And that was just January…
Takeways: We said 2014 might look pedestrian in comparison, but that was some start to the 2015 rollercoaster. Oil prices below $50, ECB taking a QE leap, a new Greek government with debt ‘requests’, Swiss Franc rising 14% in one day, the IMF’s biggest global growth downgrade for three years…. This is still a recovery, but it’s obvious that this amount of policy change, volatility and uncertainty will affect companies’ ability to plan, forecast and finance. It’s something we saw developing at the end of 2014 with a 6-year high in profit warnings. Currency markets in particular look set for significant swings. Contracts may not be inked so readily in uncertainty. Equity markets are hesitant despite ECB largesse. It underlines the importance of building in operational and capital resilience – and flexibility. And of seeking out opportunities amid policy divergence – Eurozone assets/debt are looking cheap(er) from the outside.
Growing economy and rising profit warnings…go figure!
So the outlook is murkier, but how did UK profit warnings hit levels more consistent with a period of economic shock at the end of 2014? UK quoted companies issued 93 warnings in Q4 2014, the highest fourth quarter total since 2008, with FTSE 100 warnings in 2014 as a whole higher than during the credit crunch
If we take the first cut of Q4 2014 GDP at face value, then the UK economy did slow a little at the end of 2014. The IMF and World Bank have also cut their global growth forecasts, reflecting the rise in uncertainty and drop in confidence we saw at the end of last year. Contract delays featured in 27% of UK profit warnings in Q4 2014, against 16% in the same period of 2013. However, UK growth is still the fastest it’s been since 2007. The global economy grew faster in 2014 than 2013. Expectations may have run ahead and uncertainties prevail, but what comes out from the profit warning data is that the triggers go beyond simple growth concerns.
Exchange rate volatility helped to trigger 17% of profit warnings in 2014 – 27% in the FTSE 350, which helps explains why warnings here were just three-short of 2008. Disruptive technologies and businesses continue to reshape sectors. Pricing and competitive pressures are reverberating along supply chains, featuring in 21% of profit warnings in 2014, compared with 7% in 2013. The shape of this recovery, in particular low levels of insolvency, has also created overcapacity, leading to intense competition.
These are new realities, not a passing phase. An improving macro outlook no longer guarantees a smoother ride. Just ask the UK’s largest supermarkets. This makes for a tougher economy to read. We’ll be exploring how companies can improve their planning and forecasting processes to match the vagaries of this recovery in the coming weeks. You can also find the latest report and insight from our Chief Economist Mark Gregory on our profit warning page.
“I have no explanation for deflation” Not a quote from Mario Draghi, but Tom Brady, New England Patriots’ Quarterback, who’ll be appearing in Super Bowl XLIX this Sunday. Cue much giggling from the economists at the back. Of course there is another tenuous link from Mr Brady back to Mario Draghi, since Gisele Bündchen of “pay me in Euros” fame, has since married the Patriots’ QB1. Back in November 2007, the Euro was a wise choice, buying around $1.44 dollars and rising to $1.60 within the next 6 months. However, many supermodels may be eschewing the Euro today – down to $1.13, although the weakness against the dollar is as much due to the increasing strength of the dollar as much as the Euro’s QE accelerated weakness. It’s a divergence that offers some benefits, some complications but also some obvious opportunities – if you can take a relatively sanguine view on Greece.
QE’s ability to depress the Euro could provide the greatest overall benefit. Cheaper Euros should increase exports, increase demand at home by making imports more expensive – which should give a much needed nudge to inflation – now firmly deflation. The QE promise is also dampening Eurozone sovereign bond yields amid Greek worries. However, as we’ve said before, it’s hard to see how QE will boost asset prices in the region. Interest rates and credit spreads are already near rock-bottom. Banks say they’re willing to lend, but companies aren’t confident enough to borrow.
The complications? Other central banks can’t just sit back and watch their currency appreciate against such a large trading block. The ECB’s QE salvo fans the flames of currency wars – or more accurately currency surrender. The Danes have lowered their rates deeper into negative territory twice in the last week. This obviously isn’t just a European issue. Asian economies will be squeezed between a weakening Yen and Euro. Canada has also lowered its rate, when it so often follows the US. This will be food for thought for the Bank of England and the Fed. The former doesn’t seem to feel much imperative to raise rates – certainly not with inflation about to become deflation. The Fed appears to be on the path to tightening by mid-2015. However, in the last year, throwing apple peel over your head under a new moon would have been a better Fed predictor than their minutes or money markets. They may now be minded to be more ‘patient’ than they indicated in yesterday’s minutes if major central banks are all heading in the other direction. The upshot? The Eurozone may not see major benefits from QE and companies look to be in for a wilder currency ride in 2015.
Certainly, US companies are feeling the dollar pinch. Caterpillar, Procter & Gamble, Microsoft and United Technologies have all noted a dent to earnings in the last week. However, there are opportunities for those with dollars in the bank: each buys 88c versus 73c this time last year. Eurozone assets and debt look more attractive in this light. There are a few companies who could buy up the Greek Stock Exchange in cash. Although, it’s not something we’d recommend and Eurozone acquisitions need some thought. The majority of the Greek population want to stay in the Euro. It’s not a Syriza policy to leave. That said, as S&P puts it, the new Syriza-led government’s policies are “incompatible with the policy framework agreed between the previous government and Greece’s official creditors”. Athens should be able to reach a deal with more favourable terms and financing, however there’s a significant risk of a damaging standoff first. Syriza’s victory could also embolden parties elsewhere with anti-austerity and restructuring agendas. These are still uncertain times. Therefore, we expect US companies to be looking at (relatively) cheaper high quality Eurozone assets, but with a focus on Northern Europe and companies with access to US markets.
Increasing cross-border acquisitions – especially US to Europe – is one of our Five Global M&A trends for 2015.
From Russia with less
S&P’s downgrade of Russia this week didn’t come as much of a surprise. As recent profit warnings and withdrawals have highlighted, doing business in Russia is progressively more difficult. Companies face recession against previous growth of around 2.5%, increasing sanctions, rising interest rates, record lows in the rouble, increasing relations and taxes. It’s a reminder that what might be a key growth region one year could be a strategic exit the next.