Takeaways: Last year had its moments, but the last 12 months could look pedestrian compared to 2015. Of course change and even faster growth can bring challenge along with opportunity. Time to wheel out that old, but true, maxim that recovery can be the best, but also the worst of times for companies – and this is no ordinary recovery. The year ahead is full of possibility for the resilient, the flexible and the innovative – but potentially full of pitfalls for those unable to adapt.
Well hello 2015…
No-one pressed the reset button at midnight on 31 December. Monetary policies remained loose, oil prices remained low, ‘disruptive’ businesses carried on…..err disrupting. Does anyone have a better adjective? However, there are reasonable grounds for taking stock now. It felt as if we moved into a new era at the end of 2014 as the Fed countdown began and oil prices dived. This year also contains pivotal elections – which brings us to our first theme of 2015…
You’d get pretty steep odds on a ‘Grexit, UK National Government and Russian default’ accumulator. But, the mere fact that this combination is a ‘grey’ rather than ‘black’ swan – a possibility, not unimaginable – tells you everything you need to know about 2015. Complexities and conflict create new realities each day. What might be a key growth region in January could be a strategic exit by June. By the end of spring 2015, the global economy might have shifted onto a radically different path – or, indeed, not. How about Syriza agrees a mild debt restructuring, UK elections are decisive, Russia pipes down?
Fluid’ is potentially an understatement. Companies should dust down their risk registers – if they haven’t already. We could be talking about a UK EU referendum from June. Timing will be all important in debt and equity issues – beyond Q1 lies uncertainty.
2. It’s not right, but it’s okay….
We’re cautious, but not gloomy. The economy has built enough resilience to stand a bit of buffeting. Central banks and governments are well practiced in the application of liquidity and stimulus bandages. Our base case for 2015 is for improving, if below par growth – barring calamities. See (1) – which yes, is our ‘get out of jail free’ card.
Global growth of 4% is possible in 2015. Developed market growth of around 2% will feel like progress. UK GDP growth should come about 2.9%. Emerging markets could see 5%. It’s not racy, but it should feel better.
It’s still the kind of growth companies need to work for – not the 2005-7 type that dragged almost everyone up regardless.
3. Cloudy with a chance of rebalancing…
Of course we have to have China in here. It’s like waiting for that debt maturity hurdle….both will surely give some day. China has obvious troubles: deflationary pressures, weakening property prices, escalating debts – especially in the shadows and fears over defaults. It sounds daunting and the outlook is uncertain. Growth of around 5-6% is tough when you’re used to 8%+. However, on balance, there shouldn’t be a systemic crisis. There are enough signs of rebalancing to be optimistic – services outpacing manufacturing, consumption ahead of investment etc. Although, we’re not underestimating the reforms still required.
Growth of around 6% and the rapid expansion of the middle classes are hard to ignore. However, the growth of the private sector will increase domestic competition – other markets could look more attractive.
4. Tumbling with a chance of defaults
Oil prices are likely to stay low, through the first half of 2015 at least, due to high levels of supply and reasonably tepid demand. Bad news for countries reliant on oil revenues, companies who extract it and businesses who work further down the chain. In the UK, it’s this latter group that’s issuing the most profit warnings. The fall is also causing palpations in HY bonds due to its US shale exposure.
Default risks for companies – and some countries – the immediate hit to revenues and the fear that a low price signals low growth explains why oil prices aren’t a balm overall to markets right now. However, the long term net effect should be positive for the global economy. If the Bank of England raises rates in 2015 it won’t be under inflation duress. Although, a significant hit to oil industry investment now could lead to sharp price increases when demand ramps up.
Oil users can make hay now – but watch the bounce. Companies in the sector need to adapt their business models to price volatility: driving efficiencies; building greater flexibility into their cost bases; strengthening their working capital position and flexing their capital structures….actually a good call for pretty much everyone. Much depends on how long the price lingers around $50/barrel. Another 6 months will create significant stress and opportunities for opportunistic purchasers.
Better on average isn’t better for all. There is a wide divergence in economic performance and therefore monetary – which will also amplify divides. On one side, we have loosening Japan and a stagnating and deflating Eurozone – now seemingly set for full-blown QE. Although, even there, there is a significant divide between Italy’s record high and Germany’s record low levels of unemployment – the economic tensions continue. Meanwhile UK moves slowly and the US more quickly toward their first interest rate rise – perhaps by April in the US, late 2015/early 2016 for the UK. The expectation of Fed action alone is reducing dollar flows – although for some ‘emergers’ this is less of an issue than China’s slowdown.
In all, it’s an increasingly complex, diverse and uncertain global picture, where central banks have long abandoned solidarity in the fight to keep their economies competitive. Arguably the biggest benefit of QE to Japan and the Eurozone is a weaker currency to help exports. They won’t be alone in ‘defending’ this advantage. The falling rouble will also force Russia’s trading partners to take action.
