The chemical industry has long been the best leading indicator for the economy. It is the third-largest industry in the world, with its products used in every aspect of our daily lives, in every country. It warned of the subprime crisis, and was proved correct. It has been warning here of likely recession for months – and finally the “experts” are catching up.
The problem is two-fold:
- Central banks believed they had become ‘Masters of the Universe’, and could deliver constant growth
- Financial advisers make more money in good times than in bad, so they hate to recognise bad news
It was clear from April last year that inflation was moving out of control, as we warned at the time. And now Treasury Secretary, Janet Yellen has admitted there were:
“Supply bottlenecks that affected our economy badly that I didn’t, at the time, fully understand.”
This is good news, as it means she may now learn from her mistake. But as Dimon notes, most investors don’t bother doing their “own homework” and just go along with the crowd, chasing momentum.
It also means, as the Financial Times chart shows, that investors and policymakers have mistaken inventory build for strong end-user demand. After all the supply-chain problems, companies are now operating on a ‘Just-in-Case’ basis, instead of ‘Just-in-Time’.
Inventories at Black & Decker, Intel, Walmart, Target and many others are far too high – and will have to reduce as we go into H2.
BEWARE THE ‘ZOMBIES’ AS WE HEAD INTO A MAJOR RECESSION
The Pandemic was followed by War, and now looks certain to be followed by Famine as fertiliser costs soar. This “Putinflation” is out of control, as discussed last month. So finally central banks are refocusing on the need to raise interest rates.
Some describe this as “tightening”. But in reality it is simply “normalising”. After all, interest rates were 14.6% when inflation was last at today’s levels. Today they are just 2.9%, and have a long way to rise before they are even close to “tightening”.
And so our Base Case is for a serious and extended downturn. The problems caused by the 3 Horsemen are unlikely to be quickly resolved. This also creates major risk for asset markets – especially stocks and housing. We doubt that central banks can/will ride to the rescue this time.
In turn, companies and investors need to focus on managing key risks:
- Scenario planning needs to reflect a wide range of potential outcomes, and not just be slightly more optimistic or pessimistic
- Cash is king. Fixed and other costs must be managed very carefully. Cash, rather than profit, is always key to survival
- Back to Basics. Companies need to manage their credit/supply chain risk very carefully, and monitor inventories like a hawk
- Beware the zombies. As the chart highlights, major bankruptcies are inevitable as they can no longer roll over debt
There are positives in all this, as the Green agenda will create new opportunities to replace those that are now disappearing. But for the moment, at least, the risks associated with a likely lengthy and deep recession are likely to dominate. Please be careful out there.