Get ready for a tough 2009

29-Oct-2008

After months of this column predicting a possible recession, it appears we are now at the beginning of a recessionary period that is likely to last until at least early 2010.

Unfortunately the stock market is now worrying that the recession could be much deeper and last much longer. Hence the market’s rather muted response to the government’s bail-out of the banking system. I think ‘better late than never’ on that front, but nonetheless we should all be prepared for a very tough 2009.

The mood on the stock market has changed noticeably over the last few weeks following the realisation of the scale of the banking crisis. The primary focus of many investors right now is banking covenants, and in particular what would need to happen for companies to breach their covenants.

Up until now it appears the banks were largely preoccupied by their own problems and had no desire to take more risky assets onto their own books. However, there is a growing belief that now the banks are more confident of their own solvency, they will start to focus on profiting from their struggling borrowers.

Most of the large listed recruiters (Michael Page, Hays etc) are either cash rich or generating more than enough cash to cover interest payments.

Typically, recruiters have only limited debt, as there are few assets to borrow against, so this isn’t a direct issue for most recruitment stocks. However, the rising cost of borrowing and the slowdown in the economy will have a significant impact on employment rates as companies are forced to cut costs.

Many companies built up excess costs over the bull years and these perks will be first to go. After this, the quickest way to make savings is usually a reduction in head-count. There will be some natural attrition, especially as the weak pound makes the UK less attractive to migrant workers. However, unemployment is likely to rise rapidly over the next few months as businesses start to realign their cost base with the recessionary outlook.


Michael Vassallo, equities analyst, Brewin Dolphin Investment Banking