Dear reader,
Watching the UK’s capital markets firestorm from the other side of the world is a peculiar experience. Here in San Francisco, the biggest news of the week was a rumour that Apple might not scale up production of the new iPhone 14. West coast priorities can be a little out of touch.
True, US tech companies are concerned about the strong dollar’s impact on upcoming earnings. But there is nothing here that compares to the self-inflicted chaos in pound and gilt markets. I liked one Lex reader’s vivid description of the situation as a house of horrors.
My other favourite snapshot of the UK’s reaction came courtesy of Prime Minister Liz Truss’s bruising local radio interviews. Her team presumably hoped these would be softer than a traditional Sunday morning political TV show. No such luck. Interviewers in Leeds, Bristol and Lancashire were relentless in asking sharp questions about the Bank of England’s intervention in gilt markets. You can listen to them here. There are an awful lot of awkward silences.
Rising rates are not necessarily a problem for pension funds. In fact, higher long-dated gilt yields will take more schemes into a surplus. The problem is the speed at which yields are moving. Defined pension schemes have struggled with ultra-low rates for years. To protect themselves, they have used liability-driven investment strategies (so-called LDIs). These are an attempt to match long-term promised payouts to assets. A sudden jump in rates means that pension funds have to pay more collateral following margin calls. That triggers a sale of assets — such as gilts. The sales exacerbate the drop in gilt prices and so the cycle continues. There is a good FT Opinion column from Toby Nangle that pointed out the potential problems of LDIs back in July — although of course no one then was predicting the current market moves.
It’s not all bad news
There is always a bright spot. Of the 2,000 biggest listed, non-financial UK groups, about 40 per cent of their sales originate in the US and they will benefit from the pound’s fall. Sterling is still very weak by historic standards, even though this week’s decision by the Bank of England to embark on a £65bn bond-buying programme helped it to erase much of the losses triggered by last Friday’s “mini” Budget.
Lex expects UK house prices to fall sharply, but the declines are unlikely to be as severe as in the financial crisis or early 1990s. Nor do we think there will be a comparable level of repossessions. Tight lending regulations in the past decade or so mean borrowers are not as exposed. Take a step back and consider how fast house prices have increased in recent years too. Even if they dropped 15 per cent, the average UK house would just be back to pre-pandemic levels.
OK, back to the bad news
It is, however, a question of when, not if, recession arrives in the UK. Inflation is outpacing the EU and US. Already high energy costs will be pushed higher as import costs rise. During the pandemic, the government cushioned the blow. You can read Lex’s prophetic long read on this from 2020 here. This sort of assistance is no longer on the cards. Corporate credit risk is on the rise. UK insolvencies are up more than 40 per cent on last year. Look at the chart below and the pattern of debt vs ebitda two years ago is obvious.
Lex also took a moment this week to consider the impact on international companies with exposure to the UK. particularly in Asia. These include Hong Kong-listed banks such as HSBC, where the UK and Europe accounted for a fifth of pre-tax profit last year, and local utility companies such as Power Assets, which holds 41 per cent of Northern Gas Networks.
In the US, companies derive about 30 per cent of their sales outside the country. The US Dollar index is close to a 20-year high. For companies such as Apple, converting overseas sales to US profits will take a toll on net income. But Lex wonders if the strong dollar, like the war in Ukraine, is about to be used as cover for disappointing results that companies should bear responsibility for.
Signature style
Which chief executives will survive the onslaught? Watch out for the ones who sign their names with extravagant letters who may promise more than they can deliver. Lex spotted an oddity this week — a study of the signatures of corporate leaders compared with their performance. Unusual methods of scrutinising personality traits can produce some questionable conclusions. You might remember the 2010 study that claimed up to one in five chief executives exhibited psychopathic traits. It is not all that surprising that the people who believe they can lead global companies might be risk-takers with above-average self-confidence. It’s up to the rest of us to distinguish between self-confidence and self-aggrandisement. We might take a few pointers from the hosts of UK local radio.
Enjoy your weekend,
Elaine Moore
Deputy head of Lex
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