Stockwatch: The big worry for markets now
27th November 2015 10:19
So is the economic cycle turning? Listening to an ebullient George Osborne relish the Office for Budget Responsibility's prediction - for UK growth to ease only about 0.1% to 2.4% towards 2020 - the future sounds secure.
There are also City analysts who reckon fiscal tightening means a 3.5% net retrenchment of GDP to 2018, and economists who insist UK borrowing should be trimmed to better withstand global risks.
Others argue it should increase, so public investment can replace demand in a downturn. As ever, economists head-to-head will never reach a conclusion, but the crux for share valuations and dividends is the trend in companies reporting. What do we see?
Biggest rise in profit warnings in four years
Reading statements daily, I see a clear majority "in line with expectations", albeit with a caveat of "broadly in line" creeping in. This investor relations tactic allows wriggle room; to fussy observers it suggests doubt and a desire to try and avoid shock.
Firms actually beating expectations have certainly shrivelled in number. Profit warnings I notice increasing, although there was going to be fall-out from the sharp drop in commodity prices, especially oil and metals, and global demand is generally muted.
Ernst & Young LLP - the accountant now promoting itself as EY - has tallied the biggest rise in profit warnings in four years: to 79 in third-quarter 2015. That's 10 more than third-quarter 2014 and over a third more than second-quarter 2015, when there were 57 warnings.
Altogether, 5.6% of UK quoted companies warned recently, the highest third-quarter percentage since the 2008 credit crisis. The crux issue is whether this is just a snapshot in time - of unstable recovery from "the great recession" - or, more ominously, a cyclical turning point after an historically long period of expansion from the trough of 2009.
Service firms bearing the brunt
With services dominating the UK economy, warnings will happen - but their extent needs noting. The greatest number of third-quarter warnings came from support services (16, followed by software & computer services (10), then media (9) and travel & leisure (8).
Since "support services" involves the oil and mining industries, there has been an inevitable contraction after commodity price falls. However, contract cancellations and delays, plus write-downs, are manifest. A sign of the times is one of the historically more dependable groups, , seeing its interim operating profit fall 9.5%.
It blames a reduction in healthcare outsourcing and energy services, although the £1.1 billion company has spread itself widely, relative to its heyday as a more focused UK growth business.
is much more international in operations, renting power generation and temperature control equipment, and had a difficult year, with like-for-like underlying revenue down 7% in the third quarter.
During the summer, tool rental groups and both issued their second profit warnings of 2015.
"Plant hire" can be quite a leading economic indicator, albeit a sector where management must keep on the ball - e.g. Speedy has confessed various managerial weaknesses. Despite some maturity in the outsourcing trend, it's still a concern to see the sector characterised so.
Software & Computing services: canaries in the coal mine
This isn't a sector I tend to focus on, given the challenge to keep on top of contract and technology issues. Such firms are also exposed to private sector confidence in capital investment, and/or a public sector affected by fiscal austerity measures.
But that makes them a useful indicator of changing conditions. In fairness, a longstanding solid performer such as , with a high element of recurring income, has been able to issue a robust trading update as it continues to benefit from the fast-growing digital retail market.
While its division serving food and drink processors has experienced project/order delays, it is now bouncing back. After I drew attention to this stock seven months ago, it should be relatively resilient - and if it does warn, then it's a thrill canary.
Media warnings largely reflect the shift to digital
While advertising sales can indeed be a leading indicator, media's ongoing transformation towards digital content means winners and losers. The trend is typified by ,whose last update cited print declining by 8% within publishing revenues, while digital grew 24%.
Overall, however, third-quarter revenue still declined by 9%, versus 13% in the second quarter. Even so, strong cash flow and cost savings mean analysts target a re-rating of pre-tax profit from about £70 million to £100 million - i.e. some managers are coping and the sea-change within media is going to mean warnings of sorts. So it's vital to distinguish this from the trend in advertising over months ahead.
Travel & Leisure exposed to terror fears
The warnings followed the high threat of terrorism in Tunisia and social instability in Greece - two popular destinations for British tourists - and volatile exchange rates impacting the early season.
The chief risk going forward is the extent that travel bookings will be affected by fears, e.g. the Russian jet downing making cancel flights to Sharm el-Sheikh, one of its popular routes, and overseas holidays firms being affected further if terrorism reoccurs.
These appear exceptional factors; it's hardly clear the warnings result from any change in consumer discretionary spending.
Nine-month low for UK retail sales is a concern
It doesn't really feature in EY's ranking of warnings, but I'm mainly concerned by weak retail sales: allegedly the result of mild weather and lower food store sales.
But it doesn't look good in a context of wages picking up and house prices soaring once again, while inflation indices and interest rates are at record lows. Even a retailing supremo like Philip Green is seeing weaker sales, and blaming the weather.
It puts the outcome of Black Friday and, obviously, Christmas trading, into the spotlight.
Sector-specific issues help explain many of the warnings in EY's overview; but they combine to say something about the underlying business trend.
Investors must take care also because this Autumn's stockmarket recovery from Summer jitters over China appears mainly related to sentiment shifts and flows of funds.
The brief commodity rally - e.g. in oil stocks - shows how sentiment can easily turn and, if the sum of profit warnings continues to increase, it will fan cyclical fears.
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