UK corporate optimism has fallen.
UK businesses are in “wait and see” mode according to the results of EY’s latest Capital Confidence Barometer, a survey of almost 1,600 corporates worldwide, 10% of which are based in the UK. The shift in sentiment since our last survey is dramatic: only 27% of UK businesses cite growth as their primary focus, down from 49% in only 6 months.
But the mood is not one of doom and gloom, far from it. Looking at the UK, 93% of respondents are confident about their UK earnings, 76% see good credit availability and 68% are positive about equity valuations. These levels of confidence would ordinarily translate into aggressive expansionary plans, we tend to see higher M&A activity and increased capital investment when earnings and equity values are high and credit is readily available, but this is not the case currently all the signs are of businesses adopting a cautious approach.
So why has UK sentiment moved so sharply, making the UK significantly less optimistic than the USA for example, despite the two economies growing at comparable rates?
It’s the global economy stupid…
Without doubt, a change in the expected global economic outlook has impacted UK corporate sentiment. Only 14% of UK respondents see the global economy improving in the next year, a massive fall from 57% with this view in April and the lowest response of all the major European economies.85% of UK businesses see the global economy as stable, but stable is no basis for rapid expansion given the relatively low growth rate by historic standards. 46% see the UK economy improving but this is also down compared to 63% six months ago and adds to the move towards risk minimising activity.
…and it’s scary out there.
This lack of growth in the global economy is coming at a time when concern over risk is increasing. 37% cite increased global political instability, 31% worries over QE tapering and 18% slowing growth in emerging markets as their major worry. All of these risks reflect issues largely external to the UK and may go some way to explaining the UK’s lacklustre trade performance. UK plc is increasingly planning to rely on the domestic economy to support its performance which clearly sets limits to the scale and pace of any expansion plans.
But don’t worry, we can cope
Despite the challenging backdrop described about, which was also prominent in the recent EYITEM Club Autumn Forecast, business appears confident in its ability to manage through potentially difficult times. The confidence in earnings mentioned above confirms this: UK businesses are more confident in earnings than the global average. A closer analysis of the responses to our questions on planned actions gives some clear insight into how businesses are reacting to the slowing global economy by: balancing costs and growth strategies; sticking close to their core activities; and pursuing low risk M&A.
UK businesses are preparing to adopt relatively cautious strategies based around striking a balance between watching the bottom line and investing for growth. Cost management is the focus for 50% of UK businesses compared to 35% of global corporates. Having survived the recession, UK companies are in no mood to throw away the gains they have made and so a strong focus on efficiency will remain central to their plans,
Organic expansion will be similarly cautious with a rigorous focus on core products and markets and adding complimentary sales channels preferred to existing in new geographies or large-scale increases in R&D. The plan is clearly to seek out lower risk, incremental benefits rather than making big bets.
The cautious theme can also be seen in the proposed approach to M&A. Only 16% of UK companies expect to make an acquisition in the next year compared to 40% of the global total. And the corporates doing deals expect these to be relatively modest with 86% of expected deals under $500 million. Moreover 90% of deals will be in the core business. So deals will be cautious, relatively small and close to the existing business model.
The plans seem clear but the level of confidence is very high. The worry is that there is little slack and current plans are dependent on no major shocks and continuing support form central bankers.
The owners seem happy.
At times over the last couple of years we have sensed pressure from shareholders for more aggressive strategies. This does not seem the case today. When asked what shareholders want, 45% of companies cited share buybacks, 41% cost reduction, 37% divestments and 30% increased dividend payments. With only 1% mentioning pressure for acquisitions, we can be reasonably confident that shareholders are happy with cautious strategies that minimise the risks of incremental investment and prioritise returning income and capital to shareholders. This appears to be a time for caution rather than expansion.
No time for rash moves by business or government.
A weakening economic outlook and increased risks are driving UK businesses to adopt cautious strategies based around preserving capital and minimising exposure. Having learnt the lessons of survival during the recession, managements are not panicking and are confident in their ability to manage in a low growth economy. This is a time for cool heads and rigorous, emotion free decision-making. While keeping calm it nevertheless makes sense to be developing contingency plans based around scenarios of potential shocks to the economic outlook, especially from Europe and key emerging markets. Although businesses are confident in their ability to cope, the worry is that this assumes the willingness and ability of central bankers to step in remains unchanged and there is limited slack to absorb further shocks.
Our research also contains clear messages for policy makers. Although businesses are confident in their ability to cope, the worry is that this assumes the willingness and ability of central bankers to step in remains unchanged and there is limited slack to absorb further shocks. In an uncertain environment it is important that confidence is maintained. With no signs of inflationary pressure in the UK, it seems sensible for the Bank of England to hold off on any interest rate rises for as long as possible. Any moves to tighten policy in the UK are unlikely to improve business confidence or incentivise greater risk-taking and do run the risk of increasing the slowdown.
Yet it is also clear that credit remains readily available. Indeed, anecdotally there is a feeling of increasing pressure to lend to meet targets and concerns that credit standards could become too relaxed. the worry is that the competition for business could either lead to asset bubbles or to an increase in riskier lending. Continued macro-prudential vigilance is therefore essential in a low-interest rate, high liquidity environment.
Cool heads all round.