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Sitting On The Fence Involves Choosing Failure

China, Company Strategy, Economics, Environment, Europe, Oil & Gas, Sustainability, Technology, US
By John Richardson on 25-Apr-2016


By John Richardson

IF you choose not to decide, you still have made a choice. So the choice today is yours. If you remain on the fence, still unsure about whether the end of the Supercycle is real or not, you will be no different to those who say that the fundamentals that govern the chemicals industry haven’t changed. Just like them, you will effectively have chosen to place the survival of your business at great risk.

It really is that simple, in my view, because the evidence continues to build that the comfortable world in which we used to live is over – for good, I am afraid.

Take the latest IMF data on the global economy in 2015 as a great example (see the above chart). What the data says is that last year’s collapse is even worse than it originally thought, as:

  • The fall, when measured in current dollars, is now thought by the IMF to have been a record $4.7tn versus $3.3tn in 2009.  And GDP was down 6% in percentage terms versus 5.3% in 2009.

What is even more worrying is that the IMF outlook for 2016 continues to deteriorate. They now expect GDP this year to be just $0.8tn higher than in 2015 – only 1% higher. And they don’t now expect GDP to recover to the 2014 level until 2018 at the earliest.

Too many people are also sitting on the fence when it comes to the US economy. “Yes, true, some of the data is discouraging, but just look at the number of jobs created since the end of the Great Recession” is one comment I often hear.

But the data for me is strongly pointing in the opposite direction of a “business as usual” scenario. For example, as Carl Delfeld writes in a Wall Street Daily article.

  • US Corporate profits look as they will be flat in 2016, the labour participation rate remains stuck on a historically very weak 63%, and non-residential construction has stalled.
  • Capital and credit has been flowing to the wrong places, with government debt and consumer debt sharply expanding, while corporate debt has been flat. Venture capital investment is at one-third of the level seen during 2000-15, and IPOs are down 50% from that time period.

You also need to look at the type of jobs created in the US since the end of the Great Depression

And, as I discussed on Friday, China has taken two steps back in its reform drive. The recent renewed rise in credit should set alarm bells ringing everywhere because in Q1 this led an increase in the country’s debt to 237% of GDP. Experts who spoke with the Financial Times concluded that this will result in one of two things:

  1. A financial crisis if the government deals with this problem head on. (Separately, Charlene Chu – the financial analyst who has a great track record of being right – has told Barron’s that Chinese non-performing loans could be as high as 22% of total lending)
  2. China instead chooses to “extend and pretend”, by propping up failing companies and lenders.  It would, like Japan, suffer a long period of stagnant growth. As the FT writes: Many are now concerned that China’s debt could lead to a so-called balance-sheet recession — a term coined by Richard Koo of Nomura to describe Japan’s stagnation in the 1990s and 2000s. When corporate debt reaches very high levels, he observed, conventional monetary policy loses its effectiveness because companies focus on paying down debt and refuse to borrow even at rock-bottom interest rates.

I also warned at the start of this year about rising international trade tensions if China further attempted to export its deflation in an effort to preserve jobs.

Now Reuters reports that China’s proportion of global exports rose to 13.8% in 2015, from 12.3 percent in 2014, data from the United Nations Conference on Trade and Employment shows. This was the highest share any country has enjoyed since the US in 1968.

The wire service warned that was largely the result of Chinese firms flooding overseas markets with their oversupply – for example, the rapid increase in Chinese steel exports.

And, as I again suspected would happen, the Chinese government is boosting the competitiveness of its exporters in an effort to shore-up domestic growth. Reuters writes in the same report:

On Wednesday [of last week), Beijing rolled out fresh measures to support machinery exports, including tax rebates, and encouraged banks to lend more to exporters. Machinery and mechanical appliances make up the biggest portion of China’s exports.

The Reuters story also supports my view that as China edges up the manufacturing chain, innovation will be focused on making “mid-market” goods such as smartphones that compete with likes of Samsung, rather than the leading brand Apple, at very affordable prices. These goods will be both for export, and for the local market, and will thus pose a double threat to Western manufacturers of mid-market goods. As Reuters again writes:

Much of Chinese industrial innovation has focused on process and production improvements to make products at lower cost but acceptable quality.

You therefore have a choice of remaining on the fence, or getting off the fence and accepting that future success depends on how you manage your own demand. I will further discuss how you go about doing this in a post later this week.