Are the bulls or the bears right? Try listening to the awkward squad in the middle, says David Stevenson
There’s a real world beyond the City of London, and a great many businesspeople in it will have been spooked by what has gone on in the stock markets over the last few weeks.
Looking at the actions of the equity bears and the bond market vigilantes, you might well conclude that we’re teetering on the edge of a double-dip abyss, with consumers running for the hills and stocking up on their gold coin holdings.
I think we should prepare for something called the New Normal. It’s a term that means many things to many different analysts and strategists, but for the reader of this column I’ll focus below on the Top 13 Boring Things You Need to Know About the New Normal.
Before I spell out the 13 in detail, a few words of explanation. On one side of the New Normal are the bears who think we’re heading into the deflationary abyss with Japan as the best example for Britain. Massive state debts, a virtually bankrupt government and low headline growth.
On the other side of it are the bulls who reckon that we’re about to see a massive pick up in demand in the key US markets and that we’re just months away to a return to solid upward growth.
The New Normal awkward squad sit in the middle. They agree with the bears that growth is actually fairly resilient, but not very exciting. In these boring, tough circumstances they focus on the cash flow and P&L lines and call for a relentless focus on profitability rather than grabbing market share.
The New Normal brigade also think that talk of a massive inflationary surge is nonsense and that the bigger threat is from mild deflation, which could easily turn nasty if the government pushes taxes too high.
Let’s get down to those 13 markers for the future, with some practical ideas about how you might position your business.
1. Equity markets could easily derail the slow recovery if they suddenly panic about a double dip recession. But the evidence so far is that we’ve had a 10 to 15% correction, which is normal, and that most investors have done very little except add a bit to their cash holdings. So far there is still a less than 25% chance of a double dip recession – expect more sustained growth in the last quarter of 2010 and most of 2011.
2. The equity markets are dominated by fears of risk in the bond markets, i.e the bond markets tell the equity markets what to do. Currently the bond markets have very few fears about the UK and our debt levels. Crucially there’s a good chance that UK government debt yields will keep falling as bond and equity investors seek the safety of gilts. That means that the perception of inflation risk is still very, very low.
3. We’re only two to three years into a multi-year process of massive de-leveraging, i.e taking debt out of the economic system. That involves swapping bad debts for good government debt. This is done by banks buying government debt. This easing process pushes interest rates down to ever lower levels but also keeps borrowing to small to medium sized companies at very low levels as the government crowds out other demands for scare capital.
Expect bank business funding to grow more difficult and more expensive, although if you can get low cost access to debt, go for it. Currently the banks would rather lend to the government than smaller businesses. And they need to do this lending in order to fund our schools and hospitals.
4. Big companies are sitting on large piles of cash which are growing bigger by the day. They should hand this money back to their shareholders via dividends, but most will choose to waste it on bad takeovers and mergers.
They’ll also compete with private equity funds that still have lots of cash to invest in the right business. This is all great news if you happen to own a business that will become a target of these two sets of predators – they’ll stupidly bid up prices, so sit tight and wait for the knock on the door from buyers.
5. Financial markets will remain volatile and dangerous, going up and down with gay abandon. That makes an IPO on the stockmarket fairly unappetising and it will keep the cost of risky debt and capital very high, i.e at above 6% per annum, if not closer to 10%.
Beware the corporate sharks out there trying to make money out of this volatility by selling you expensive debt which they finance cheaply because they have rich City backers.
6. In this slow recovery, employment growth here in the UK will be very weak, especially as the public sector cuts back with a vengeance. We’ll undergo the same recovery as the US in the last decade, a jobless recovery.
It’ll look like steady growth, increased profit margins for corporates but declining average incomes. That’s good news if you’re an employer, bad news if you’re an employee.
7. Low employment growth will translate into a weak housing market outside the City State Principality of London and the Home Counties – this is a separate economy powered by fundamentally different forces from the rest of the UK.
Outside the Home Counties UK house prices are still 30% over where they should be and they’ll spend the next ten years drifting sideways and downwards with occasional rallies that will be over in six months. Don’t bank on housing prices rising and consumers spending like there’s no tomorrow.
8. Pressure to save more is growing inexorably. Everyone in the UK economy is guilty of not saving enough. Most pension schemes are built on faulty models of long term growth in shares, trends that won’t actually translate into wonderful final pensions – expect panic to set in when the penny finally drops.
This will force investors to put yet more money into their savings plans, dragging down consumer spending as savings increase. Most of the focus of this move to greater savings will happen with younger people who up till now have been more willing to spend – be careful about relying too much on the youth pound.
9. Big ticket items of consumer spending will still command premium prices – consumers will focus on spending less money on more key things that matter to them.
Potentially that’s good news for big ticket holidays, less good news for the rest of the travel spend. But that focus on a smaller number of bigger ticket items will reinforce existing trends to research the details of the spend and make sure they’re getting the absolute best.
10. Don’t worry about rampant inflation for at least another two to three years. The nighmarish days of higher inflation will eventually come and almost overnight inflation will shoot up from 2 to 3% to 5 and 6% and then 10%.
This will force a sudden increase in interest rates in the medium term and a sudden downturn but these dark, dark days are a long, long way off…
11. The UK government will not be able to achieve 80% of the deficit reduction by expenditure cuts alone. Taxes will keep on rising and business leaders should expect a second round of increases late in 2011 as the size of gaping hole at the exchequer becomes more apparent. Expect income tax and CGT to increase in 2012. Also VAT may have to rise to 22%.
12. Despite the decent recovery in 2010, 2011 and the first part of 2012, there will be a huge and sustained output gap. This all sounds a bit technical but it means that pricing pressures will stay low as there’s a great deal of spare capacity out there. It also means that wages rises are pushed down and, most importantly, that some regional economies within the UK will stay crushed for many years hence.
13. The US economy will eventually ride to the rescue in 2011 and the rate of increase in growth will slowly pick up again worldwide late in 2010. Just be patient.