..but while there’s liquidity, spare cash and romance let’s face the market and transact! The prevailing corporate attitude in 2015 was to fight disruptive forces, low growth and uncertainty by transforming the portfolio and building resilience. Our base case for 2016 is that companies will face similar challenges, turned up a notch. There’s an air of fin de siècle in high yield debt markets and rising levels of uncertainty in the geopolitical, economic and natural environment have left us questioning what is truly unthinkable. But, as they did in 2015, we expect companies to meet challenges head on rather than bunkering down. There will be tough times, but there should also be enough positive momentum to keep the recovery on this bumpier road.
Turning it up a notch…
It’s that time of the year when we pick out our top ten themes for the year ahead. Some are new, but we’ve also ‘upcycled’ some of last year’s. Many did indeed hold true and of course the global economy didn’t reset at New Year. Indeed, if we have to pithily describe our view on 2016, it would be: “like 2015 – and then some….”
Our first ‘upcycle.’ ‘Fluid’ was potentially an understatement last year and may-be more so in 2016. Again, there will be unthinkable questions we haven’t asked. Last year we badged this our ‘get out of jail free’ theme; but, in all seriousness, it is hard to understand any outlook for 2016 without understanding exactly how fluid the outlook is for US monetary policy, the Middle East, China and oil prices – to name but a few – and therefore how many directions 2016 could go. Check out Bloomberg’s list of 1 in 5 chances for an eye opener…
Companies should dust down their risk registers – if they haven’t already – taking in uncertainties in political, geopolitical, economic, technological and natural environments. It may not be possible to second guess the exact form threats will take, but it’s a fair assumption that companies will face a variety of familiar and new challenges in 2016.
There could be even more ‘political’ influence on UK companies and markets this year than the last. The US election will dominate the global agenda and the BREXIT vote – likely by autumn – could have a bigger impact on market sentiment than any recent UK poll. Uncertainty already appears to be contributing to a drag on sterling. In or out the vote will also polarise and leave scars. Beyond these votes, we expect to see continuing pressure for governments to get tough on rule-breakers, whilst further M&A activity could test regulatory boundaries. Meanwhile, geopolitical tensions are also ramping up, with a consequent impact on migrant levels and a rise in populist politics. A more partisan era with growing divides and less consensus creates tensions that will feed into the markets.
Companies will need to keep a weather eye on the political calendar as much as the economic – and be prepared for some significant market volatility around key dates. Lack of faith in polls could effectively shut down markets around the BREXIT vote, unless the outcome is exceptionally clear.
Governments are not the only agency putting companies under the microscope in areas like CSR, product performance, financial reporting and cyber-security. Social media has also upped the level of attention and the stakes for when companies get it wrong. It’s a matter of when – not if – most companies will come under cyber-attack, although the threat is still largely underestimated.
It’s always been vital for companies to employ robust controls to avoid operational or financial misreporting. Investing to fight the cyber-security threat – and to have measures in place to mitigate and manage breaches – has also become a fundamental requirement. It’s not much of a prediction to say that there will be numerous successful cyber-attacks in 2016.
What’s new, you might ask. Disruption is already out there:
· The world’s largest taxi company owns no taxis
· The largest accommodation company owns no hotels
· The largest retailer has no inventory…. Etc etc….
Companies have already been forced to re-evaluate where they sit in the value chain, but most sectors haven’t experienced a complete disruptive revolution. Maybe it’s a matter of time or salutatory early examples – like music – have stopped savvy companies underestimating the threat. What’s is apparent – and we expect to see more of in 2016 – is incumbents fortunes increasing sagging as disruptors create lower cost models and skim off the most lucrative business. This is starting to happen in banking, where fintech companies are making inroads in profitable areas like payment services and avoiding the more routine, less profitable elements. Banks are responding and keeping a close eye on their fintech neighbours on level 39. The total game changer here would be if someone figures out how to use blockchain to replace banks in areas like transaction clearing. Plenty of bridges to cross before that happens – but the last few years have taught us to never say never.
If you don’t know about blockchain, it’s really worth mugging up to drop into conversation in 2016; whether you decide it could be the greatest innovation or disappointment of our time. The pace of disruptive change means companies cannot assume anything about what their sector will look like in 10 years’ time and will need to remain alert and ready to adapt their business models – or even bow out of some sectors.
Markets look set to pivot on inflation – particularly US inflation – and like so much in the global economy, we’re in the hands of oil and ‘crude’ estimates. The latest Fed minutes show they expect falling energy prices to depress inflation for longer than previously anticipated. Oil isn’t the only factor, but Goldman Sachs believe that even a minor fall in price could cause the Fed to pause or even reverse their recent rate increase. But, given the low comparatives, a faster than expected increase in the oil price could lead to US inflation moving up quicker than expected, putting pressure on the Fed to hike. Most estimates sit in the moderate $50-60 range, with temperate growth, the strong dollar and still slowly adjusting supply keeping a lid on price rises. That sounds logical, but this market rarely is and oil and the Fed’s path remains uncertain.
