Week in Review

November 27, 2018

Global Roundup

The U.S. and China are giving off bad signals ahead of a crucial meeting between Trump and Xi Jinping. President Donald Trump may be talking up the prospects of a deal to ease trade tensions with China, but much of his administration is still acting like any agreement is a long way off. (HSN)

Russia ignores Western calls to free captured Ukrainian ships. Russia on Nov. 26 ignored Western calls to release three Ukrainian naval ships and their crews it fired on and captured near Crimea at the weekend and accused Kiev of plotting with its Western allies to provoke a conflict. (Reuters)

U.K., EU approve hard-fought Brexit divorce deal. Now the harder work begins. European Union leaders approved on Nov. 25 a treaty outlining divorce terms with the U.K., a milestone in Britain’s bid to extract itself from the bloc that now leaves Prime Minister Theresa May with a tough task selling the deal to skeptical lawmakers in Parliament. (WSJ)

Swiss vote no in sovereignty referendum. Swiss voters have rejected a proposal to give Swiss law precedence over international law and treaties, according to results coming in from a national referendum. (BBC)

The week ahead—Brexit, the FED and the G20 to hit the markets. (NASDAQ)

New obstacles arise for the new NAFTA. President Donald Trump was quick to proclaim victory in September with the sealing of a deal to replace the North American Free Trade Agreement. But that marks just one step on the new NAFTA’s winding road toward becoming a business reality. (HSN)

Argentina G20 summit offers chance for trade war turning point. The United States and China have in the coming week what may be their last chance to broker a ceasefire in an increasingly dangerous trade war when their presidents meet in Buenos Aires. (EurActiv)

What the EU and U.K. agreed to on Brexit. European leaders signed off on a Brexit deal, which sets out the terms of the U.K.’s divorce from the bloc and seeks to shape the future relationship. (HSN)

Spain: Time to strengthen resilience, promote inclusive growth. The difficult structural reforms that Spain undertook in response to the global financial crisis continue to bear fruit. But the economic recovery is maturing and new risks are clouding the medium-term outlook, according to the IMF’s latest economic health check of the country. (IMF)

Malaysia, Japan, Philippines among nations that benefit from U.S.-China trade war. Asia, at the broad level, will lose from the United States-China trade war, but a few countries will emerge as relative winners. (Business Mirror)

Pence-Xi clash at Apec shows U.S.-China divide still widening. United States Vice President Mike Pence traded sharp barbs with Chinese leader Xi Jinping in back-to-back speeches at a regional summit, showing that neither country appears to be giving ground in an escalating trade war. (Business Mirror)

Trade Talks Going Nowhere Fast

Chris Kuehl, Ph.D.

The meeting of the Asia Pacific Economic Council (APEC) was supposed to be an opportunity for the U.S. and China to work out their differences to some degree and to do this in a forum that was not quite so public as previous meetings had been. It didn’t turn out that way—not at all.

The utter collapse of this meeting has been blamed on the increased acrimony between the U.S. and China. Many have reported there were moments when the delegates nearly came to blows. There was a single phrase that seemed to trigger the most anger within the Chinese delegation: We agreed to fight protectionism, including all unfair trade practices.

This was supposed to be part of the final APEC communiqué; but in the end, the organization chose not to issue one at all. This is the first time that has happened in the 30 years the group has existed. In past years, this would have been looked at as another of those diplomatic sops that sound good, but that nobody really acts upon in any meaningful way. This time was different and illustrates just how much tension there is between the U.S. and China.

It was really the last three words of this phrase that set the Chinese off. This is Trump speak. It’s a phrase he has used over and over again to reference China. The reaction of the Chinese was an acknowledgment that they knew it was aimed at them.

The bigger story of the APEC meeting was that there was more of a united front building against the Chinese than had been seen before. The U.S. had been successful in getting most of the other members to see things its way: China is a transgressor and violator of trade rules and practices. In truth, most nations skirt close to violating trade rules. The U.S. is no exception. The Chinese have been more blatant as far as these violations are concerned, however.

Analysts have been watching the impact of the U.S.-China trade war to see which nation is going to suffer more. The consensus view is that both will feel the impact, but at slightly different times.

The U.S. is likely to see the first damage. In many respects, it already has. Ford has become the latest manufacturer that has indicated it will lay workers off (20,000 of them) due to the higher price of steel. These tariffs have cost Ford a billion dollars as steel prices have risen by an average of 40%. The farm sector has been damaged by lack of imports from China. The Chinese have also been affected by their inability to sell to the U.S. and by the fact that many Chinese companies are trying to swallow the tariffs and keep their prices low enough to stay competitive.

The bigger picture has China at more risk than the U.S. The simple reason is that China has to find new consumers as active as those in the U.S. Quite frankly, there are none. The U.S. is tasked with finding other sources for the products that were purchased from China. It will take time for other nations to step up and fill that gap, but they are eager to do so. That was one aspect of the APEC meeting that worried the Chinese. The other members of APEC would love to sell more to the U.S. than they do now. If the trade rift between the U.S. and China continues to accelerate, they will doubtless get their opportunity. This is making China more desperate and angrier. Pressure is ramping up. The U.S. will likely feel the consumer impact soon. That could change the equation as well.

