Chemicals, financial markets reach a fork in the road

“When you reach a fork in the road, take it” ran the wisdom of baseball legend, Yogi Berra. And it looks as though chemicals and financial markets will be taking his advice during the rest of the year. But which way will they go?

Financial markets have no doubt about the outlook. Fired up by two decades of central bank stimulus and zero interest rates, they are expecting to move higher, much higher, by the end of the year.

After all, the support provided to asset markets since 2003 has been mind-boggling, as the chart shows. It had already reached a total of $73.5tn at the end of March – and will be even higher today.

So it is no surprise that stock and housing markets have taken off since the stimulus programmes began after the dotcom crash of 2000-2.

But there is an even more dangerous aspect to the stimulus:

  • As discussed last week, the last 15 years have been “very, very unusual” in terms of interest rates
  • A whole generation has grown up with the idea that rates are always close to zero
  • And they also “know” that central banks will always print more money if needed

The chart tells the story of this bizarre world. It shows that markets have just kept rising. Up and up. As if nothing could ever stop them.

And even more bizarrely, actual corporate performance no longer matters, as the Financial Times’ headline on Saturday confirms:

“Factors behind Apple’s soaring stock are less obvious, as it has recorded back-to-back quarters of revenue falls“.

And as the FT and other media have commented recently:

“The performance of the S&P 500 index is now the most concentrated it has been since the 1970s. Seven of the biggest constituents — Apple, Microsoft, Google owner Alphabet, Amazon, Nvidia, Tesla and Meta — have ripped higher, gaining between 40% and 180% this year. The remaining 493 companies are, in aggregate, flat.” (Our emphasis)

IT FEELS LIKE ‘LEHMAN II’ IN THIS CRUCIAL INDUSTRY

The chemical industry is usually the best leading indicator for the global economy. And as Lanxess CEO, Matthias Zachert, recently warned the markets, “This feels like Lehman II“.

Lehman’s collapse in the 2008 subprime disaster, led to a massive rise in stimulus.  And today, as Bloomberg notes:

“Lanxess’s European and US chemical peers, plus a host of companies in other cyclical sectors, face similar problems as elevated customer inventories meet the most rapid interest rate hiking cycle in decades, as well as a stuttering Chinese economy.”

This is the “real world” served by the chemical industry. Interest rate rises are squeezing a whole generation of young consumers, who have never known a recession:

  • They were told to buy the biggest home they could possibly afford, as prices could only ever go up
  • So they committed to buy houses based on the monthly interest rate they were being charged
  • After all, if prices are never going to fall, then there is no need to worry about repaying the capital
  • They were told to “treat your home as a pension” and plan to retire on the surplus cash when you sell

But now the central banks have lost the plot. Wars are always inflationary, and so Russia’s invasion has returned interest rates to more “normal levels”. And many of those who bought homes and stocks at their peaks can’t afford the new rates.

Of course, 2 years of lockdowns mean that everyone is keen to socialise again. Planes and restaurants are temporarily full again, as people make up for lost time.

But China’s economy, which led the world out of recession in 2008, is now suffering as its real estate bubble bursts. And the problems caused by its ‘One Child Policy’ are becoming obvious, as it meant China “Lost 73 million Brides“.

So we have reached the fork in the road. Maybe financial markets will be proved right. But as I told Bloomberg last week:

“Either chemical markets are wrong or the financial markets are wrong and obviously we think it’s the latter,” New Normal Consulting Chairman Paul Hodges, a chemicals expert, told me. “People thought China was going to bounce back rapidly after Covid, but China’s growth since 2008 was the product of massive stimulus and property speculation which couldn’t go on forever.”