Just another quiet week…

Just the first round of the French Presidential election, new US tax plans, sterling at a seven-month high and more big deals…. Can we cover all this in 800 words and give you the low-down on our latest EY Quarterly Profit Warning report and 16th Capital Confidence Barometer?  Yes – and we begin and end with politics. Deals are going on almost regardless of geopolitical strife, but we still need to be mindful of the big policy decisions yet to come and the changing political climate in 2017.

Starting with politics…

It’s not usually a good omen when we start with politics – as we often do these days. This week the result of the main event buoyed markets judging from the widespread “relief rally” on Monday. Macron’s strong lead against Le Pen in the opinion polls – which seem to work in France – has reduced fears of FREXIT. Risk off?

Near-term, probably. But I’ll just point out three things – beyond the obvious that the second round vote hasn’t happened yet. 1) The first vote essentially chose two non-establishment candidates. 2) Le Pen won the vote amongst 18-34 year olds followed by Mélenchon  3) Whoever wins won’t have a majority to work with.

French yields

…moving onto the UK and sterling…

Back in the UK, politics has also created a rally of sorts. Following last week’s snap election announcement, the pound hit a seven-month high at over $1.29 -seemingly undented by lower than expected GDP growth figure of 0.3% for Q1 2017.

Sterling’s path matters. Our latest EY Quarterly Profit Warning report echoes the picture painted by EY ITEM Club of an economy being reshaped by a weaker currency. Profit warnings citing pricing pressures rose up to 28%, the highest proportion since Q2 2011 when oil was $120 a barrel and inflation on its way over 5%. Meanwhile, companies able to offset rising import prices with higher export volumes – capitalising on the global economic pick-up – have seen their warnings fall. Industrial sectors have been particular beneficiaries -as confirmed in the GDP data.

So, as our profit warning analyst points out, 75 warnings for Q1 2017 might look like 76 in Q1 2016, but the underlying picture is very different. Expectations have also fallen, which helps to explain low levels of retail warnings. The hit to consumer spending from inflation has been in the forecasts since June.  A rise in the pound could ease some pressure – if it lasts. But, sterling remains over 11% weaker year-on-year at $1.29, which will keep pushing up prices and keep the pressure on disposable income. Most companies warning on price also have deeper structural issues. Thus, we expect the number of warnings to ease back in Q2 – barring shocks – but by late 2017 we expect the decline in GDP and further challenges from Brexit to tell.

..and then markets….

Capital markets continue to roll with the punches, rising on any news that confirms the reflation-growth narrative. There’s a growing amount of this good news in continental Europe. Eurozone economic confidence has climbed to near-decade high and you get the sense that a stable period in politics & financial markets could get companies believing and investing.

In the US, markets are in watchful mood after the President published outline tax plans. There is clearly the will to act – and markets are in receptive mood – but they’re waiting for the detail. If we do see a change to a territorial tax system this will encourage more US companies to bring dollars home on a long term basis beyond the widely anticipated one-off incentive.

..but look at deals!

Companies have also learnt to roll with the punches. In EY’s 16th Capital Confidence Barometer, 69% of executives questioned cited some form of geopolitical or policy issue as the main risk to the global economy and their core business. And yet, more than half (56%) plan to pursue acquisitions in the next 12 months.  Organic growth is still hard to come by. Companies have to find growth elsewhere – as well as keeping up in the digital race.

It seems that uncertainty might not affect the level of deal activity in the same way as it has in the past. At least not at this level of uncertainty.  Although – as we’re seeing in the UK data, due for release on 8 May – economic and political upheaval can have a significant impact on the type of activity.

And back to politics

The latest IMF report on the global economy contained three key messages, as recently noted by Mohamed A. El-Erian on Bloomberg:

  1. Global growth is seeing a short term pick up,  but still has the same medium-term trajectory
  2. The risks are getting bigger
  3. To lock in growth, we need better national policy making and cross-border coordination.

The third point is the vital one. We discussed the divergence between economic data and market sentiment  – previously in this blog.  An argument in favour of markets  is that they’re ahead of the curve. Earnings are picking up and economies will follow. There is some merit in this. But, to go back to where we started, most of the risks identified by the IMF are political, including big decisions yet to be made and implemented in the US and Europe. It’s still all to play for.


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