German SMEs, Mid-Caps Have Higher Average Credit Risk than Italian

Small- and medium-sized enterprises (SMEs) and mid-caps pose a much higher credit risk than multinational corporations, according to Euler Hermes Rating’s latest study.

Italian SMEs and mid-caps, however, have lower average cumulative default rates than German firms, and credit risks are higher for companies in France and particularly in Spain, the study notes.

SMEs and mid-caps in Italy have a lower average two-year default rate (2.05%) than their German (2.59%), French (3.05%) or even Spanish (3.67%) counterparts. However, the financial profile leader is Germany’s Mittelstand (i.e., SMEs and mid-caps). At 32.4%, the German firms have the highest percentage of investment-grade financial profiles (from BBB to AA and higher) of the four countries studied.

According to the study, one possible reason for Italy’s lower default rates is the fact that the raw materials manufacturing and wholesale and retail trade sectors have relatively low default rates but account for a large share of the companies studied in Italy. Default rates are relatively high in Spain as a consequence of the international financial crisis that left many companies reeling. Insolvencies soared nationwide. The Spanish real estate and construction industry was hit particularly hard. After a years-long construction boom, the real estate bubble burst in 2008 in the wake of the global financial crisis and drove up default rates in these industries sky-high.

Analyses of European credit risks demand more than ballpark estimates

“Even well-diversified credit funds are exposed to a wide variety of default risks in individual countries and industries,” said Kai Gerdes, credit risk director at TRIB Rating, the rating service that Euler Hermes Rating launched in cooperation with Moody’s to provide internationally comparable ratings for smaller European businesses. “Consequently, you have to consider multifaceted, complex issues in order to analyze and assess European credit risks adequately. It’s one thing to conduct national multi-sector evaluations. It’s something else entirely to perform industry- and company-specific analyses. Ballpark estimates just don’t cut it—and could be dangerously misleading to boot.”

The study finds that the countries have some similarities as well as significant differences. In Germany, as in France, construction, other manufacturing and machinery and equipment manufacturing all have above-average default rates. In Italy, agriculture and mining are particularly risky investments while Spanish SMEs and mid-caps in the construction, real estate and rental industries are especially prone to stop making debt payments. The default rate of the wholesale and retail trade sector is slightly below average in all four countries compared to the other industries. However, Spanish companies in this industry still default more than twice as often (2.82%) as those in Italy (1.38%). That said, risk in this industry also depends heavily on the products being sold.

Sector volatility and sector outlook directly affect default rates

“Sector volatility, sector outlook and market structure have a tremendous influence on sector risk and, by extension, on default rates,” Gerdes said. “Default rates are almost uniformly relatively low in normally stable sectors such as utilities or public and community services. These industries also benefit from fairly low competition and high barriers to market entry. The exact opposite holds true in more volatile, occasionally highly fragmented industries such as construction, other manufacturing and machinery and equipment manufacturing. Of course, a company’s risk profile also hinges on its ability to respond to cyclical, market or innovation cycles and capitalize on its competitive position.”

Differences are the key to success in investment risk management

In short, the key to success in the fast-growing direct lending segment is to look at these differences in risk profiles. That is especially true when defining investment criteria, selecting individual companies to invest in and managing investment risk overall.

“You can manage a lot of risks through detailed analyses,” said Gerdes. “But some of the risks inherent in alternative investments will remain—no one has a crystal ball, after all. Markets are constantly changing, and future projections have to reflect that fact. However, some developments can’t be easily extrapolated into the future, especially if they are driven by an accumulation of different risks.”

UK SME Business Confidence Down Almost 20% from 2017

U.K. small- and medium-sized enterprise (SME) confidence in future financial success is down 19% compared to last year, according to research commissioned by Dun & Bradstreet. The study found that almost a third (32%) of respondents have considered leaving the U.K. to increase their chances of success.

As well as ongoing uncertainty over Brexit impacting growth, the research also shows that late payments have risen in the past year. Cash flow remains a critical issue, with the average amount owed to SMEs at any one time over the past 12 months now at £80,141—an increase of nearly 25% from 2017. The consequences of these late payments include cash flow difficulties (31%), delayed payments to suppliers (28%) and reduced profit performance (22%). Nearly two-thirds of respondents (63%) feel that there should be financial penalties in place to tackle late payments and 62% believe there should be legislation in place to mitigate the problem.

Other factors cited as impacting the future financial success of SMEs include recruitment of the right talent and resources (35%), adoption of new technology (26%) and ability to deal with increased regulation such as the GDPR (20%). Operating in an uncertain business environment has had a clear impact on SME business plans, with 63% of respondents saying they had a clear business strategy in place, down from 70% in 2017.

“Given the changing political, regulatory and economic landscape, it’s unsurprising that small business confidence is down,” said Tim Vine, head of European trade credit at Dun & Bradstreet. “There’s no doubt the months ahead will continue to be challenging as we move towards the Brexit deadline. Small business leaders are having to contend with scenario planning on top of dealing with day-to-day priorities such as cash flow management, late payments and securing finance for future growth.

“Despite the range of factors at play, positively, over half of the businesses we spoke to were confident that their business can achieve financial growth over the next five years. The resilience of SMEs will stand them in very good stead through these changing and complex times.”

Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations