Uber’s IPO next month is set to effectively “ring the bell” at the top of the post-2008 equity bull market on Wall Street. True, it is now expecting to be valued at a “bargain” $91bn, rather than the $120bn originally forecast. But as the Financial Times has noted:
“Founded in 2009, it has never made a profit in the past decade. Last year it recorded $3.3bn of losses on revenues of $11bn.”
And Friday’s updated prospectus confirmed that it lost up to $1.1bn in Q1 on revenue of $3.1bn. In more normal times, Uber would have been allowed to go bankrupt long ago,
So why have investors been so keen to continue to throw money at the business? The answer lies in the chart above, which shows how debt has come to dominate the US economy. It shows the cumulative growth in US GDP since 1966 (using Bureau of Economic Analysis data), versus the cumulative growth in US public debt (using Federal Reserve of St Louis data):
- From 1966 – 1979, each dollar of debt was very productive, creating $4.70 of GDP
- From 1980 – 1999, each dollar was still moderately efficient, creating $1.20 of GDP
- Since 2000, however, and the start of the Federal Reserve’s subprime and quantitative easing stimulus programmes, each dollar of debt has destroyed value, creating just $0.38c of GDP
After all, if one ignores all the hype, Uber is just a very ordinary business doing very ordinary things. Most people, after all, could probably run a serially loss-making taxi and food delivery service, as long as someone else agreed to keep funding it.
Yes, like the other “unicorns”, it has a very customer-friendly app to help customers to use its service. But in terms of its business model:
- When one takes a ride with Uber, the driver often also drives for Lyft and for the local taxi firm, and her car is often also the same car
- This means that in reality, Uber’s main competitive advantage is its ability to subsidise the ride or the food bought via Uber Eats
DEBT HAS CHANGED FINANCIAL MARKET BEHAVIOUR
This addiction to debt on such a scale, and for such a long period, has changed financial market behaviour.
Nobody now needs to do the hard graft of evaluating industry dynamics, business models and management capability. Instead, they just need to focus on buying into a “hot sector” with a “story stock”, and then sit back to enjoy the ride. The chart above from Prof Jay Ritter confirms the paradigm shift that has taken place:
- It highlights how 80% of all IPOs last year were loss-making, compared to around 20% before 2000
- The only parallel is with the late 1990s, when dot.com companies persuaded credulous investors that website visits were a leading indicator for profit
Like other so-called “unicorns with $1bn+ valuations, today’s debt-fuelled markets have allowed Uber to raise money for years in the private markets. So why has Uber now chosen to IPO, and to accept a valuation at least 25% below its original target?.
CORPORATE DEBT IS INCREASINGLY FUNDING STOCK BUYBACKS TO SUPPORT SHARE PRICES
The above 2 charts from the Wall Street Journal start to suggest the background to its decision:
- They show the ratio of US corporate debt to GDP has now reached an all-time high at 48%. The quality of this debt has also reduced, with the majority now just BBB-rated and with record levels of leverage
- BBB ratings are just above junk, and most major investment managers are not allowed to hold junk-rated bonds in their portfolio. So they would have to sell, quickly, if this debt was downgraded
The problem is that much of the corporate debt raised in recent years has gone to fund share buybacks rather than investment for the future. President Trump’s tax cuts meant buybacks hit a record $806bn last year, versus the previous record of $589bn in 2007. According to Federal Reserve data, investors sold a net $1.1bn of shares over the past 5 years – yet stock markets powered ahead as buybacks totalled $2.95bn. As Goldman Sachs notes:
“Repurchases have consistently been the largest source of US equity demand. Since 2010, corporate demand for shares has far exceeded demand from all other investor categories combined.”
