A really striking recession indicator came out last week.
It wasn’t the Bank of England’s massive rate cut. No, this was far worse. Sales of mince are rocketing as people stay in to cook more, said online grocer Ocado. At the same time, sales of little treats such as doughnuts and smoothies are plunging, as shoppers “return to frugality,” according to Ocado co-founder Jason Gissing.
The British consumer has started to cut back and make savings where they can. Faced with the massive debt burden we’re carrying as a country, it’s what we need to do.
Unfortunately, it’s also very bad news in the short-term for profits and jobs…
More and more companies are going bust as consumers cut back
If you’re in debt, it makes sense as an individual to save. But if everyone does it at the same time, it means the entire economy is in for a downturn. This of course, is why Keynesians say that when people start saving rather than spending, the government needs to spend in their place.
But it strikes me that a more sensible alternative would be for policymakers to stop encouraging consumers to overspend so drastically during the good times. The government has followed deliberate policies of making saving unattractive, by encouraging low interest rates, raiding pension funds, and cutting the tax-free Isa allowance every year in real terms.
Against that kind of backdrop, it’s little wonder that lots of people didn’t see the point of saving. And now that we’re being forced to cut back, it’ll take a long time to get back up to the sorts of levels where people feel happier with the state of their personal balance sheets.
So any business with any reliance on consumer spending is heading for very hard times. My colleague David Stevenson has been writing recently about how British businesses are already running into severe cash flow problems (read about it here: Companies are leaking cash – that’s bad news for jobs). And the latest data show that the number of companies for whom the crunch is proving terminal is rising sharply.
Figures at the end of last week revealed that corporate insolvencies had risen at their fastest rate for 18 years between July and September. Across England and Wales, 4,001 companies went bust. That was a 26.3% jump on the year, and a rise of 10.5% on the previous quarter.
And some of the bigger names in British business are feeling the strain. For example, estate agent giant Countrywide has had its credit rating downgraded by ratings agency Standard & Poor’s, which reckons the company could run out of cash in the next 12 months, reports The Sunday Times.
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Why the interest rate cut won’t help
Now you’d expect companies in the property sector to be suffering of course. But the casualties are rising in other sectors too. Electrical retailer DSG is selling off its central and eastern European unit, while car dealership Pendragon is flogging off its software arm Pinnacle, to try to raise cash and cut costs. Even mobile phone giant Vodafone is this week expected to rein in its full-year profit forecasts.
Can the latest huge interest rate cut help? James Ferguson, economist and stock broker at Pali International, reckons not. As he points out in the latest edition of his email newsletter, the 1.5% cut would “in normal times… be very re-inflationary and would mean easier credit for us all. However, these are not normal times.”
As we’ve already been pointing out, banks will want to cut back sharply on the amount of risky assets on their balance sheets. That means that they rein in lending to new borrowers and act more rapidly to shut down the borrowers most at risk of default. And just as saving en masse causes pain to the wider economy, so does across-the-board bank deleveraging. As asset prices fall further, credit conditions get tighter and more risky borrowers are forced to default early.
“Typically in year one, the real estate and developer industry gets hit. Year two eats into the retail, leisure, restaurant and hotel trades. By year three… the recession has hit revenues and profits sufficiently hard, that few industries are immune and manufacturers and other basic industries start to get tipped into bankruptcy too if their businesses are too cyclical or their balance sheets too leveraged.”
It’s not time to get back into the housing market yet
What does this mean for your investments? Well, although this whole process usually takes four to five years to work through the economy, James is actually fairly upbeat on stocks, as they have largely been bought without leverage. He reckons they could bottom out soon.
However, anyone who’s feeling convinced by opportunistic pieces from pundits saying you should pile back into residential property after the rate cut, should think again. James points out that residential property is among the most illiquid of debt-financed assets, and among the last to recover, bottoming long after the wider economy has started to perk up. “I expect house prices to halve and to take nigh on a decade doing it.”
So – not time to get back into the housing market yet then.
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