2016 in business: Mixed outlook for the year ahead

The glass for Scots whisky, worth about £5bn to the economy, remains half full. Picture: Getty

Business investment has recovered, but is not in the fast lane. Meanwhile, many corporates have been unveiling reasonable financial results while keeping a wary eye on potentially adverse developments such as any worsening of the downturn in emerging markets or a reversal of the eurozone’s tentative progress back to health.

UK manufacturing and exports remain problematic. But the much bigger services sector seems to continue to pull the UK out of a hole. Meanwhile, geo-political influences, this time including the Syrian crisis, the Ukraine standoff and South China Sea tensions, remain with us as wild card factors. Here we look at the bigger picture.

MARKETS

Barring any unlikely volatility on the final day of stock market trading today, the FTSE 100 index that tracks the stock market health of Britain’s biggest companies is finishing 2015 down about 4 per cent. That follows a near-3 per cent fall in 2014.

Mainly the index has been battered by the slump in both oil and commodity prices, a major swing sector of the Footsie these days. If looked at through that prism, one would not expect blue-chip stocks to do much better in 2016 as there seems little indication of an early recovery for Big Oil or the miners.

That negative backdrop of sentiment will only worsen in the coming year if China’s economic deceleration, which cast a shadow over the second half of 2015, gathers speed.

The Footsie, as for quite a while now, is playing on two factors: the strength of the US recovery and the prospects for weak emerging markets.

It is difficult to get one of these right, never mind two. As such, I believe 2016 will see Britain’s premier share index largely treading water, with modest gains and losses due to vicissitudes in those parts of the world roughly cancelling each other out.

Interest rates

So, Janet Yellen and the Federal Reserve ended this year with the much-awaited first lift in US interest rates since historic lows of 0.25 per cent to 0.5 per cent came in after the 2008 financial crash.

Will the Bank of England follow suit in 2016? My guess would be not until the second half of the year at the earliest. This is despite the fact that there are quite a few economic similarities between the UK and US as we stand today.

Inflation remains nicely low and employment nicely high in both countries. Quantitative easing (QE) has done a good job both here and across the Atlantic. Business investment in both countries is healthier than it was in the extended downturn.

But, having said that, Britain is more exposed to a problematic European Union than the US is. Indeed, our whole membership of the club is in the balance.

The European Central Bank has embarked on QE, but it is too early to tell how successful it is. But the stakes are high for the UK, which exports nearly half its goods to the EU.

It could be therefore that both political and economic uncertainties stay the Bank of England’s hand in making its first upwards move on interest rates in getting on for seven years now.

Retail

Whither retail? The high street enjoyed a robust sales performance in November, helped by Britain’s strong employment levels, rising real wages for consumers and the Black Friday phenomenon.

But the underlying challenges that have dogged the sector in recent years are set to remain the backcloth for 2016. The one-way escalator of business rates is a significant headwind for the retail sector, even though there is a review of them whose results will be known about the time of the next Budget.

There will still be the continuing roll of winners and losers in how well retailers digitalise their business.

And the catch-as-catch-can food retailing sector, ravaged by the discounters and food deflation, looks every bit as likely to have as difficult a 2016 as the previous few years.

The likelihood is that independent small shops will also remain at risk, as they lack the economies of scale and internet expertise that are helping insulate the bigger boys against tough conditions.

More than anything, the high street – much of it boarded-up – will be hoping that the Bank of England reins in the impulse to raise rates and thereby threaten consumer spending (see above) as long as possible.

Oil

Oil is languishing below $40 a barrel. And, with pivotal producer Saudi Arabia playing hardball in refusing to end a production glut in order, one suspects, to try and stifle the long-term threat from US fracking, it is difficult to see a marked upturn in the coming year.

In fact, such is the air of concern and retrenchment around the industry, I think at this juncture many oil executives would privately bite your hand off if you offered them a possible price “recovery” to just $50 in 2016. Sovereign wealth funds are likely to stay shy of such a beleaguered sector when there may be better returns in the likes of property and more advantageously placed equity sectors (banks with most, though not all, of their  problems behind them, see below).

At current price levels, we are likely to see the energy majors only pursue exploration projects that they have a lot of faith in. A reasonable possibility of finding oil and gas will not cut it in this climate. Expect more sector redundancies.

This bleak scenario is likely to continue to also exert pressure on both the smaller energy explorers, with their stretched financial reserves, and the oil and gas services industry that is seeing less demand for its expertise as their clients’ projects are mothballed or left on the drawing board.

Banking

Expect the so-called “legacy issues” for the banking industry to continue next year. Ever since the financial crash, those issues – essentially the “Not me, guv” defence of current banking chief executives as they unveil hefty financial fines for wrongdoing that did not occur on their watch – have tarnished the more general recovery in the sector.