THE FED’S RECENT PANIC OVER INTEREST RATES HIGHLIGHTS THE STOCK MARKET RISK
Against this background, it is not hard to see why the US Federal Reserve panicked in January as 10-year interest rates rose beyond 3%. For years, the Fed has believed, as its then Chairman Ben Bernanke argued in November 2010 that:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Rising interest rates are likely to puncture the debt bubble that their stimulus policy has created – by reducing corporate earnings and increasing borrowing costs for buybacks.
Uber’s IPO suggests that the “smart money” behind Uber’s IPO – and that of the other “unicorns” now rushing to market – has decided to cash out whilst it still can, despite the valuation being cut. They must have worried that in more normal markets, they would never be able to float a serially loss-making company at a hoped-for $91bn valuation.
If they really believed Uber was finally about to turn the corner and become profitable at last, why would they accept a valuation some 25% below their original target of less than a month ago? The rest of us might want to worry about what they know, that we don’t.
The chemical industry is the best leading indicator for the global economy. And my visit to Singapore last week confirmed that the downturn underway in the Asian market creates major risks for developed and emerging economies alike.
The problem is focused on China’s likely move into recession, now its stimulus policies are finally being unwound. And the result is shown in the above chart from The pH Report, updated to Friday:
- It confirms that the downturn began before oil prices peaked at the beginning of October, confirming that companies were responding to a downturn in end-user demand
- Since then, of course, the oil price has – rather dramatically – entered a bear market, with prices down by nearly a third
The question now is whether finance directors will choose to aggressively destock ahead of year-end results, to mitigate the volume decline with a decline in working capital. This would be a bold move given continuing geo-political uncertainty in the Middle East, and would also conflict with the more upbeat guidance that was given earlier with Q3 results.
But a review of ICIS news headlines over the past few days suggests they may have little choice. Inventories are described as “piling up” in a wide range of major products, including polyethylene – the biggest volume polymer. Indian producers are even offering “price protection” packages on polypropylene, to safeguard customers from losses if prices fall further.
Asian countries and their major partners (eg Argentina, S Africa, Turkey) were, of course, the first to be hit by China’s downturn. But Q3’s fall in German GDP shows the downturn has now spread to the Western economy that most benefited from China’s post-2008 stimulus bubble. As The Guardian noted:
“Goods exports make up 40% of German GDP – a much bigger proportion than for the next two biggest eurozone economies, France and Italy.”
Of course, consensus opinion still believes that the US economy is sailing along, regardless of any problems elsewhere. But the chart of oil prices relative to recession tells a different story:
- The problem is that oil prices have been rising since 2016, with the summer proving the final blow-off peak. As always, this meant consumers had to cut back on discretionary spending as costs of transport and heating rose
- The cost of oil as a percentage of GDP reached 3.1% in Q3 – a level which has always led to recession in the past, with the exception of the post-2008 stimulus period when governments and central banks were pouring $tns of stimulus money into the global economy
- In turn, this means a downturn is now beginning in US end-user demand in critical areas such as housing, autos and electronics
Oil markets have therefore provided a classic example of the trading maxim for weak markets – “Buy on the rumour, sell on the news”.
- Prices had risen by 75% since June on supply shortage fears, following President Trump’s decision to exit the Iran nuclear deal on November 4
- As always, this created “apparent demand” as buyers in the US and around the world bought ahead to minimise the impact of higher prices
- But the higher prices also negated the benefit of the earlier tax cuts for his core supporters just ahead of the mid-term elections, causing Trump to undertake a policy u-turn
- He is now pushing Saudi Arabia and Russia to maintain production, and has announced 180-day exemptions for Iran’s 8 largest customers – China, India, S Korea, Japan, Italy, Greece, Taiwan and Turkey.
Understandably, oil traders have now decided that his “bark is worse than his bite“. And with the downturn spreading from Asia to the West, markets are now refocusing on supply/demand balances, with the International Energy Agency suggesting stocks will build by 2mb/d in H1 2019. In response, OPEC are reportedly discussing potential cuts of up to 1.4mb/d from December.