Stress continues to flow down the commodity supply chain and into exposed economies and there are more uncertain times ahead for both. Mitigating factors like cost cutting and hedging mean 2015 might just have been the prologue to trouble if prices continue to linger around $40 – or below. There will be more pain in 2016 is if prices remain depressed and capital markets become less accommodative. Commodity exposed companies have been adapting their business models to price volatility, but there is still more to do in efficiency, cost base flexibility and working capital. We expect more commodity-related M&A and restructuring in response.
It might be a surprise to hear that many forecasters expect growth in 2016 to be better than 2015 – although still below the pre-crisis average. The global economy really is remarkably robust – especially when it’s being supported by what is still exceptional monetary looseness. Virtually all high-income economies have returned to growth and the Eurozone is looking hotter than it has for some time. Of course the thing is about 2016, is – as we keep repeating – that we have a very long worry list. Plus these estimates have tended to fall.
China remains the biggest growth concern in 2016, with its obvious rebalancing issues, escalating debts and capital flight risks creating waves across the global economy – for example the export of spare capacity in steel. So far: China slowdown + commodity downturn + strong dollar = EM stress. That is the measure of it so far – stress, not crisis and not universally. India is doing rather well. Emerging market divergence in a growing theme to the point where the term becomes meaningless. A market shock like 1998 remains a significant risk, but it looks like it will need a big trigger – like a significant hike in US rates or a major default – to tip emerging markets into full-blown crisis.
> Thus, we’re considerably more cautious than 2016, but not really gloomy. The global economy has built enough resilience to stand a bit of buffeting and even the ECB is applying liquidity bandages, which will mitigate some Fed tightening. That said, there is always a risk that combination of factors could create a fear spiral. Even without a crisis, companies will need to think about the geographical balance and country risk given significant risk, divergence and volatility already out there. Arguably sovereign debt restructuring is overdue in some areas. Capital will flow into the Eurozone if it remains on its current path without a significant sovereign event.
A theme we’ve been peddling since 2014. By the end of 2015, monetary policy divergence had moved from attitude to actual with ECB adopting QE and the Fed raising interest rates. This divergence is likely to remain in place in 2016. The ECB is very unlikely to tighten. The Fed’s path is unclear (see ‘Crude’ above) but the most likely path is at least one hike in 2016. The main risk – once the Fed starts to move – is usually that markets underestimate increases. Meanwhile, the UK remains on the path to tightening, but we don’t expect any movement until late 2016 and sterling strength is somewhat tempered by BREXIT risk.
Last year’s narrative was dominated by central bank moves and this year looks like more of the same, albeit without the same intensity we saw before the first Fed move. The anticipated movements of the big three central banks – and their currencies – will trigger moves elsewhere, making it another tricky currency year. Divergence always creates challenges and opportunities. There are obvious stresses on dollar-denominated borrowers outside the US, but also opportunities for those looking to borrow (and may-be buy) in Euros.
It almost goes without saying that given all of the above we’re expecting market turbulence in 2016. We didn’t need to wait long for the first steep dip in the rollercoaster with one of the worst starts to the year in European markets since the 1970s. It won’t be the last lurch. George Soros’s ‘echos of 2008’ might feel a little alarmist; but it’s understandable why markets are so jumpy when there is so much to look at.
Tense markets jump when data says ‘boo’ – however softly. We expect to see significant IPO appetites in 2016, but in the UK – at least – they may be first half weighted due to BREXIT uncertainty. It will be vital to stand out from the crowd with a compelling proposition and to get the timing right. Timing may be more in the hands of the gods than normal if investors remain on edge. Falling equity valuations create PE opportunities – but jumpier debt markets (and regulation) could require some innovative debt raising strategies.
More accurately, this should be ‘divergently tighter’. There is still ample support for debt raising for well-established investment grade credits exposed to faster growing areas. Nevertheless, there is undoubtedly increasing investor caution in high yield that appears to be focused in commodity/emerging market exposure for now, but could easily spread.
Investment grade companies can still call the shots – but shouldn’t delay. With low default levels, a fair wind, volumes and pricing could remain relatively robust elsewhere, but not for those with weak profiles in weak sectors and we expect more discretion and pushback.
As they did in 2015, we expect companies to quietly get on with it. By this, we don’t mean do nothing, but to rise above the short-term market noise where possible. Companies were exceptionally busy last year, engaging in record levels of M&A and – as our Capital Confidence Barometer shows – focusing on generating operational efficiencies to meet long-term challenges head-on. We expect more of the same in 2016. Transactions might not hit the same heady heights, but there is still a great deal of post-deal reshuffling required after some mega-transactions and strong imperatives to do deals in many sectors, like Pharmaceuticals and TMT. Plus it’s now that the real hard work begins for buyers who now need to integrate and deliver on synergies.
We expect deal flow to remain robust –so long as markets allow – as companies try to stay on the front foot in a rapidly changing world. Indeed, deals may become more radical as challenges increase. Building operational and forecasting resilience should also remain high up the corporate agenda. High companies are issued profit warnings in 2015 in what were still relatively positive conditions. We also expect to see more innovative forms of cost reduction as the easy-wins diminish and costs increase. The inflation holiday won’t last forever and UK companies will need to counter the impact of the Living Wage. There is potential for businesses to make use of the sharing economy and partner more effectively to cut costs. Rising wages may also lead to a rethink of the balance of labour and capital.