In it for the long haul

Long haul
Driving on Britain’s roads it’s difficult to escape the number of lorries, especially when you are in a traffic jam behind one. Subconsciously I tend to track brands I see. Basically, if a company has lots of lorries out on the road, that tells me that they must be pretty busy. Put simply, more lorries equals more goods being delivered and in turn more sales!

Which got us thinking. The UK is facing an alarming shortage of HGV drivers. With the prospect of mature HGV drivers approaching retirement or the end of the road, there simply aren’t enough young drivers coming up to replace them. New entrants are seeing many ‘no entry’ signs. Extend LGV training times, EU legislation which requires a mandatory Certificate for Professional Competence along with a truck licence costing £3,000.

Given 85% of the UK’s goods are moved by road and the ongoing growth of internet shopping, then a crunch point could be looming. It is estimated that the UK needs an extra 150,000 HGV drivers by 2020. Service standards are likely to reverse and this could drive up wages but also means companies have to absorb higher distribution costs or seek to pass these onto shoppers. Importantly, could the UKs economic growth possibly stall as a result?

I expect there are some UK companies whose personnel departments are currently playing ‘spot the lorry’ driver!

What have we been watching?

Another volatile week for investors with the focus, this time on the banking sector, particularly European banks due to concerns about debt default in a slowing global economy. Concerns about Deutsche Bank’s contingent convertible bonds (CoCo bonds) and a profit warning from Societe Generale, created shockwaves across the sector. UK banks, the largest sector within the FTSE 100 at one point last week had fallen almost 25% so far this year. This has not been just a UK bank issue as the world’s top ten investment banks had lost a third of their value in 2016 at one point last week.

Those banks most exposed to emerging markets and commodities have been the biggest fallers which along with ongoing weakness in the oil and mining sectors have created more market volatility with daily movements in the FTSE 100 of plus or minus 100 points. The UK market and some of the banks rallied on Friday after Deutsche Bank announced a bond re-purchase programme and Commerzbank released re-assuring results. Although Deutsche did reaffirm their intention to issue €35bn of CoCos in 2016 to bolster its Tier 1 capital.

At the start of 2016, Chinese currency weakness took centre stage which was then followed by another fall in the oil price. This time it appears to be concerns about the health of global banks mostly due to what Chinese currency depreciation, lower oil prices, slowdown in global growth and challenging conditions in emerging markets might do to their Balance sheets.

In recent years, some European Bank Balance Sheets have been bolstered by the issuance of coco bonds which, with high yields were easy to sell to fixed interest income investors at a time of historically low interest rates. European holders of coco bonds are now beginning to realise that CoCo bonds may not be a very secure investment. If the banks can’t attract investors to buy more CoCo bonds how are they going to raise money?

Market slump
At the low point last week, global equities entered bear market territory with the FTSE All-World stock index down over 20% from the 2015 peak. Markets seem to have lost their belief in the powers of the central bankers. Are central bankers running out of ammunition? Following Japan’s introduction of negative interest rates, Sweden’s central bank cut its overnight borrowing rate by 15 basis points to minus 0.5%. The prospect of further interest rate cuts from the ECB or the introduction of negative interest rates has affected sentiment towards the banking sector, exacerbating the scale of the equity sell-off. The fall in share prices has been accompanied by a rise in credit default swap rates which, reflect the cost of insuring exposure to bad debts. New EU ‘bail-in’ regulations may be adding to the uncertainty as this would potentially shift the cost of potential bank failure from the taxpayer to senior bond holders and large corporate depositors. Italian banks in particular look the most vulnerable from this change.

Unsurprisingly, safe havens have been in demand with gold rising to a twelve month high and government bond yields in the US, Germany and the UK all falling, with the UK yield 10 year Gilt at an all-time low of 1.2%. However, Eurozone periphery bond yields in Portugal, Spain and Italy increased. The Brexit issue continues to dominate UK press headlines and later this week Council president Tusk’s draft proposal on the UK’s amended relationship should be signed off by other EU leaders.

Japan Flag
Japan had a particularly volatile week and on Tuesday the equity market lost 5% of its value in a day, and is in bear market territory with a fall of over 20% since mid-2015. The Yen hit a 15 month high and the yield on 10 year government bonds turned negative- a first for a G7 nation. The BoJ faces a major challenge to stimulate economic activity given Q4 GDP contracted by 1.4%.

China Flag
In China, the governor of the central bank played down concerns about the countries falling foreign reserves and said he saw no basis for continuing depreciation in the renminbi.

Oil Drum
Oil slipped on news from the International Energy Agency which said that the global oil surplus was bigger than previously estimated and that the recent rebound in prices was probably ‘a false dawn’, although rumours of a potential OPEC cut continued to circulate.

So, as we have asked before, is it the end of the world? The global macro-economic view may be more challenging but it is not a disaster and lower oil prices will help consumer spending in many leading economies. The slowdown in US growth momentum and tightening of financial conditions especially in European financial credit along with China and oil producing countries suggest things will remain challenging and equity markets will be volatile. Challenging global trade conditions were reflected in comments from Maersk, the world’s largest shipping container group which suggested that it was enduring conditions in container shipping that was markedly worse than during the 2008 financial crisis. However, lower fuel prices are helping US consumers who account for two-thirds of US economic activity, with a better than expected 0.6% rise in consumer spending in January.


As things stand currently, it will now probably require either positive news from one of the central banks or further co-ordinated action by central bankers to create a sustained change in investor risk appetite. The US Fed appears to have ‘changed its tune’ with US Federal Reserve Chair Janet Yellen warning that economic conditions in the USA have become ‘less supportive’ of a further interest rate rise. All eyes will now be focused on the ECB and its next meeting on the 10th March for support. The Chinese also return from their New Year celebrations this week, and so far there have been no major stimulus measures from China’s central bank given Chinese trade volumes were much worse than expected. The next G20 meeting is in Shanghai towards the end of February so will world leaders come up with a plan to comfort global financial markets?

For us, the main concern would be if company management teams became more cautious in view of the current global financial turmoil, or banks being less willing to lend money. If this led to a deferral of business expansion plans then it would affect capital spending and employment and impact global economic growth. We have not currently seen evidence of this except, within the oil and mining sectors which, have had to cut costs aggressively in the face of the collapse in commodity prices.

When there is a storm, all trees will be blown about and it is not the age or the size of the tree that matters but those with the strongest roots that survive. Similarly with equities, for in stormy conditions most companies are likely to see some volatility in their share price. We continue to avoid heavily indebted, cyclical businesses and focus on those having the strongest roots with sound balance sheets, solid cash flow and dividends.

Finally, we have talked before about the distorting effect of the central bank QE programme. News last week that European regulators have opened a preliminary cartel investigation into possible manipulation of the $1.5trillion government sponsored bond market. Which got us thinking. Hasn’t the ECB been actively buying bonds as part of the QE programme? Isn’t that effectively a form of market manipulation?

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