.

Many readers have been out of the office during August on a well-deserved break. I am therefore highlighting below the main postings over the past month, in the hope this will help them to catch up quickly on key developments - please click on the highlighted title if you want to read the original posting:

• Oil prices were still close to $150/bbl in early August, but the blog again warned they could easily slip towards $100/bbl in the absence of any military action on Iran. Since then, they fell to a low of $112/bbl.
• Change, challenge, complexity. We published a major Study on the outlook for the petchem industry over the next few years. The post also contains a link to my feature article in ICB, summarising its key conclusions.
• US housing and auto markets continued to slow. US house prices fell again, and the number of new housing starts reduced. BMW warned on the outlook for 2009.
• GDP forecasts were cut by BASF. The UK's Finance Minister said the global economy was at a 60-year low, and China's minister referred to the need for economic restructuring.
• The credit crunch continued. Warren Buffett memorably referred to 'the nudist beach on Wall Street' where those bankers who had been 'swimming naked' were now being exposed.

All in all, reading through these headlines makes me think that August was probably a good month to go away. Welcome back, if you have just returned!

Another policy maker has decided realism is the best policy when talking about the current credit crunch. China's Liu He started the trend earlier this month, by talking about the need for 'economic restructuring'. Now the UK's Finance Minister, Alistair Darling, has become the first western official to abandon reassurance and instead to focus on the reality of current problems.

His analysis is stark in tone, and acknowledges that the depth of the crisis is far worse that he had previously understood. He says:

• Today's economic times 'are the worst they've been in 60 years'
• The downturn 'will be more profound and long-lasting' that most people had expected

Some research in yesterday's Financial Times yesterday also highlights the depth of today's problems. Its shows that Merrill Lynch has already lost 25% of all the profits it has ever made, since it became a listed company back in 1971. And, of course, there are probably still more losses to come, as global housing markets remain weak.

Housing is a vital market for chemical companies. It boomed in the US and other Western countries as credit standards were relaxed between 2003-7. Now it is at the centre of the credit crunch. Martin Feldstein, Harvard economics professor, and the man who chairs the Board that determines the duration of US recessions, is clearly very worried. Writing in the Financial Times today, he summarises the outlook as follows:

'The US economy is sliding into recession. Employment, industrial production and real incomes are declining. Monetary policy has little traction because of the dysfunctional credit markets and the collapse of housing. The fiscal policy of tax rebates failed to achieve a significant impact on consumer spending. The economy will continue to decline and the financial markets to deteriorate unless a policy is adopted to stop the downward spiral of house prices.'

Anyone preparing budgets for 2009-11 will need to include a Downside Case that covers what might happen to demand, and margins, if house prices do continue to fall.

US house prices, according to today's S&P/Case-Shiller Index, are still falling quite sharply. As shown in the chart, they are now down 17% versus last year. The key influence, according to S&P, is that 'the markets that were the high-flyers during the recent real estate boom continue to be the ones that are leading the current decline'. Thus prices in Miami, San Francisco, Las Vegas, Los Angeles, Phoenix and San Diego are all down around 25%, whilst cities such as Atlanta, Chicago, Detroit, Minneapolis and Washington are 'only' down around 10%.

Continue reading "US house prices keep on falling" »

China's growth rate is slowing quite sharply. Exports to the US grew just 9% in H1, half the 2007 rate. In addition, ICIS news has reported that China's important textile industry has seen a 25% decline in orders, whilst US polyethylene exports to China are also slowing. And the above chart showing China's latest Purchasing Managers Index (PMI) indicates the ratio of inventories to new orders has risen 45% since April.

Until recently, rapid growth in most Western housing and auto markets created a virtuous circle for chemical producers worldwide. Not only were these major sources of chemical demand in their own right. But as the blog noted last December, they also enabled an export boom to take place in China, due to its role as the world's leading manufacturer. In turn, this supported domestic growth and caused China's own import demand to jump. Now, unfortunately, we may be seeing a vicious circle develop, as slowing Western markets reduce China's export growth, and hence its GDP growth, in turn reducing its own import needs.

When you're the richest man in the world, you can generally say what you think. Thus Warren Buffett reflected reality back in March, when he commented that 'by any commonsense definition, the US is in recession'. Yesterday, he probably ruffled a few more feathers when he told CNBC that he thought the US economy was still in recession, and 'could be worse' at the end of the year.

He also remarked that a 'financial crisis reveals which players have been swimming naked, because the tide goes out'. And, he added, 'we (have) found out that Wall Street has been kind of a nudist beach'. As a result, he expects both the US mortgage giants, Fannie Mae and Freddie Mac, to require 'federal government help' to survive. He also expects more US banks to collapse as a result of 'failures where the bankers were dumb in what they did'.

A year ago, the noted investment analyst, Jeremy Grantham, described the credit crisis as a 'slow motion train wreck'. The Financial Times has now updated the metaphor to describe what has happened since. It notes that train crashes happen more quickly than economic ones, and that there are pauses before the next carriage hits the one in front. It believes this explains how we have since 'moved from crisis to crisis, with rallies in between, as participants persuade themselves that the worst is over'.

Its conclusion is not encouraging for chemical companies. It expects that the problems in banking, housing and consumer markets will continue to play out 'in very slow motion'. As a result, it warns that 'we may have much longer to wait until the final impact has juddered through the train'.