City Insider: Global economic trends and the implications for travel

City Insider - FT journalist David Stevenson on the travel industry

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David Stevenson takes a temperature check on the big economic factors that may impact on the travel sector and concludes 2016 should be a bumper year before a tougher 2017

This month I’m going to take a short economic temperate check, assessing the health of global (and UK) markets and economies, with some obvious takeaways for the travel sector.

The first and most obvious point to make is that the stock market has gone into something approaching a funk.

The market meltdown in China has terrified all and sundry and virtually every investor I talk is now worried about a hard landing over there – a concept which implies that economic growth will massively undershoot the target 7% annual GDP growth.

This rather unfortunate realisation has coincided with some equally unpleasant events.

In the background investors are worried that US corporates are experiencing a slowdown in profits growth which in turn rather suggests that the US economy itself is close to a mid to late stage in the cycle of growth, with a recession about a year away.

This worry has intensified as the US central bank, The Federal Reserve, ponders interest rate rises – one wouldn’t normally think about this cycle of rising rates unless one believed that we were 12 to 18 months from the peak of an economic cycle.

Whizzing away in the background is a core fear of many investors – deflation. The idea here is that the economic recovery from the global financial crisis has been lacklustre, delayed and frankly a bit anaemic.

A concept called ‘sub trend growth’ has emerged which argues that the US and UK economic rebound has been below the levels seen in previous economic recoveries.

What’s holding back businesses and consumers? In simple terms, debt. There was too much of it around in 2008 and in some places the stock of debt has actually massively increased after the crisis.

Central banks may be desperate to get all of us out there spending like crazies but most businesses and consumers are actually mildly cautious, keen to pay down debts and generally stay level headed.

All of these drivers have the net effect of depressing global demand, and keeping prices low – that subdued inflationary pressure is being fed by lower oil prices, the Chinese slow down and emerging markets devaluing their currencies and exporting lower prices to the west.

Thus the debate for central bankers is whether their economies have achieved what’s called escape velocity from this deflationary quagmire.

On balance most investors think the US has, the UK probably has, but the Eurozone and Japan are still in some difficulty.

This concern about global growth is already showing up in hard numbers, with China’s industrial sector struggling, Japan’s exporters worried about an Asian slowdown and the UKs manufacturing sector reporting fairly dismal numbers.
But I wouldn’t get too carried away with all this cynicism and gloom. Most investors and analysts I talk to think this is what’s called a growth scare – an unfortunate bump on the road to recovery.

Yes, some corporates are struggling, and yes China is likely to slow down faster than we first thought but the evidence still suggests that we are not yet at the peak of a recovery globally.

Those lower oil prices are feeding through into improved consumer demand and low inflation rates are helping to put more money into most people’s pockets.
Some analysts now think that the US and the UK may in fact be at least one to two years from any peak in the recovery.

Paradoxically some might even welcome a small increase in interest rates as part of a normalisation process, which will allow lower rates in say 2017 as the recovery slips into recession again.

Personally I suspect most investors would welcome some small moves upwards in US interest rates with UK rates edging up in Q1 or Q2 next year.

Panic about China is also completely misplaced. It has more than its fair share of economic and financial challenges and there has been a vast accumulation of debts but it’s a local problem that can be dealt with painful reform and some ruthless balance sheet readjustments.

Export orientated sectors might be struggling and housing construction in a funk but overall the domestic economy is moving along at a sensible rate with consumer spending surprisingly buoyant.

Crucially the numbers coming out of the Eurozone and Japan tell a very different, more optimistic story – these two huge economies are much earlier in their recovery process with massive potential for improvement.

My gut feeling is that the fastest growth rates will be seen in Germany and the Nordics over the next year (outside of oil dependent Norway) with France also recovering some its mojo in 2016.

The developed world economies will be helped along by a powerful headwind – oil prices.

I’ve long been banging the drum for markedly lower prices for Brent and US sourced oil (measured by the West Texas rate) and I think we are now in the final leg below $40 a barrel and then $30.

Even the great vampire squid investment bank Goldman Sachs is now suggesting that $20 is a realistic low for oil prices.

This almost tectonic shift is terrifically good news as it redistributes cash from petro states, which tend to horde cash, back to consumer economies which have a high propensity to spend the stuff.
So all in all I’d expect 2015 Q4 and then the first half of 2016 to be fairly positive for the UK and Europe. But there is a big fly in the ointment, and it’s called the Brexit.

As Greece’s troubles move back into the margins again, investors will be concerned about the uncertainty over the UK’s role in Europe. Regardless of your own views in this emotional debate, foreign investors are worried by the very real threat of an exit.

A recent note from analysts at big French bank Societe Generale suggested staying away from British businesses. The report concluded that “an exit from the EU would cause major damage to the UK economy”. 

The banks’ economists identified a number of concerns including:

  • UK growth hurt by more than 0.5% per annum.

  • Net exports to the EU could fall by a peak of 5% over ten years;

  • The Bank of England would run a looser policy to partially compensate but the productive potential of the UK would be reduced, lowering its medium-term growth rate;

  • UK Bank Rate to fall by more than 1pp compared to non-Brexit path;

  • Foreign direct investment declines by £5bn pa (1/3% of GDP). The largest source of FDI into the UK is Europe. If the UK were to detach itself from Europe, it would then become a far less attractive destination for such FDI inflows. Business investment could fall by £5bn per annum

I’m not sure this list is that definitive or even accurate but there are some big worries out there. British citizens may take a different view but my sense is that this worry will have an effect and that we’ll start to see a very real impact on consumer spending patterns from the summer 2016 onwards.

So, given this consensus view what should the travel sector be watching out for?

I’d keep an eye on four main developments:

  • Mergers and acquisition activity. Most chief financial officers will correctly surmise that the window for big deals will probably close at the end of 2016 or maybe spring 2017;
    That means they’ll push hard for any deal to be pushed through in a window between early 2016 and autumn next year. The travel sector is ripe for some big deals with Thomas Cook the most likely target followed by the smaller airlines. I also suspect that we might see a megadeal in the cruise sector;

  • As borrowing costs slowly start to rise we might see a dash towards accelerating big capex spending plans with big tickets purchases in the first half of next year;
    The time is now to finance those new planes, boats and hotels. But the downside is that as leverage increases, investor’s will start focusing on the likely increased cost of capital.

  • As the Brexit debate starts to loom large we’ll see spending plans pushed into a key first half 2016 window;

  • Last, but by no means least, the final push to $30 for oil will help consumer spending in the UK and the Eurozone.

The bottom line? The first half of 2016 should be another bumper year, arguably the last good one before a much tougher 2017.

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