Buchler Phillips Quarterly Bulletin No.5

Leadership after Brexit

No team can win without good leadership. Fresh from England’s three-test whitewash of Australia’s rugby players, coach Eddie Jones has again extracted from his men the brilliance that his predecessor failed to find. Their footballing cousins, however, were eclipsed by Wales in the Euros, prompting manager Roy Hodgson finally to fall on his sword. His replacement will inherit largely the same squad, so success will depend on what he can coax from them. In business, it’s often called ‘sweating the assets’.

Faced with the post-Brexit economic uncertainty that many had feared, UK business leaders must in the same way rise to the challenge of generating returns from existing resources. The service sector  - dominated by financial and professional services – remains a core competency for the UK, which has an opportunity to cement its position as a global centre of excellence in this regard. Service businesses which emerged from the 2008 financial crisis intact and even stronger were those which looked carefully at the needs and strategies of their clients. Insight, experience and delivery for services clients must not be blunted by the volatile economic environment. In this sector, perhaps more than any other, leaders must encourage a winning state of mind in their teams, as well as harnessing the right skills.

Tough at the top

Poor leadership is arguably the single largest factor in businesses failing – perhaps even greater than cash, since many cashflow problems may be avoided by prudent management. Many leaders, whether CEOs of large public companies or MDs of SMEs, feel isolated in their decision making. The top job is even more lonely if it has been inherited in a family business. Trading conditions expected to prevail in the foreseeable future will be unkind to those not facing up to difficulties proactively. Collaborative, transparent decisions, helped by strong advisors and non-executive directors, have a better chance of delivering positive outcomes.

Fear of failing

Even before Brexit, most forecasters expected an upturn in SME administrations this year, after a five-year slide. Recent events won’t improve that outlook, as currency-hit links in the supply chain go under, debtor days lengthen, cash tightens and the domino effect on other businesses is set in motion. Relaxed lending rules can only help, but will they be too little, too late? The UK’s entrepreneurial spirit is holding firm, however: start ups and company registrations remain at record highs.

For practitioners and troubled companies, the landscape may change post-Brexit, but it is worth remembering that most EU laws relating to insolvency and schemes of arrangement have also passed through the UK Parliament and are as such effectively enshrined in UK law in their own right. Nonetheless, it may be that when the UK eventually leaves the EU, a residual level of UK-specific legislation in this area may not be recognised automatically elsewhere in Europe and that some form of agreement about automatic recognition would need to be negotiated.

Retail therapy needed on the high street

A post-Brexit dent in consumer confidence is the last thing needed by UK retailers: a mild  winter left seasonal clothing overstocked, while a wet start to summer further dampened demand. Fashion sales in the 12 months to June slipped 0.1pc – the first decline in seven years. Most fashion retailers buy goods in Asia and pay in US dollars, so a weak pound is hurting. Expect high street names to follow BHS and Austin Reed into administration, as base rate cuts fail to prise purses open. On the plus side, UK supermarkets, hammered by German discounters and food deflation, may find a silver lining in the sterling cloud.  Bernstein Research estimates that every 10% fall in the pound leads to 3.3% of food price inflation.

Property in the eye of the storm

In an already wobbly commercial property market, major funds worth billions, including Henderson and Aberdeen, have in early July written down their portfolio values amid fears of a sector collapse. Cash-rich foreign investors – private and institutional - have been big buyers of UK commercial and residential property in recent years for a safe yield in times of global economic stress. They have plenty more to spend, but are expected to remain on the sidelines until  details of the UK’s EU divorce are clearer. M&G, Standard Life and Aviva all suspended fund trading to avoid withdrawals. Regulators claim there is no liquidity crisis in UK commercial property, but they are still concerned about such relatively illiquid assets being held in open-ended funds. UK banks are also major holders of UK property, with the balance sheets of three high street names exposed to the tune of £50bn at the end of 2015.

House builders are expected to have their own problems.  On the cost side, weak sterling will be unhelpful, not least since almost £5bn of materials came from the EU last year. While long term demand for housing remains an unstoppable juggernaut, short term uncertainty will slow residential market activity, with agents probably feeling the pain most, particularly in the foreign buyer-led London market.

UK outlook

Although the full macroeconomic impact of Brexit will take years to quantify, the vast majority of forecasters have, since June 23, downgraded GDP estimates amid low business sentiment, significantly weaker sterling and a pessimistic outlook for the labour market. A consensus of ten leading research houses reviewed by us expects GDP to grow by 1.4% in 2016, down 0.5 percentage points from last month’s estimate. For 2017, the same group projects economic growth of 0.3%.  Outlooks change quickly. In our last Bulletin in February, the balance of analysts was still expecting a base rate hike some time in 2017 from the 0.5% of the last six years. In view of the perceived hit to demand of Brexit, notwithstanding the weak pound, the Bank of England has already flagged a base rate cut as early as this August.

Conversely, two factors are likely to drive UK inflation sharply higher over the next 12 months. Firstly, the sharp depreciation in sterling of around 12% instantly increases the price of imports, with an immediate yet temporary effect on inflation. Secondly, and more importantly, a widely predicted increased deficit spending stimulus could have more lasting effects, pushing almost non-existent UK CPI inflation to above 2% and very possibly to above 3% early 2017. Since the prospect of a higher CPI is unlikely to influence wage levels successfully, higher inflation across all measures should be contained in the 2-3% range.