This is my last blog as EY TAS Markets Leader before I hand the baton to Adrian Browne. It has been an eventful two years and I wanted to take time to look back, but also look as far forward as we can in such extraordinary times.
My first blog on 7 May 2015 came on the eve of what turned out to be a pivotal UK general election, an on-going Greek crisis and an M&A boom. That’s not even half of what was happening then – let alone since. It’s tough to single out any particular theme or moment – let alone make predictions – but here are my thoughts and expectations as I sign off.
The ballot surprises
Surprise results, referendums and elections…has there ever been a period like this? The hangover from the financial crisis and the differential impact of QE, globalisation and digitalisation goes some way to explaining the incredible shift in the political landscape. But, the overall picture is complex and voter reaction even harder to pin down. If there has been a constant theme, it’s been a vote for change. But, who voters trust to bring this about has constantly defied prediction and generalisation. In France, the desire for something new led to the creation of a new and successful political party. Although, ultimately, French (and Dutch) voters didn’t abandon the centre ground as they did in the latest UK election.
Where does this all leave business? Needing to develop plans that can adapt to a wide variety of outcomes. We’ve talked in the last few years about developing flexibility and resilience and the next few years will test these plans. Businesses need also to be ready for greater political intervention and an end to laissez-fair attitudes to globalisation and business operations, regulations and deals. This is one trend that does cross the widening political divide
The Brexit vote
Arguably the biggest change and shock of all – at least for me. A year on and we’re still speculating with the close general election result increasing conjecture that the government will aim for a ‘softer’ Brexit to gain cross-party support. That said, neither of the two main parties campaigned on what might be considered a ‘soft’ platform. Thus, businesses should continue their scenario planning with Britain leaving the EU with an FTA as the most likely option.
There is the potential for a transitional arrangement after the March 2019 deadline to avoid the ‘no deal’ cliff-edge, which The Bank of England said “could have most impact on UK financial stability”. But, this is still all conjecture. The Financial Times has picked out six scenarios, with service sector challenges especially apparent. For now, sterling’s post-Brexit fall is the most pressing issue as it continues to reshape the weakening UK economy. Manufacturing (orders at multi-decade highs) is currently fairing much better than retail (five of top 10 most shorted stocks) where problems go deeper and wider than Brexit – as increasing US distress illustrates.
The Eurozone revival
At the start of 2015, the ECB announced a bigger than expected extension to its QE programme. By May, Greece was on the brink again as struggled to meet bailout conditions. But, even then we were starting to see the start of the revival that has culminated in the Eurozone being one of the brightest spots in what is still a sluggish global recovery.
All things are relative and – as with so much of the last two years – there are caveats. Greece has a new deal, but still needs support – and more debt relief. Italy’s bank bailout has raised questions – and isn’t the end of its bad debt problems. The region is still reliant on an incredible amount of central bank life support – where isn’t? But, we’ve still come a long way from when the Eurozone crisis seemed to dominate every summer.
The becalming of markets
On 24 August – aka ‘Black Monday’ – Chinese concerns, falling commodities prices and expectations of a US rate rise boosted the dollar, hit ‘emerging markets’ and culminated in a 13% fall in global equities. The fall highlighted the still heavy reliance of markets on central banks and faith in China to act as ‘buyer of last resort’. Still, we thought that reaction was overdone given the improvement in corporate earnings and in Eurozone and US economies in particular.
Today, markets seem too becalmed. There are reasons to optimistic, but investors seem too inured to trouble and too used to central banks’ unconditional support. Capital is cheaper and more available than I can remember. It’s pushed investors up the yield curve and helped all but the most struggling of credits to refinance. This has benefited many companies, but we have to question its sustainability given still sluggish economic growth. The Bank for International Settlements reports that global debt-to-GDP levels are 40% higher today than on the eve of the global financial crisis. The Bank of England is increasingly expressing concern over rapid growth in UK consumer credit.
Any reckoning could come slowly given that 44% of EMEA debt matures beyond 2021, according to Moody’s. And, if I’ve learn any lesson since 2015 it’s not to over-estimate the pace of interest rates hikes! Inflation isn’t an issue for most major economies. Crude is trading below $50 and unlikely to breach $70 without fundamental changes. There is also little wage pressure, despite low unemployment. That said, we’re no longer talking about deflation. Three of the main central banks are trying or talk or are actually tightening and I’m not sure markets are prepared.
The UK’s unique inflationary and economic conundrum is creating divergent views that makes it hard to predict where its rates go next. Then there’s the disparity between soft and hard data in the US and a growing divide between dovish market expectations and a more hawkish Fed narrative. A more hawkish sounding ECB has also boosted the euro. This suggests we can expect more currency fluctuations at least – and maybe just a little more risk reflected in markets?
Deals, deals, DEALS!
Readily available capital, low market volatility, low growth and a strong imperative to meet the disruptive challenge. This compelling deal mix led us to record deal making in 2015 and high levels since. But this by no means an undisciplined buying spree. We highlighted two deals in 2015 that exemplified trends in smarter capital allocation. The first was VW, BMW and Daimler’s coming together to buy Nokia maps. The second was Pearson’s disposal of its The Financial Times/Economist Stake, where it acknowledged an the FT needed a different type of owner to put in necessary investment and it needed to reinvest new capital into its core business.
Thus, deals have continued despite of – and in some cases because of – the turmoil of the last few years. There are concerns about rising multiples, especially when buying proven disruptive technologies and models. But, companies have responded innovatively with more companies starting or building up corporate venture funds to tackle the issue of when and how to invest in new ideas and technologies. We’ve also increasing activity in joint ventures and alliances as companies look for ways to spread risk and capital.
One area that has struggled in recent years – IPOs – seem to be picking up in the rest of Europe as the growth outlook improves. This isn’t happening in the UK due to Brexit uncertainty and related currency fluctuation – and concerns are spilling into the M&A market. We’ve already seen a tail off in UK inbound deals. Growth and digital deal imperatives remain, but the deal environment doesn’t look as helpful and politics and regulation will also loom larger. We’re still unsure not just about the path of the UK, but also the US – noting the IMF downgrade this week. And we haven’t heard much from emerging markets in a while – although there are clearly issues building, including Middle East tensions and problems in South Africa, Turkey, Venezuela and growing financial problems for other oil exporters.
So, I leave you at a very interesting time – on the cusp, perhaps, of a new and more testing era. Many thanks for your support and I look forward to reading Adrian’s views on whatever comes next!