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A New Era of Economic Acceleration Amid Political Uncertainty?

Posted on February 7th, 2017 by in Chemicals Industry News and Analysis

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Dow Chemical CEO Andrew Liveris has hardly ever been more bullish than on the company’s Q4 earnings conference call. Citing positive momentum in the US and global economies going into 2017, his comments contrast starkly with those about dealing with a “slow growth” world just a couple of years ago.

For the US, he cited a “tailwind” from the Trump administration’s intention to cut taxes, streamline regulations and embark on “fair trade” policies to create a “vibrant manufacturing sector”.

And the outlook for the rest of the world is none too shabby from his view.

“Europe continues its gradual recovery, despite increasing political uncertainty and geopolitical tensions. China’s transition is progressing on a robust path, and sustained growth of Asia’s middle class continues to drive demand throughout the region. And finally, we see improvement in Latin America from its low base, with slow but stable gains continuing in Brazil,” he said.

While GDP numbers have been less than inspiring – the US recently printing a weak 1.9% growth rate for Q4 2016 – the manufacturing sector appears to be faring far better than many expected.

The US, eurozone and China manufacturing PMIs (purchasing managers’ indexes) – key leading economic indicators of manufacturing activity – are all firmly showing expansion. In the PMI readings, anything over 50 indicates expansion while below 50 indicates contraction.

The US ISM (Institute for Supply Management) Manufacturing PMI surged to 54.7 in December 2016, up from 53.2 in November and the highest in almost 2 years. The January PMI was due out on 1 February.

The flash Markit Eurozone Manufacturing PMI in January hit a 69-month high at 55.1, up from 54.9 in December.

In China, where activity has been persistently weak for years, the Caixin General Manufacturing PMI rose to 51.9 in December, up from 50.9 in November and the highest in nearly four years.

Aside from the 30 January downdraft in the US along with many global equity markets on the heels of Trump’s executive order implementing a temporary travel ban on seven countries, the business mood in the US has been buoyant.

While Trump has spurred both enthusiasm about lower taxes, less regulation and major infrastructure spending as well as concerns about protectionist trade policies, and potential clashes with other nations, the US equity market has largely climbed Trump’s proverbial “wall of worry” with recent record highs on all three major indexes.

And it’s not just a US phenomenon. Even in light of the impending Brexit, the UK equity market as measured by the FTSE 100 recently hit a record high, as did Germany’s DAX. Yet China’s SSE Composite Index, while rising, is far off its bubble peaks in 2007 and mid-2015. Japan’s Nikkei 225 is likewise on the upswing, but a long way from its 1989 peak.

The US is in its 7th year of economic expansion – the third longest on record but one characterised by much slower growth than past expansions. The longest was from 1991-2001. Can the US economy keep going… and even pick up momentum?

This remains to be seen as sentiment can shift easily. The US temporary travel ban and the trial balloon talk of a 20% border tax (tariff) for imports from Mexico could signal a hard line on not just immigration, but on trade. That’s likely rattling markets in the short term.

Separately, a proposed border adjustment tax (different than a simple border tax) in the US Congress is an entirely different animal – different species, but still in the animal kingdom.

In this more complicated tax system, export sales would be tax advantaged (exempt as taxable revenue or a portion of it), while imported costs would be penalised (not being allowed to be deducted as a cost or a portion of it).

That would mightily favour companies that produce products in the US for export. It would include a number of US chemical producers, especially those that are building massive cracker complexes in the US with downstream polyethylene (PE) that is primarily or significantly for export.

It would in turn disrupt and devastate US companies that mostly imported products or raw materials for sale in the US. Supply chains would have to be reconfigured.

US President Trump has yet to signal support for such a border adjustment tax, being more vocal on direct import tariffs and a simple reduction of US corporate taxes. Direct tariffs would make the US more prone to retaliatory tariffs from other countries, potentially harming chemical and polymer exports.

Even without the swirling debate on any potential new tax regimes, manufacturing activity in the US, Europe and China is swinging in the right direction. For chemical producers, so is crude oil, which is holding up well after the OPEC agreement, providing upward momentum for pricing.

Dow is not only bullish on the global economy but also on ethylene and PE in particular, seeing no usual trough in the cycle but rather an extended plateau, even amid major supply additions set to come on in the US in 2017 and 2018 from a wave of new crackers.

While several analysts and consultants expect a trough in ethylene and PE operating rates in 2018-2019 as major new capacity comes on and ramps up in the US, Dow only sees a flattening.

It would be unwise to deem the ethylene cycle, historically characterised by peaks and valleys, dead. But a strong crude oil price and a pick-up in the global economy could go a long way towards mitigating a downturn.

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All opinions shared in this post are the author’s own.

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