Beware of Zombies

Last week, it was reported that businesses in UK have lost almost 750,000 jobs since the start of the coronavirus lockdown and it could be getting much worse without ongoing government financial support. Begbies Traynor, a leading independent business recovery specialist recently warned that some 527,000 businesses were in ‘significant financial distress’ reflecting a ‘toxic mix’ of reduced sales and increased debt.

The rate of insolvencies will have been cushioned during the second quarter by Chancellor Rishi Sunak’s £160bn support package for UK businesses. However, Ric Traynor, Executive Chairman of Begbies Traynor has warned that ‘many of the support measures will have simply delayed the inevitable’. The fear is that ‘zombie companies’ that function day-to-day, but cannot pay off the debt they owe or find the cash to fund working capital or grow, will be forced out of business as the economy emerges from the Covid-19 lockdown.

Unlike globally diversified companies or those quoted on the stock market that have been able to readily access bank finance, together with tapping either corporate bond markets or shareholders, many small private companies rely solely on banks. Despite government pressure on banks to increase lending to small businesses, the banks are in turn being hit by significantly higher impairments on loans. For example, Lloyds Bank was recently forced to set aside an additional £2.4bn to cover potential bad loans – £1bn more than the market had expected.

The Business, Energy and Industrial Strategy department (BEIS) is also seeking ways to offer state-backed loans to debt laden companies owned by private equity groups that employ large numbers of people without breaching EU state aid rules although there is no guarantee it will find a solution.

With the furlough scheme due to unwind at the end of October but social distancing and regional lockdown risks remaining, the Autumn will be crunch time for zombie companies and jobs. Good thing Boris Johnson is planning to get fitter, as keeping the UK economy from losing recovery momentum and delivering on Brexit is certainly going to keep him active.

What have we been watching?

The Covid-19 pandemic would appear to be over as far as US equities are concerned, with the S&P 500 index closing just shy of a fresh all-time high propelled by the FAANG technology heavyweights and also aided by positive vaccine news. Even apparent deadlock between US politicians over fiscal stimulus didn’t appear to cause concern. It would appear investors feel the US Federal Reserve has ‘got our backs covered’ having signalled its willingness to run the economy hot and focus on the labour market recovery. However, over the weekend there was some more disturbing news with trade talks between the US and China postponed.

Meanwhile, the number of new Covid-19 cases has grown to over 20million with new infections rising across parts of Europe. For example, France is reporting 2,000 new cases a week compared to 1,000 just three weeks ago while Spain is in a ‘critical situation’ with the worst infection rate in Europe. Meanwhile, President Vladimir Putin said that Russia had developed a vaccine called Sputnik-V, for Covid-19 after less than two months of testing on humans and that mass vaccination would start in October. Russia appears to have skipped phase III trials, which track antibody-dependent enhancement (ADE), a phenomenon well-known to virologists.  The Russian vaccine is currently not among the WHO’s six vaccines that have reached phase III clinical trials. This news comes at the time of another twist in the Covid-19 pandemic. Authorities in the Chinese city of Shenzen say that a surface sample taken from some chicken wings imported from Brazil has tested positive for Covid-19.

The spat between the US and China continues with US Treasury Secretary Steve Mnuchin saying that as of next year all Chinese companies must comply with US audit requirements or be de-listed from the US stock Exchange. Meanwhile, China has started to suppress any potential dissent in Hong Kong with the arrest of media mogul Jimmy Lai and others in his organisation. High-level talks between Washington and Beijing to review progress on ‘phase one’ of their trade deal were due to take place over the weekend but have been postponed.

The thorny issue of trade tariffs re-surfaced last week. Canada is threatening to raise tariffs on US goods after President Trump re-introduced a 10% tariff on Canadian aluminium exports. However, the US said it will hold off a threatened hike in tariffs on $7.5bn of European goods that it imposed as punishment for subsidies by the EU for Airbus. Last month Airbus said it would alter some deals responsible for the long-running dispute with Boeing, including increasing interest rates on loans from France and Spain.

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The first official estimate of the damage inflicted on the UK by the Covid-19 lockdown revealed a 20.4% contraction in the economy in the second quarter -the biggest quarterly fall since comparable records began in 1955. Household expenditure collapsed by 23% and business investment by 31%. These numbers had been expected and investors focused on the path ahead. While output dropped by 20% in April, it recovered by 2.4% in May and increased by 8.7% in June which was slightly better than expected. July is expected to show further solid recovery given the easing of lockdown restrictions. However, the key challenge for the government will be keeping the economy from losing momentum in the latter part of the year and early part of 2021. As the UK approaches the end of the furlough scheme in October a rise in unemployment seems likely while  the warnings of a second wave of Covid-19 persist. This is something Chancellor Rishi Sunak appears to have been weighing in recent days amidst reports he is considering delaying the Autumn budget to a later date.

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Eurozone industrial production continued to recover in June, increasing by 9.1% although this was slightly below expectation and the rate of growth seen in May.

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In the US, Whitehouse hopeful Joe Biden announced Kamala Harris as his choice of vice president to challenge President Donald Trump in early November. She is the first black woman and South Asian American in this role. Meanwhile, investors appear to be losing patience with the bipartisan failure to agree a fiscal stimulus package. The big difference between the two sides is that the Democrats want $3trillion of support while the Republicans want $1trillion this time around. Meanwhile, US retail sales were not as good as expected in July with car sales a bit weaker.

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The Japanese economy contracted at its fastest rate on record in the second quarter, falling by 7.8% or 27.8% on an annualised basis reflecting the impact of Covid-19. Economic growth is expected to re-bound in the coming months.

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China reported weaker than expected retail sales for July. Perhaps reflecting this and the postponement of trade talks with the US, the People’s Bank of China provided additional monetary stimulus.

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Finally, given the exam result shambles it’s a good thing President Trump is not taking history as he may need to re-sit. When asked about the global Covid-19 pandemic at a recent press conference he said ‘The closest thing is in 1917, they say, the great pandemic. It certainly was. It certainly was a terrible thing where they lost anywhere from 50 to 100million people. Probably ended the Second World War.’

 

Read Last Week’s Alpha Bites – Ageing Gun

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.