By John Richardson
LACK of clear thinking about the challenges ahead worries me at the moment. I am concerned that petrochemicals companies, because of the strong profitability they have enjoyed so far this year, might well not be adequately prepared for the fault lines opening up the global economy.
Here are ten themes that you need to consider:
- The Greek plebiscite on Sunday. People hope that financial contagion will be limited, but I worry that there is every chance that this could spread. We are in uncharted territory. There is therefore every chance of a steep decline in crude-oil prices. The only thing that is propping oil up right now is financial speculation.
- Oil is also vulnerable to the potential of a final nuclear deal between Iran and the West by the 30 June deadline.
- The essential point here is that crude markets remain fundamentally long. Too much supply is chasing to little demand.
- Too much supply is largely the result of misguided Fed stimulus policies that have led to overinvestment in shale oil (and as people continue to chase yield due to record-low interest rates, this explains why crude markets are still being driven by financial speculation, and so could unwind very suddenly).
- Too little demand is the result of the secular, long term decline in the global economy, which is being driven by demographics in the West.
- People simply have to stop being in denial about China. The latest interest-rate cut and the reduction in the bank-reserve requirement were not signs that we have returned to the stimulus days of old.
- This view ignores the facts on the ground. Further monetary easing was instead about making the debt burden a little less painful for heavily-indebted companies.
- These companies face high debt burdens because they overinvested in badly oversupplied real estate in some of China’s cities, and in oversupply across most manufacturing industry. I heard an estimate the other day that average industrial capacity utilisation in China is just 50%.
- And because of oversupply, China is in deflation, which, of course, makes the real burden of debt even harder to pay back, as real interest rates, adjusted for inflation, are still very high, despite the latest official reduction in interest rates.
- It is important to separate the recent stock market euphoria in China from what is happening in the real economy where painful, but ultimately success, economic reforms will continue. Despite the number of new stock market accounts that have been opened since late year, the number of people who trade equities in China is still only 15%. So this could never create the lost “wealth effect” resulting from economic reforms. And, anyway, as we all know, local equities are highly volatile and have suffered sharp corrections over the last few days.