It’s hard to take your eyes off what’s going on in the markets. We’re not ignoring these stresses and strains and this week’s blog covers the primary themes in four charts. But, I also want to think more practically. Given that uncertainty looks set to be an overused word for many, many months yet, there’s a danger that we worry about everything and do nothing. So, what can companies sensibly do now?
Post-BREXIT markets in four charts
Nothing that’s happened in the post-BREXIT markets has been that surprising. But it’s one thing to expect and another to experience. This is a slow growth world with well-worn central bank safety nets – a fact that was already making markets jumpy. Adding the uncertainties of BREXIT into this mix was always likely to amplify existing stresses and create new pressure points.
The UK’s large current account deficit has made sterling the main focus of any concerns relating to trade and stability. This week the pound fell below $1.30 and back to levels last seen in 1985 – when Boris Becker first won Wimbledon. The debate over the benefit of the weakening pound continues. The example of 2008 – when the sterling dipped below $1.40 – suggests that the boost might be limited. And – as we also discussed last week – weak sterling is not without its downside. Hedging delays the impact, but prolonged weakness has consequences . In 2009, UK quoted companies issued 30 profit warnings linked to sterling’s weakness. Not as high as the record 50 set by the strong pound in 2014, but a reminder that this isn’t a straight forward equation.
The FTSE 100, which earns three quarters of its revenues overseas, has recovered from its post-BREXIT lows. It’s benefiting from the fall in sterling and its greater breadth of geographical coverage than the more domestically-oriented FTSE mid-250. But, our second chart with the index in dollars shows a different story with the FTSE 100 remaining considerably lower than its pre-BREXIT high. A reminder that this isn’t an international vote of confidence.
The areas of concern we highlighted last week – sectors most strongly exposed to falling GDP, the falling pound and regulatory uncertainties – are certainly being eschewed by investors. But it’s not all bad news. Our third chart shows sectors with higher levels of exports and international exposure are obviously performing well, as are areas of the UK economy that investors regard as defensive such as utilities and areas of the knowledge economy that might be seen to be more immune. There is also greater nuance appearing within sectors, with investors moving towards more resilient business and heavy selling of companies that issue profit warnings. Companies who have warned since the referendum have seen double the share price drop on the day of warning of those who warned in Q1. We’ll be releasing our full Q2 profit warning data on 24 July.
The risk-off attitude is exemplified by record lows recorded in government bond yields. This week, benchmark 10-year government debt yields from the US, Germany, the UK, Japan, Switzerland, France, Denmark and Sweden all hit record lows. It’s worth just running your eyes across that again….eight major economies with benchmark 10-year bonds at record lows. This is a measure of risk aversion, it’s a measure of the low expectations for interest rates – and expectations of a long slow recovery. It’s one reason why bank shares continue to struggle, why Italian banks are in the spotlight and why pension deficits have hit a record £935bn.
Practical steps in an uncertain world
It’s obviously difficult for companies to make major decisions when so much is up in the air; but on the other hand it could be a very long period for companies to sit on their hands when the world keeps turning, organic growth remains slow and competitors in other geographies move on. In terms of positive actions companies can take now, I’d point to discretionary cost management and cash optimisation. Depending on their sector, companies could be in for a bumpy ride in the coming years and ensuring that their business is as fit as it can be is a sensible priority. It also makes sense to keep stakeholders informed to ensure they understand the company’s position and strategy to ride out this first wave – and those beyond.
It’s this longer-term planning that is exceptionally tough given the sizable number of scenarios for companies exposed to significant uncertainty. The danger is that companies worry about everything and do nothing. In the short-term this might not be a problem – and missteps could be expensive – but this looks like being an extended period of uncertainty and there is normally an advantage for companies who are on the front foot when opportunities arise.
Our way through this impasse is through clean thinking, a way to clearly identify areas of BREXIT uncertainty, think about where they intersect with the business and to prioritise the ‘unknowns’ based on their urgency and impact. Companies can then work through scenarios for their priority areas. Will we need to sell a business, buy in a new sector or location or set up a new HQ? Do we have the capital in place for these scenarios? Can we afford to wait to register for new licences or to buy or invest?
Our experience of previous shocks and previous period of uncertainty shows that a dynamic assessment of opportunities and risk helps companies build adaptive resilience – the ability to remain on the front foot and to respond quickly to challenge and opportunity.
It’s also important that companies keep doing all the good things they were doing before. For some sectors BREXIT isn’t the biggest challenge and – we have to say it – life goes on. There are still other regulatory changes, such as BEPS to contend with. Companies will still need to refinance and they’ll want to be ready to transact when opportunities arise. Indications from most lenders we have spoken to is that it is business as usual. Uncertainty has created short-term volatility, but the fundamental drivers of liquidity have not changed and companies should be ready to move when windows open.
The activity of recent days also suggests that M&A activity will also continue. Not at its previous pace, but it’s by no means at a dead stop and valuations are starting to look attractive for those looking for UK assets rich in IP possibilities and with global markets.