Plus ça change, plus c’est la même chose – the more things change, the more they stay the same! This has pretty much been the theme of the blog for the past few years. You only needed to look at volatility indices – and the growth in their derivatives– to appreciate the extent of this stasis.
But the times, they are a-changin’. To illustrate, I’ve picked out five charts that show how 2018 is just that little bit (or a lot) different.
In 2018, capital markets are clearly on a new footing: not quite certain how far inflation and interest rates will go and how much growth will offset the impact on earnings. After all, growth is good – but until recently it hadn’t triggered inflation or sustained interest rate rises. The chart below shows that the Fed still expect three hikes in 2018. The ECB minutes this week included more hawkish noises. Mark Carney says that financial markets 50%+ expectation of a May rate rise are in line with the underlying economic data.
More interest rate speculation could also trigger more currency volatility – which won’t be new for UK companies in the post-Brexit era, but it’s looking like we’ll also see more dollar variation. The ECB minutes express a clear concern about currency wars as US officials talk about the benefits of a weak dollar. It won’t be quiet on this front in 2018.
- UK growth
UK is still struggling for momentum. Revised GDP growth of 0.4% (from 0.5%) for Q4 2017 also contains a largely unappealing component breakdown, including flat business investment, negative net trade and slowing consumer-spending growth. The upside is that 1.7% growth in 2017 was better than had been widely expected at the start of the year. Productivity is also improving. Manufacturing sectors continue to do well. The downside is that this is the UK’s slowest growth since 2012 and the fact that it’s now lagging the Eurozone.
In 2018, UK growth should improve a little to 1.7% as the inflationary squeeze on consumers’ eases. Net trade should make a modestly positive contribution to growth due to the combination of more robust global expansion and a still ‘competitive’ pound. But, Brexit and other political uncertainties will continue to limit investment unless resolved.
The UK continues to offer many advantages for companies. For a long time it has been a favoured M&A destination. But, the location-equation could be changing – and we’ll have more on this next month.
We’ve talked a great deal here about digital disruption and the corporate dilemma of whether to buy or build – not just to keep up, but also to stay ahead of the field. In crowded sectors, companies also need to work harder and harder to differentiate themselves from competitors.All of this needs capital – and perhaps more capital than many companies are budgeting for in 2018. Our UK profit warning data shows a significant increase in warnings citing higher than expected investment costs. Meanwhile, rising price pressures are limiting the cash available to invest.
Clearly, some companies are doing incredibly well in allocating their capital and these businesses tend to be those leading the way in their sector. But, in 2018 we are seeing and expect more stress and distress from companies being left behind in more testing and less benign conditions. If capital raising becomes more difficult, this could increase again.
- Greener pastures
Bats Indices have split Britain’s 100 biggest companies in half on the basis of whether they derive most of their revenues domestically or abroad, i.e. high or low UK exposure – as per the chart below. Some of the divergence is due to the fall in sterling, which clearly boosts overseas profits. Some is due to Brexit uncertainty as we approach the crunch of talks. Some is due to general UK political uncertainty and the growth slowdown – as above. Overall, it signals the potential for greener earnings grass elsewhere.
For most UK companies looking to raise capital in 2018, it will still feel remarkably similar to 2017. In debt markets, many of the fundamentals actually remain the same. It is still – at most levels – a borrowers market due to an ongoing supply-demand imbalance. There is still ample liquidity and although bond yields are rising, this isn’t translating yet into any significant move in pricing.
That said, the US’s increasing debt requirements could cause a significant increase in competition for investors, forcing yields up further than markets are expecting. Moreover, companies looking to raise capital in more pressured sectors will find it harder to find willing participants – especially where we’ve seen more credit events or where the outlook is more troubled, as in consumer-related areas. We’ve spoken here before about the restaurant sector, which continues to struggle. A problem for those needing to invest.
- US tax reform
US tax reform offers a complex range of scenarios for UK companies. We’ll be considering the deal and broader capital implications here in a few weeks. For now, I just want to flag up two developments that underline how differently 2018 could pan out.The first refers to what we’ve seen so far in this reporting season. A number of UK companies with US operations have already registered significant deferred tax asset write-downs for FY 17. As for the longer–term impact, companies are still running scenarios; and there are many moving parts including changes and interactions in and with other tax regimes. Nevertheless, for FY 18, most expect low to mid-single digit improvement in their effective tax rates.
The second is to underline how far the ripples from this generational change in US could run. Spreads on banks’ two-year bonds widened by more than 15 basis points in the first few weeks of February, according to Bank of America Merrill Lynch – h/t The Financial Times. BoAML suggest this is a sign that big US multinationals are liquidating savings they had invested offshore after tax reform. Companies that invested primarily in corporate bonds were large buyers of short-term bank bonds.
The other aspect of overseas cash repatriation we have pushed for this year is that financial markets are losing one of the biggest providers of funding in the front-end...
And will US companies use this money to pay down their own debt, invest, buy, return to shareholders – or all of the above?
Watch this space!