To the casual observer, current weather patterns are mirroring the mood of the nation post Brexit. Or, maybe one is driving the other. Mid summer weather was pretty variable over the piece, but the last few weeks have been blessed by the makings of an Indian Summer. Similarly, the immediate post Brexit sentiment in July was downbeat and depressed in many parts of the business community, only to rebound over the later summer as past economic trends re-asserted themselves. This was helped immeasurably by the speedy resolution to a potential political maelstrom post David Cameron’s resignation as Prime Minister.
Yet, there are signs that both meteorologically and metaphorically, the season is on the change. What lies ahead is going to be less comfortable. On the basis that our weather forecasting track record is as dire as our Marketing Director’s Ryder Cup betting record, we will end the allegorical part here, and confine ourselves to commentary only on the business outlook.
So sticking with this, it is appropriate to note that the mood across certain sectors of the domestic economy is darkening. This is most apparent in the retail sector, where the weather is clearly having a direct impact on sales. It is especially acute for clothing retailers, whose Autumn and Winter ranges have been left on the shelves as customers get more use out summer dresses and cargo shorts. Primark has recorded its first same stores sales decline in 16 years within the last month; Bonmarché’s profit forecast was almost halved after its recent trading statement. It is easy to blame it on the weather. It is easy to blame it on Brexit. It is also easy to say that these will pass, and everything will revert to normal. But there are other more permanent pressures building. If Sterling’s recent weakness is maintained, then import costs (and therefore input costs) are going to rise, at least on a one-time basis. Perhaps more pertinently for medium term expectations, government policy has increased the cost of hiring labour – particularly at the lower end of the market where the introduction of the national living wage, pension auto enrolment and the apprentice levy has generated a material increase in labour costs at a time when the persistent decline in unemployment has tightened the labour market so that real wages were rising naturally again anyway.
So this has created something of a perfect storm for retailers, for whom labour costs are a significant part of overall costs, and are most likely to be affected relatively by the measures just mentioned. But it is not only retailers as last week’s profit warning from Mitie Group showed. Indeed, any business with low margins and high labour costs is likely to find it very difficult in the coming months to fully protect historic returns. There is simply not enough growth in end user demand across great swathes of the UK and wider global economy to give producers and distributors of homogenous or low value-added goods any kind of pricing control. Against that backdrop, margins typically suffer; when sales growth is low that means that profits also suffer.
Over the last couple of years, there has been a particular political awakening over the extent to which globalisation has increased the level of inequality in developed western economies. The benefits of growth have gravitated to those individuals with the skills and learning that allow them to differentiate themselves against an increasingly global supply of other workers. This is not just about immigration, but also the transfer of basic manufacturing and administration jobs to lower wage economies, and about the automation and robotisation of both manual and clerical tasks. This is at the root of much of today’s growing popularity of political parties advocating greater isolationism and nativism.
It is not for us to pass judgment on others’ political leanings. But we must recognise that the factors that exacerbate inequality for individuals will have similar impacts on businesses. No matter the political rhetoric, progress in communications and transportation means that economies and their agents cannot simply turn their backs on globalisation. That route of denial will simply leave these countries further behind. Like individuals, the only defence for companies is to “upskill” to the extent that competition is diminished, in order to make the pressure of global competition less severe. Firms with inherent technological, branding or know-how skills are at an advantage in defending market positions. Manufacturers and distributors of scarce outputs can more easily pass on building cost pressures onto their own customers in the form of price increases. Those who have little competitive advantage – whether nationally or internationally – cannot pass these cost increases on. Over the long term, these trends amount to a transfer of wealth from businesses with weak market positions to those who have strong positions; mirroring what can be observed in the market for labour. When times get tougher, and end user demand is insufficient to facilitate general increases in prices, then these trends are played out in sharper relief. We are seeing evidence of this in certain sectors now.
All of this suggests to us that keeping focus on what drives a company’s competitive environment is crucial in today’s equity market. We have noted in earlier reports that the prevailing economic environment across the globe is likely to remain uncertain for a number of years. To prosper best in that environment will require a portfolio of businesses that have some element of pricing power.