Markets rebounded cheerily on the news that the US was going to bail out mortgage institutions Fannie Mae and Freddie Mac, before the troubles at Lehman Brothers derailed them again. The question now is whether Lehman Brothers is also in line for a government handout or whether it will be left to markets to decide its fate.
The directors are scrabbling around for a buyer. It is thought that the authorities are putting pressure on the group to close a deal at any price. But this, as yet, has been the extent of Government involvement and it seems that it may be where it puts its foot down. Lehman is not ‘too big to fail’, though there would, of course, be ramifications. However, I wonder how bad they would be and how long-term. The market has been expecting a default of this scale and that we have escaped without one until now is surprising. Short-term pain is inevitable, but the market would soon recover its equilibrium.
A side issue on the Lehman case is the reaction of the rating agencies, with Moody’s and S&P both warning that they would downgrade Lehman’s credit rating this week if it didn’t find a buyer. With the company on the brink of collapse, it seems astonishing that they haven’t done so already. The problems at Lehmans are already well-reflected in credit market spreads. To me, this suggests the ongoing weakness of the unwieldy rating agencies, who always seem to be one step behind. Imagine if investors actually relied on their ratings as an indicator of financial strength. Enron, anyone?
Back in the UK, waning consumer confidence really began to bite. Several retailers reported results, which reflected a grim picture. John Lewis has been seen as a bellwether stock for middle class consumer confidence and saw profits knocked 26% as it sacrificed margins to maintain its market share. Tuscan holiday groups may be getting twitchy. However, like for like sales only slid 1%, which in the context of Home Retail and Next looked positively resilient. Next saw falls of 6%, while Home Retail’s two brands – Argos and Homebase – fell 5.8% and 8.3% respectively.
When supermarket chain Morrison’s announced increased profit and market share, the market was quick to attribute this to shoppers flocking to cheaper chains. We are, apparently, all swapping our organic hummus for baked beans on toast. I would suggest it is too soon to make this kind of blanket conclusion.
I think the retailers that will suffer most are those who are neither one thing nor another. Next neither sells quality basics like Gap or fashionable clothes like TopShop. And it certainly doesn’t fall into the ‘treat yourself’ category. When markets are buoyant, this lack of differentiation doesn’t matter, but it becomes crucial when times are hard. People will need a good reason to move away from the discount retailers and Next simply doesn’t provide it at the moment.
But it wasn’t just bad news for the high street retailers – it was a case of another week, another holiday group forced into liquidation. Package holiday firm XL went into administration. This came hot on the heels of the collapse of airline Zoom. Many holidaymakers are finding themselves forced to take an extended break, probably no bad thing given the economic gloom and dismal weather.
There are always casualties in this type of climate. However, the speed at which some of these businesses have failed says little for their original business plans. It’s the same with estate agents. They have just participated in years of unprecedented economic expansion and yet their business models are so lacking in resilience that they can’t take one summer of economic slowdown. Any company that has nothing in its armoury for a bit of a dry spell shouldn’t be in business (with apologies to stranded holidaymakers and property speculators everywhere.)
Mervyn King can’t be being invited to a lot of dinner parties at the moment. He gloomily warned of ongoing weakness in the economy and predicted that he would be writing to the Chancellor again next week as inflation remained above target. Surely declining commodity prices should be reflected in inflation figures shortly? Despite OPEC’s surprise cut in production this week, oil is still 30% below where it was a couple of months ago. At least King had the sense to refer to it as a temporary problem, rather than Alistair Darling’s hysterical, and sharply retracted, verdict that the UK faced the worst conditions for 60 years. Next week’s figures may well shed some light on this distinctly cloudy area.