Companies need to prepare for significant gyrations in currency – and therefore commodity and energy prices – and think carefully about their territories. The Eurozone is back on the agenda – if it ever left. However, there are opportunities in divergence – e.g. issuing debt in the Eurozone for yield, buy in US for growth.
6. I don’t think we’re in Kansas anymore….
Deflation not inflation is the enemy. ‘BRICS’ is defunct. Changes in technology and behaviour create ‘economic conundrums’ – e.g. UK productivity. From listening to music to taxi hailing our world has been turned on its head. Changing economic paradigms and disruptive technologies aren’t new. Coins and the wheel were pretty disruptive. This may indeed be the year of disrupted disruptors – certainly growing pains. But, there is no getting away from the pace of change and the range of businesses feeling the impact of new technologies and practices – which certainly feels greater than before.
Huge challenges and opportunities. Companies need to take a dynamic approach to markets and – in many cases – take radical decisions to get back on the front foot and avoid being at the mercy of events and new challengers.
7. Banking on change
Another blast from predictions past: another testing year for banks with more regulatory hurdles to jump. The AQR built a good foundation, but many European banks will require capital raising and disposals to meet ‘fully loaded’ Basel III compliancy. Added to this is the removal of implied government support – which will cut credit ratings and increase funding costs. In response, more banks are adopting investor-friendly core/non-core splits for problem assets and shifting their focus to utility, simplicity and domesticity. Meanwhile, the global shadow banking sector continues to increase rapidly – at some point we should see greater regulation here.
Bank lending will increase further in 2015, but increasing regulatory demands will limit the uptick leaving space for alternative funds continue to grow. Opportunities should (finally) open up in Eurozone distressed assets– we expect a steady flow, rather than a wave.
8. Remember risk?
The market’s need to re-price risk is obvious; it’s the timing and steepness of the curve that’s the issue. At some point investors who’ve chased yield will need to exit and will find more illiquid secondary markets, with fewer banks able/willing to participate. How quickly they exit is key and given 2015’s uncertainties, re-pricing has to be on the agenda – even with the expected ECB largess.
Not so much for investment grade companies. A high level of competition from banks keen to consolidate relationships and use funds in a tight market, combined with ECB loosening, keep a lid on yields – albeit with some uptick from US/UK monetary tightening. However, the HY outlook is more fluid. With low default levels, central bank support and a fair wind, volumes and pricing could remain robust. However, it’s a finer balance than previous years and we expect more discretion and pushback against the perceived erosion of credit quality even without a specific ‘trigger’.
Meanwhile, IPO markets look set to return in early 2015 – the supply and demand is still there – but again with greater discretion and that timing issue.
Investment grade companies can still call the shots – but shouldn’t delay issues given the monetary policy changes afoot and uncertainties beyond Q1. IPOs will face more scrutiny – and that timetable. HY should also take their chances – the market might not need many more ‘wake-up calls’ beyond Phones 4U.
9. Taking the initiative
As in 2014, we expect many companies to use strategic acquisitions and divestments to take the initiative, putting cash piles and cheap credit to work in search of fresh growth and efficiency savings. That includes cross-border deals – especially from Europe to the US as they hedge against low growth and deflation. At the same time, US players may look to acquire underperforming assets in Europe. Within industries, TMT companies are using deals to meet the challenges of convergence. Healthcare and technology sectors will see a drive for high quality IP rich assets – and deals to keep down costs. The oil industry has obvious need to consolidate.
We anticipate more deals to optimise capital and operational structures. Spin-offs, split-offs and carve-outs look set to be the key trends for 2015. The past year has seen a surge in companies undoing past mergers that no longer fit with their main business.
Industrials and less geographically diversified players are in greatest need of consolidation. Deal volumes should rise through 2015 – but as in 2014, it’s about quality, with shareholders keeping a close eye on proceedings.
10.Tales of the unexpected
To go back to our first point, it’s not just that the situation in 2015 is fluid; it’s likely that a whole flock of swans of various hues await us in 2015 – as they did in 2014. Known knowns, known unknowns, unknown unknowns – who knows? Who had oil at $50 at the start of 2014, Russia invading Ukraine, US equities hitting highs, US bond yields hitting lows – no rate rises to see here! Of course – as the old adage goes – the only point of economics is to make astrology look respectable. But is it me, or is the world getting less predictable?
We’re seeing more UK companies issuing profit warnings than really should be the case at this point in the cycle. Arguably, it’s partly due to increasing uncertainties. But, if this is the new reality, companies will need to build in more operational and capital resilience. Stakeholders will increasingly be looking at their assets and thinking: ‘How do these operational and capital structures look at: $45/barrel, with deflation, with a 10% margin squeeze on a major contract, without Russian revenues….’