From the rigging of Libor and forex markets to international sanctions busting, money laundering, mis-selling of insurance and mis-selling of hedging products to small businesses, regulatory fines on both sides of the Atlantic have littered the financial results of the UK’s big banks. It is clearly not over, with Royal Bank of Scotland boss Ross McEwan just one of the industry’s captains who has flagged more “bumps in the road” ahead from past mis-doing.

It is too early to call the end of the Libor scandal, banks flogging financial products based on dodgy US mortgages and, in particular, the saga of mis-sold payment protection insurance (PPI).

The good news is that the banks’ underlying operations are decently profitable, and are likely to continue so, with bad debts steadily falling since the last recession.

In addition, net interest margins – the difference between what banks charge on loans and pay on deposits – have largely stabilised.

The insistence of regulators on far more solid balance sheet cushions to back banks’ loanbooks in the wake of the financial crisis also heralds a more resilient industry medium-term.

Banking will still have its share of public relations problems over the next 12 months, as those legacy issues continue to raise their head. But, the underlying numbers at the likes of RBS, Barclays, Lloyds, HSBC, Santander etc will continue to show the worst is behind the sector.

Motor industry

The Volkswagen (VW) scandal, where the German manufacturer fitted software to cheat on pollutant emissions tests, hung over the whole motor industry in the second half of this year. The sector’s fortunes in the coming 12 months hinge to a large extent on whether any other major manufacturers come forward and admit similar wrongdoing.

If the scandal is confined to Volkswagen, the underlying trading dynamics look good. Unemployment is low in both the UK and US, while real wages are on the up, a conducive backdrop for car sales.

However, if the many rumours flying around the industry about other car manufacturers having broken the rules and conned consumers prove true, then there could be a substantial negative impact next year.

Cynics might merely point to the banking industry as evidence that, where malpractice applies, whole sectors tend to move in a herd.

Players hear on the industry grapevine what the opposition is up to, and lean towards doing the same to prevent their rivals gaining an unfair competitive advantage. If that does prove the case, then consumer retribution could be swift. VW car sales fell by a fifth in November compared with the same month in 2014.

It is likely the big boys, from General Motors and Ford downwards, will ramp up their marketing to counter the negative publicity surrounding the industry.

That would be even more the case if the diesel emissions scandal is found to be hydra-headed. And that could hit profit margins industry-wide.

At this stage, however, it remains hypothetical. If the VW scandal, with about one million vehicles worldwide being affected, is found to be a one-off then the sector’s wider prospects remain as solid as they have been for some years.

Whisky

The Scotch Whisky sector has reasons for moderate good cheer in 2016. Holyrood’s attempt to introduce a 50p per unit minimum price on alcohol suffered a setback earlier this month when Europe’s top court ruled it would be against European Union law as a restraint on trade as other tax options existed.

In addition, up to 40 new distilleries are planned across Scotland by Scotch whisky producers, a tangible gesture of faith in prospects for an industry that has been buffeted in the past few years by the well-chronicled problems in emerging markets where Scotch is an archetypal “cachet” product.

There is even modestly good news on the latter. Figures in November showed that the decline in Scotch exports has slowed sharply, raising hopes that previous strong growth in those emerging markets may resume in the not too distant future, if not in 2016, then the following year.

Exports by value in the first half of 2015 fell 3 per cent to £1.7 billion, compared with a deeper 11 per cent slide in the same six months of the previous year. Particularly welcome is the crucial Chinese market returning to growth in the first half, as much for its demographic potential as bottom-line contribution.

That is good news even if it is too soon to get carried away, with economic headwinds and political uncertainty still negative factors in various parts of the world, and the relative strength of sterling also not doing the Scotch sector too many favours.

Equally, no early recovery is seen in more mature whisky markets such as Germany, France and Spain, given the eurozone’s fragile economic state.

Even so, as we enter the new year it is not unrealistic to say the glass for Scots whisky, worth about £5bn to the economy, remains half full rather than half empty.

Cyber sector

Cyber-security has definitely moved from the realms of science fiction to a crucial concern for business and government. IT systems are seen as the new likely avenue for attack for hackers, be it governments, terrorists or common-or-garden criminals.

As accountancy giant KPMG noted yesterday, a recent field trial by the Office for National Statistics suggested that there could have been more than 7.5 million cyber offences committed against individuals last year.

The true picture is likely to be even more worrying, as many cyber crimes against business organisations are likely to remain unreported, sometimes for fear of both alarming and losing customers.

Nudged on by the regulators, including the Bank of England, quite a number of financial institutions have conducted mock-up attacks on their IT infrastructure to see if their cyber security comes up to snuff.

That is a trend that is likely to continue, and business investment in secure electronic systems that underpin their operations will undoubtedly accelerate in 2016 and beyond.

It is difficult to argue with one of KPMG’s conclusions, that the public will increasingly want transparency from  companies handling people’s data and money as to how they are addressing cyber weaknesses.

If the result of that is a sharp ratchet up in spending on sophisticated anti-cyber crime software, then so be it.