Reality checks in more than one context this week: The Party Congress in China coming concluding, Brazil voting its next president (and our view on market implications; let’s hope that the ballot proves stronger than the bullet); and the ECB decidedly dovish with a 75bps rate hike. More reality checks coming up for many corporates as the ongoing energy crisis, interest rates shock and untampered recession risk triggering a wave of business insolvencies in 2023. And a batch of revised sector risk reports (Chemicals, Machinery & Equipment, and Paper) and our weekly wrap-up on relevant economic events this week. Happy Halloween!
Our full analysis can be found here.??
- Half of the countries we analyze have recorded double-digit increases in business insolvencies in the first half of 2022. European SMEs (the UK, France, Spain, the Netherlands, Belgium and Switzerland) explain two-thirds of the rise. In the meantime, the US, China, Germany, Italy and Brazil are still registering prolonged low numbers of insolvencies. In Europe, 60% of industries are experiencing a rebound of bankruptcies; food, accommodation, manufacturing and B2C services are already back to pre-pandemic insolvency numbers. This rebound comes mainly from SMEs while insolvencies among large companies are still under control (58 cases in Q3 2022 and 182 over the first three quarters, compared to 187 and 332 for the same period of 2021 and 2020).
- After two years of declines, we expect a broad-based acceleration in business insolvencies globally: +10% in 2022 and +19% in 2023. In Europe, we expect insolvencies to exceed 53,000 cases in France in 2023 (+29% y/y), 27,000 cases in the UK (+10%), 17,000 cases in Germany (+17%) and 10,900 cases in Italy (+36%). In Asia, China is expected to register +15% more insolvencies in 2023 on the back of low growth and limited impact from the monetary and fiscal easing. In the US, we expect an increase of +38% in business insolvencies in 2023 as a result of tighter monetary and financial conditions, which will mean a return to more than 20,000 insolvencies per year.
- Reason #1: The energy crisis means a massive profitability shock for European firms, which governments can only partially offset. When firms can pass one quarter of energy-price increases to customers, they can withstand a price increase of below +50%. This pricing power is limited in scope and eroding with higher prices and rationing. Many companies could still see a large chunk of their profits being wiped out. We estimate the number of firms at risk of going belly up in case of a blackout scenario to be 42,000 (or 17% of the total) in the UK, 18,700 (13%) in France and 28,400 (6%) in Germany.
- Reason #2: The interest rate shock and the higher wage bill in the wake of unprecedented inflation could be equivalent to a profitability shock similar to that seen after the Covid-19 lockdown. In 2023, an additional interest rate increase of 200bps could dent margins by -1.5pp in the US, -2.2pps in the UK and -3pps in the Eurozone, with Italy, Spain and France most affected. High cash balances remain a strong buffer. An increase of the wage bill by 4-5% in 2023 could cost -0.5pp to -1pp of margins in Europe. The construction, transportation, telecom, machinery & equipment, retail, household equipment, electronics, automotive and textiles sectors are on the watch list.
- Reason #3: Governments will only partially offset the impact of the recession, unless… We estimate that the current fiscal support is reducing the rise in insolvencies by -12pps in Germany (or saving 2,600 firms) on average over 2022 and 2023; -13pps in France and Italy (i.e. 6,700 and 1,900 firms, respectively); -15pps in the UK (4,300) and -24pps in Spain (2,100). If the expected mild recession morphs into a more severe one (à la 2009), insolvencies could rise by +25% in 2023 in Europe. Governments would then certainly resort to a new “whatever it takes” approach and have to spend at least 5% of GDP on average to avoid a 2009-like insolvency wave. This would also mean central banks turn cooperative again.
Brazil chooses its next President this Sunday, in what polls suggest to be a tight race. In the attached paper we bring some light on the challenges the new President will face during his term, and why Brazilian markets have fared relatively well 2022 besides the complicated context. The complete report can be found here. The main takeaways:
- Unlike in previous elections, there are few signs of politically driven stress on Brazilian markets. Yet, Brazilian markets are in for a reality check in 2023.?The results of the first round of the Presidential elections have reduced the likelihood of extreme policies, and markets are familiar with both candidates. Furthermore, the commodity boom and the determination of the Central Bank of Brazil had left Brazilian assets in a good position. But the next president will have a difficult task: to the external factors of Fed interest rates and global slowdown (oil price adjustment included), markets will watch closely the fiscal developments.
- Public debt is the true winner of this election. Investors will be watching for fiscal soundness. We analyze the programs of both candidates and find that the expansionist fiscal measures – irrespective of who wins –?would lead to a deterioration of the primary fiscal deficit to -1.9% of GDP in 2023, and to a 100% debt-to-GDP ratio by 2026.
- Fiscal measures will also weigh on the efforts to bring down inflation, which we expect to be 5.1% in 2023, above Central Bank’s 3.25% target. As a result, we expect the BCB to maintain the Selic rate at 13.75% well into 2023, and only lower it in the second half to 12% by the end of the year. Similarly, growth will weaken to +0.8% real GDP growth in 2023, before going to levels close to potential in 2024 (+1.9%).
We’ve recently updated our assessments for a number of industry sectors:
Chemicals: Rated S (sensitive risk for enterprises), as the energy crisis is hitting the sector hard, notably basic-chemicals producers in Europe.
Machinery and Equipment: Rated S (sensitive risk), with clear signs that the post-pandemic rebound is over.
Paper: Rated S (sensitive risk), as digitalization and environmental awareness lead to new consumption patterns that are, in turn, negatively reshaping the sector.
