Today marks my first day back after a decent summer break in the Algarve. Which at the time offered a telling perspective against which one watched the continued nonsense of the Greek debt debacle that raged whilst I was away. Whilst life in Portugal is still tough, there appears to be a calm acceptance of the job in hand and what remains to be done. In contrast to Greece, where retrenchment of spending has been severe, but reforms have been limited, the European Commission has already noted the significant steps Portugal has taken to reform inefficiencies in its labour market and its judicial system. Additionally, progress has been made on breaking the rigidity of its “network” industries (like power and telecoms) albeit it is clear that there is more to be done. As an outsider looking in, the tourism industry (which is crucial) has benefited from holding prices static for the last five years, whilst the relative decline in the value of the Euro has meant that over that same time its many five star resorts have become an affordable luxury. There is a definite sense that things are on the mend. Which makes the Greek debacle all the more frustrating to those with a vested interest in seeing European economies get themselves off the canvas.
However, like the point we made in last month’s newsletter, from the perspective of the UK equity investor, the shenanigans of the EuroZone are likely to be less important than changes that are taking place here at home. Last month, we made the point that significant mergers and acquisitions activity suggested that there was a much greater level of management confidence in the opportunities facing them from a business perspective. Since we wrote that piece, the UK national accounts for the first quarter have been released, and there is evidence to suggest that this is a trend that is being felt across the economy – not just in the quoted arena.
Those of you who have followed our story for the last five or six years may remember that we have over that period made numerous references to the UK’s net corporate surplus – or in layman’s terms, the amount that non-financial companies in the UK save or borrow in a particular year. This statistic has been compiled since 1987, and we have attached a chart showing its progression over that time. For the first decade and a half that it was measured, UK companies largely borrowed more than they saved in a year. Then, post the dot-com crash in the early ‘noughties, the there was a significant increase in financial prudence in the corporate sector (please note that this only applies to non-financial companies – it is clear that financial prudence was not the watchword in the banking sector). In the period 2010 – 2012 we were at pains to emphasise the extent to which companies in the UK were storing up future economic stimulus by saving financial resources that were ultimately being sterilised by a banking system that needed to reduce gearing and improve liquidity. We saw the future release of this capital back into the real economy as a substantial driver of ongoing economic growth.
It is with interest, then, that we note that the net corporate surplus in the UK, based on the most recent figures, has collapsed over the last year. Since the first quarter of last year there has been a modest increase in net borrowing across the UK’s corporate sector. This is being mirrored by an increase in investment in both fixed capital and inventories, and to lesser extent finding its way into the acquisition of other businesses. This change is important on two levels. The first backs up what we said last month. This is a sign that business managers are confident enough in the future that they do not feel any further need to strengthen balance sheets and are willing to loosen the purse strings a little. The second is this will directly feed into economic activity. The sums involved here are not trivial. Collectively, over the period 2010 – 2013, the net corporate surplus was £192bn. That is much more than the level of the UK government’s deficit retrenchment over the same period. At this point, we are not even talking about spending money previously saved. This is simply about the removal of a drag on economic activity.
This analysis comes with a bit of a health warning. The net corporate surplus number is a derived number, it is not measured directly. And therefore, it is subject to substantial revisions over time. So basing an analysis on the absolute changes in this indicator would be foolhardy. But the trend, and what it says about corporate activity is likely to be meaningful. Companies in the UK are less cautious over their financial position than they have been for some considerable time. They are finally coming to the party.