CHINA’S SHADOW BANKING COLLAPSE IS CREATING A NEW FINANCIAL CRISIS
Unfortunately, as in 2008, the collapse in oil prices is coinciding with the end of stimulus policies, particularly in China, as the chart of its shadow bank lending confirms. This has hit demand in two ways, as I discussed earlier this month in the Financial Times:
- Just 3 years ago, it was pumping out an average $140bn/month in mainly property-related lending *
- This created enormous demand for EM commodity exports
- It also boosted global property prices as wealthy Chinese rushed to get their money out of the country
- But during 2018, lending has collapsed by more than 80% to average just $23bn in October
China’s post-2008 stimulus programme was the growth engine for the global economy – with the efforts of the Western central banks very much a sideshow in comparison. It was more than half of the total $33tn lending to date. But now it is unwinding, prompting the Minsky Moment forecast a year ago by China’s central bank governor:
“China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous.”
As I warned then:
“Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property – is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.”
The bumps are getting bigger and bigger as we head into recession. Asia’s downturn is now spreading to the rest of the world, and is a major wake-up call for anyone still planning for “business as usual”.
* Lending has major seasonal peaks in Q1, so I use rolling 12 month averages to avoid distortions
I well remember the questions a year ago, after I published my annual Budget Outlook, ‘Budgeting for the Great Unknown in 2018 – 2020‘. Many readers found it difficult to believe that global interest rates could rise significantly, or that China’s economy would slow and that protectionism would rise under the influence of Populist politicians.
THE 2017 OUTLOOK WARNED OF 4 KEY RISKS
My argument last year was essentially that confidence had given way to complacency, and in some cases to arrogance, when it came to planning for the future. “What could possibly go wrong?” seemed to be the prevailing mantra. I therefore suggested that, on the contrary, we were moving into a Great Unknown and highlighted 4 key risks:
- Rising interest rates would start to spark a debt crisis
- China would slow as President Xi moved to tackle the lending bubble
- Protectionism was on the rise around the world
- Populist appeal was increasing as people lost faith in the elites
A year later, these are now well on the way to becoming consensus views.
- Debt crises have erupted around the world in G20 countries such as Turkey and Argentina, and are “bubbling under” in a large number of other major economies such as China, Italy, Japan, UK and USA. Nobody knows how all the debt created over the past 10 years can be repaid. But the IMF reported earlier this year that total world debt has now reached $164tn – more than twice the size of global GDP
- China’s economy in Q3 saw its slowest level of GDP growth since Q1 2009 with shadow bank lending down by $557bn in the year to September versus 2017. Within China, the property bubble has begun to burst, with new home loans in Shanghai down 77% in H1. And this was before the trade war has really begun, so further slowdown seems inevitable
- Protectionism is on the rise in countries such as the USA, where it would would have seemed impossible only a few years ago. Nobody even mentions the Doha trade round any more, and President Trump’s trade deal with Canada and Mexico specifically targets so-called ‘non-market economies’ such as China, with the threat of losing access to US markets if they do deals with China
- Brexit is worth a separate heading, as it marks the area where consensus thinking has reversed most dramatically over the past year, just as I had forecast in the Outlook:
“At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.
- Populism is starting to dominate the agenda in an increasing number of countries. A year ago, many assumed that “wiser heads” would restrain President Trump’s Populist agenda, but instead he has surrounded himself with like-minded advisers; Italy now has a Populist government; Germany’s Alternativ für Deutschland made major gains in last year’s election, and in Bavaria last week.
The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better. As a result, voters start to listen to Populists, who offer seemingly simple solutions to the problems which have been ignored by the elites.
Next week, I will look at what may happen in the 2019 – 2021 period, as we enter the endgame for the policy failures of the past decade.
