INSIGHT: Synchronised global economic upswing coming apart

Author: Joseph Chang


NEW YORK (ICIS)--Headwinds are starting to throw the global economic upswing out of sync. After a meaningful uplift this year in US and European economies, especially on the manufacturing front, Europe is slowing down markedly while China is taking measures to stave off the negative impacts of US tariffs.

The big risks going forward are trade and interest rates, with US policies causing the waves.

The latest manufacturing Purchasing Managers’ Index (PMI) readings show continuing strength in the US, but a major slowdown in the eurozone. China’s manufacturing PMI as measured by the IHS Markit/Caixin index, having long lagged the US and eurozone, is now at the neutral level.


In the latest China PMI report, new export orders declined at the quickest rate since February 2016 as the trade war with the US hit home.

The US-China trade war continues to escalate with the 3rd round of tariffs being implemented from both sides on 24 September. Chemicals, polymers and finished plastics are all impacted in the 2nd and 3rd rounds.

This latest tariff round from the US on $200bn in Chinese imports at a rate of 10% comes on top of 25% tariffs on a cumulative $50bn in imports in rounds 1 and 2. Importantly, this rate jumps to 25% by 1 January 2019 unless there is some trade agreement.

Plus, US President Trump has threatened tariffs on another $267bn in Chinese imports – essentially placing all imports from China under tariff.

China has likewise put 25% tariffs on $50bn in US imports in rounds 1 and 2, and 5-10% on $60bn in imports in round 3. It simply cannot match the US dollar for dollar as it exports far more to the US than it imports, to the tune of around $375bn in 2017, according to the US Census Bureau.

For chemicals and finished plastics, the 2nd round of tariffs impacted $2.0bn in US exports and $2.2bn in China exports. The 3rd round ratchets this up to an additional $8.8bn in US exports and $13.2bn in China exports, according to the American Chemistry Council (ACC).

China’s finished plastics exports to the US are particularly hit hard, with $1.4bn worth in the 2nd round, and another $5.6bn in the 3rd round, the ACC noted.

The US is hit harder in bulk chemicals and resins, with notable volumes of polyethylene (PE), styrene, polypropylene (PP), ethylene dichloride (EDC) monoethylene glycol (MEG), paraxylene (PX) and ethylbenzene coming under tariff, according to an ICIS analysis.

And the US has opened up trade battles on multiple fronts – with the EU, Canada, Mexico, Japan, South Korea, Turkey, Brazil and India. A major positive development has been an agreement to revise NAFTA with the new US-Mexico-Canada Agreement (USMCA). The US and South Korea have also agreed to revise their free trade agreement.

Yet the headwinds from these battles are being felt worldwide, particularly in China where financial markets and business confidence have plunged.

On 7 October, China’s central bank announced a plan to cut to its reserve requirement ratio – the amount of funds it requires banks to hold – by 1 percentage point by 15 October. This move would spur lending to support economic growth, potentially injecting over $100bn of liquidity into the banking system.

However, this did little to inspire confidence in the short term, as the benchmark Shanghai Composite Index tumbled 3.7% on 8 October – the first day of trading after the Golden Week holidays. It is now down around 19% year to date. In contrast, the US benchmark S&P 500 Index is up over 6% this year.

In late September, China also slightly eased air pollution reduction targets in a move to presumably provide relief to the industrial sector.

Europe is not immune to the US-China trade dispute, as many of its companies have manufacturing operations in the US that export to China. And the EU is also battling with the US on trade with the US threatening to impose tariffs on auto imports in particular.

The eurozone manufacturing PMI has steadily declined from a high of 60.6 in December 2017, to 53.2 in September 2018 - its weakest level since September 2016, although still in expansion territory above the 50 level.

Global trade concerns pushed business confidence down to a 3-year low, and export-led slowdowns were evident in Germany, France, Spain, Italy and Austria.

On 9 October, in its World Economic Outlook (WEO) report, the IMF took down its global annual GDP growth forecast to 3.7% for 2018-2019 versus its previous 3.9% target from April. Global growth, while still solid compared to earlier in the decade, has likely plateaued, it said.

“There are clouds on the horizon. Growth has proven to be less balanced than hoped. Not only have some downside risks that the last WEO identified been realised, the likelihood of further negative shocks to our growth forecast has risen,” said Maurice Obstfeld, economic counsellor and director of research at the IMF.

The IMF took down its GDP forecasts for the US and China in particular for 2019 because of negative impacts from the trade war.

It expects US GDP growth to fall from 2.9% in 2018, to 2.5% in 2019. For China, GDP is projected to decline from 6.6% in 2018, to 6.2% in 2019. And after growing 2.4% in 2017, eurozone GDP is estimated to slow to 2.0% in 2018 and 1.9% in 2019.

In addition to global trade tensions, rising interest rates - also led by the US – is the other major threat to economic growth.

Already, the series of interest rate hikes by the US Federal Reserve has boosted the US dollar and drained liquidity from emerging markets in particular.

Argentina, Turkey, Brazil and South Africa have seen notable economic weakness and currency declines, although Brazil’s financial markets and currency have gotten a boost from right wing and business friendly candidate Jair Bolsonaro winning the 1st round of presidential elections.

“Amid the trade uncertainties, financial conditions are tightening for emerging market and developing economies as they adjust to progressive interest rate hikes by the Federal Reserve and an impending end of asset purchases by the European Central Bank,” said Obstfeld from the IMF.

“Compared with 10 years ago, many of these economies have higher levels of corporate and sovereign debt, leaving them more vulnerable,” he added.

Also pressuring emerging markets is the rising price of crude oil, as many countries such as China and India are major net importers.

With US sanctions on Iranian exports of crude oil set to kick in on 4 November, US President Trump has been imploring OPEC to boost production to get prices down as the US alone won’t be able to make up the difference.

Meanwhile, Brent crude oil at around $84/bbl has surged to its highest level since late 2014.

While the US economy is “ripping” with robust manufacturing and services activity and record-low unemployment, the key housing and automotive sectors have been weak of late as higher interest rates start to bite.

And you wouldn’t be able to gauge the strength in the general manufacturing economy by looking at US chemical equity prices and valuations. The sector has hit a rough patch since early September and is well off its highs in late January.

Shares of DowDuPont, the largest and most diverse company in the US chemical universe, are off about 10% since September and 18% from their January high. At around $63 as of 8 October, the stock trades for about 13.1x estimated 2019 earnings versus 16.2x for the S&P 500.

More severe valuation compression can be seen in commodity oriented chemical names, indicating investors are discounting the risk of a major earnings downturn going forward.

For example, LyondellBasell at $104 trades at 9.2x estimated 2019 earnings while Westlake Chemical at $83 fetches a multiple of 9.6x.

But nowhere is investor scepticism more evident than in the titanium dioxide (TiO2) sector where Chemours at $39 trades at just 6.2x estimated 2019 earnings, even as fluoroproducts and other chemicals make up a substantial and growing portion of the company.

Other purer play TiO2 companies Tronox and Venator trade at multiples of 6.9x and 5.6x, respectively.

On a fundamental basis, juiced by corporate and individual tax cuts and regulatory reforms implemented by the Trump administration, the US is a beacon of strength in the world economy.

However, with other major economies and emerging markets faltering, this isolated strength will be harder to maintain. The world economy is still very much interdependent on trade and financial systems, and the overall risks are rising.

By Joseph Chang