As I have argued since March 2014 (US boom is a dangerous game), it was always going to be difficult for US producers to sell their vastly increased output. The expansions were of course delayed by last year’s terrible hurricanes, but the major plants are all now in the middle of coming online. In total, these shale gas-based expansions will increase ethylene (C2) capacity by a third and polyethylene (PE) capacity by 40% (6 million tonnes).
ICIS pricing reports this weekend confirm my concern, following China’s decision to retaliate in response to President Trump’s $200bn of tariffs on US imports from China:
Even worse, as the chart above confirms, is that US ethane feedstock spreads versus ethylene have collapsed during 2018, from around 20c/lb to 5c/lb today. Ethane averaged 26c/gal as recently as May, but spiked to more than double this level earlier this month (and even higher, momentarily) at 55c/gal.
The issue appears to be that US producers had calculated their ethane supply/demand balances on the basis of the planned US expansions, and never expected large volumes of ethane to be exported. Yet latest EIA data shows exports doubling from an average 95kbd in 2016 to 178kbd last year. And they are still rising, with Q2 exports 62% higher at 290kbd.
The second chart from the latest pH Report adds a further concern to those of over-capacity and weak pricing power.
It focuses attention on the weak state of underlying demand. Even the prospect of higher oil prices only led to modest upturns earlier this year in the core olefins, aromatics and polymers value chains as companies built inventory. Polymers’ weak response is a particularly negative indicator for end-user demand.
This concern is supported by recent analysis of the European market by ICIS C2 expert, Nel Weddle. She notes that PE is used in packaging, the manufacture of household goods, and also in the agricultural industry and adds:
“Demand has been disappointing for many sellers in September, after a fairly weak summer. “I don’t see a big difference between now and August,” said one, “for both demand and pricing. Customers are very very quiet.” All PE grades were available, with no shortage of any in evidence.
“The market is generally quieter than many had expected, and the threat of imports from new capacities in the US looms large – particularly with the current trade spat between the US and China meaning that product may have to find a home in Europe sooner than expected.”
US producers, as would be expected, remain optimistic. Thus LyondellBasell CEO Bob Patel has suggested that:
“Trade patterns are shifting as China sources from other regions and [US producers] are shifting to markets that are vacated. Supply chains are adjusting but there is a bit of inventory volatility as a result. Where product has landed [in China] and has to be redirected, there is price volatility. But we think that is [transitory].”
But the detail of global PE trade suggests a more pessimistic conclusion. Data from Trade Date Monitor shows that China was easily the largest importer, taking a net 11.9 million tonnes. Turkey was the second largest importer but took just 1.7 million tonnes, around 14% of China’s volume. And given Turkey’s economic crisis, it is hard to see even these volumes being sustainable with its interest rates now at 24% and its currency down 60% versus the US$.
As the 3rd chart confirms, the US therefore has relatively few options for exporting its new volumes:
- Total net exports have increased 29% in January-July versus 2016, but were still only 1.8 million tonnes
- Latin America remained the largest export market at 939kt, taking 52% of total volume
- China volume had doubled to 524kt, but was only 29% of the total
- Europe was the next largest market at 369kt, up 40%, but just 20% of the total
China’s US imports will now almost certainly reduce as the new tariffs bite. And the onset of the US trade war is likely to further boost China’s existing aim of increasing its self-sufficiency in key areas such as PE. Its ethylene capacity is already slated to increase by 73% by 2022, double the rate of expansion in 2012-2017 and from a higher base. The majority of this new volume will inevitably go into PE, as it is easily the largest derivative product.
Back in May, I used the chart above to highlight how the coming price war would likely create Winners and Losers in olefin and polymer markets. Unfortunately, developments since then make this conclusion more or less certain. I fear that complacency based on historical performance will confirm my 2014 warning about the dangers that lie ahead.
This is the Labor Day weekend in the USA – the traditional start of the mid-term election campaign. And just as in September 2016, the Real Clear Politics poll shows that most voters feel their country is going in the wrong direction. The demographic influences that I highlighted then are also becoming ever-more important with time:
“Demographics, as in 1960 and 1980, are therefore likely to be a critical influence in November’s election:
- Median age in 1960 was just 30, and 29 in 1964. Young people are by nature optimistic about the future, believing anything can be achieved – and their support was critical for the Great Society project
- Median age was still only 30 years in 1980. The Boomers were joining the Wealth Creator 25 – 54 generation in large numbers. They were keen to join the Reagan revolution and eliminate barriers
- Today, however, median age is nearly 50% higher at 38 years, and the average Boomer is aged 61.. The candidates are not mirroring Kennedy/Johnson and Reagan/Bush in focusing on the need to remove barriers. Indeed, Trump’s signature policy is to build a wall”
2 years later, the median age is still increasing, and the average Boomer is aged 63.
But there is one major change from 2 years ago. Then, President Obama had a positive approval rating at 50.7%. But today, President Trump has a negative approval rate of 53.9%.
This has clear consequences for the likely outcome of the mid-terms, with the latest FiveThirtyEight poll suggesting the Democrats have a 3 in 4 chance of winning control of the House. In turn, of course, this increases the risk of impeachment for Trump and makes it even more difficult for him to stop the Mueller investigation. We therefore have to assume that Trump will do everything he can to reduce this risk over the next few weeks.
Americans are not alone in feeling that their country is heading in the wrong direction, as the latest survey (above) for IPSOS Mori confirms. And they have been feeling this for a long time – as I noted back in November 2016:
- “China, Saudi Arabia, India, Argentina, Peru, Canada and Russia are the only countries to record a positive feeling
- The other 18 are increasingly desperate for change“
Today Malaysia, S Korea, Serbia and Chile have moved into the positive camp. But Argentina, Peru and Russia have gone negative. And if we narrow down to the world’s ‘Top 10’ economies:
- 7 of them are negative – 53% of Italians, 59% of Americans, 63% of Japanese, 66% of Germans, 67% of British, 73% of French and 85% of Brazilians
- Only 3 are positive – 91% of Chinese, 67% of Indians and 52% of Canadians
There is a clear message here, as the median ages of the ‘Unhappy 7’ are also continuing to rise:
- Median Japanese age is 47.3 years; Italy is 45.5; Germany is 43.8; France is 41.4, Britain is 40.5; US is 38.1, (Brazil is unhappy because of economic/political chaos, and is the exception that proves the rule at 32 years)
- By contrast, China’s media age is 37.4 years, India is 27.9 (Canada is the exception at 42.2 years)
The key issue is summarised in the 3rd slide from a BBC poll, which shows that 3 out of 4 people in the world believe their country has become divided. More than half believe it is more divided than 10 years ago.
There is also a clear correlation with the demographic data:
- 35% of Japanese, 67% of Italians, 66% of Germans, 54% of French, 65% of British, 57% of Americans and 46% of Brazilians see their country as more divided than 10 years ago
- Only 10% of Chinese, 13% of Indians and 35% of Canadians feel this way
POLITICIANS ARE INCREASINGLY FOCUSED ON ‘DIVIDE AND RULE’
This trend has major implications for companies and investors. As long-standing readers will remember, very few people agreed with my suggestion in September 2015 that Trump could win the US Presidency and that political risk was moving up the agenda. As one normally friendly commentator wrote:
“Hodges’ predictions are relevant to companies, he says, because of the likelihood of political change leading to political risk:
- The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat. People no longer needed to argue over “who got what” as there seemed to be plenty for everyone. But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels
- Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s
“Of course a prediction skeptic like me would say this, but I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.” (my emphasis)
Yet 3 years later, this has now happened on a major scale – impacting a growing range of industries and countries.
As the mid-term campaigning moves into its final weeks, we must therefore assume that Trump will focus on further consolidating his base vote. Further tariffs on China, and the completion of the pull-out from the Iran nuclear deal are almost certain as a result. Canada is being threatened in the NAFTA talks, and it would be no surprise if he increases the economic pressure against the US’s other key allies in the G7 countries, given the major row at June’s G7 Summit.
Anyone who still hope that Trump might be bluffing, and that the world will soon return to “business as usual”, is likely to have an unpleasant shock in the weeks ahead.
Last week, the UK’s Foreign Secretary, its chief Brexit negotiator and several junior ministers, resigned. President Trump gave an interview attacking the UK prime minister, Theresa May, and suggesting her policies would “kill” any future trade deal with the US. And the EU 27’s main negotiator on the critical Brexit issue, Michel Barnier, warned:
“On both sides of the Channel, businesses… should analyse their exposure to the other side and be ready, when necessary, to adapt their logistical channels, supply chains and existing contracts. They should also prepare for the worst case scenario of a “no deal”, which would result in the return of tariffs under WTO rules.” (My emphasis)
It was quite a week. None of us know what may happen next, as I warned when Ready for Brexit launched last month.
WHAT ARE WTO RULES?
It is now less than 9 months until the UK officially leaves the EU on 29 March. Yet according to a ReadyforBrexit poll:
- Only around a quarter of businesses have begun to plan for what happens next
- Nearly three-quarters have so far done nothing
They could have a considerable shock ahead of them, as the Brexplainer video above explains.
Currently, the UK trades with the world on the basis of around 750 agreements negotiated by the EU. Trade between the current 28 EU members is covered by the Single Market and Customs Union. But as Barnier warns, if there is no deal agreed by 29 March, then WTO rules will apply:
- WTO rules would mean that a tax, called “Tariffs”, would be reintroduced for trade in goods between the UK and the EU27. Services, including financial services, could also be impacted by restrictions on market access
- Border controls and customs checks could add time to shipments and impact supply chains. This could be particularly important for highly regulated sectors such as chemicals
- Documentation and paperwork will increase, as businesses will need to be able to prove the nature and origin of their goods, especially if they use parts or components from several different countries
HAS YOUR BUSINESS PLANNED AHEAD FOR A ‘NO DEAL’ BREXIT?
Most major businesses have been planning for a ‘no deal’ scenario for some time:
- They are increasing warehouse space, in case deliveries are delayed
- They are checking their cash flow, as VAT could be payable up-front under WTO rules
- They are working out the possible ‘no deal’ impact in key areas such Customs & Tariffs, Finance, Legal, Services & Employment and their Supply Chain
Most smaller businesses have assumed they don’t need to do anything. Yet 29 March is now only 257 days away.
SURELY ITS CERTAIN THAT WITHDRAWAL AND TRANSITION AGREEMENTS WILL BE SIGNED?
After the Brexit vote in June 2016, the chief Brexit negotiator, David Davis, was confident that all the major trade deals would be finalised by July 2018:
“Be under no doubt, we can do deals with our trading partners, and we can do them quickly… So within two years, before the negotiation with the EU is likely to be complete, and therefore before anything material has changed, we can negotiate a free trade area massively larger than the EU.”
And now, of course, Davis has resigned along with his fellow Leave campaigner, Boris Johnson.
NOBODY KNOWS WHAT WILL HAPPEN NEXT
The truth is that nobody knows what will happen next. After last week, any UK business that trades with the EU, or any EU business that trades with the UK, would be wise to start planning ahead for a ‘no deal’ WTO rules scenario:
- Have you asked your suppliers about their plans for a ‘no deal’ scenario?
- Have you asked your customers about their plans for one?
- Have you checked if your ‘just in time’ deliveries will still arrive?
- Have you checked if your insurance policies will still be valid?
As the UK’s main business organisation, the CBI, warned on Friday “It will be a make or break summer:
‘With three months left to go, it is now a race against time. The EU must now engage constructively and flexibly, as must politicians from all UK parties. This is a matter of national interest. There’s not a day to lose.’