From The Sunday Times
March 15, 2009

Turmoil pierces heart of the global economy

John Waples, Business Editor

The stark collapse in industrial output in countries such as Japan, Germany and Korea shows that the firestorm that has engulfed financial markets for the past 20 months is now sweeping into the real economy. This will have an immense impact on future corporate earnings.

Japan and Germany, two countries seen as vital cogs in the world economy, have released some horrendous figures. In Japan the economy shrank 3.2% in the final quarter of last year, the biggest contraction since the 1973-74 oil crisis. Germany did little better — its industrial production dropped 7.5% in January and is now down 19.3% on the year.

In Korea, industrial output tumbled a record 25.6% in January compared with a year earlier. Even China’s industrial output growth slowed to its lowest level on record. In many countries factories are running on four-day weeks, overtime is a distant memory and that means there is less money to go round to buy the goods that are being produced.

Then there are the knock-on consequences for other sectors such as power generation. That may be good for curbing the emission of greenhouse gases, but it is not good news for the global economy. As I point out in the next piece, there are some signs of recovery in financial markets but none at all in industry, which is experiencing a painful readjustment.

If this slide continues it will push over the edge the thousands of British companies that have been clinging on in the hope the economy will turn.

One of big themes this week will be the reform of financial regulation. This is needed, but an awful lot of people, especially those experiencing the sharp impact of the downturn, want jobs and a fiscal stimulus to be made the priorities.

What the British government must now do is ensure that our industrial base is fit for when the recovery comes and that the downturn does not damage our long-term competitive future. The big question for Lord Mandelson, the business secretary, is which industry fits the bill? Parts of the car industry do. Aerospace and defence certainly do, as does the pharmaceutical sector. On top of that there are all sorts of high-value services such as film and other creative industries. Mandelson and the government face some tough choices.

The scramble for cash LET’s not get too gloomy. For all the talk about bust banks and bankrupt institutions, the City is going to help raise some £22.8 billion over the next four weeks. That’s an awful lot of money to shore up balance sheets and produce a big windfall of fees for City advisers.

As importantly, these cash calls are already working their way through the system. This will help to re-establish confidence in the banking system, which is essential to any economic recovery, and shows that the wheels are turning again — albeit slowly. This should be seen as a positive sign. Despite the monster writedowns we are seeing from banks, at a pre-exceptional level they are profitable in both their retail and commercial divisions. The share rally we have seen in financial stocks reflects that, but this recovery is not V-shaped and banks are still hugely exposed to troubled consumer and corporate loans.

On Wednesday, Xstrata, the mining company, will successfully close its £4.1 billion rights issue. The following day British Land will complete its £767m cash call and, as the table below shows, by April 17 investors should have written out cheques totalling almost £23 billion.

The big one is HSBC, which is raising £12.8 billion. It has had a series of one-to-one meetings with investors this week to win over some of the sceptics who were reluctant to support it. A number of fund managers and analysts were initially unimpressed with the results presentation, but HSBC’s top team has since been on a global roadshow and the theoretical ex-rights share price of 342p now implies a 6.7% yield. That has helped to swing sentiment.

The rights issue will help HSBC finance some big buying opportunities in the months ahead as the more troubled banks retrench to domestic markets.

That is going to lead to a lot of restructuring and buyers will be spoilt for choice. The Asian businesses of Royal Bank of Scotland, AIG and Citi could soon be on the block and, of those, I would expect HSBC to swoop on Citi’s operations. Germans move in TO Cannes for a brief trip last Wednesday to attend MIPIM, the European property conference. This is normally a fun-packed extravaganza of over-the-top entertainment and relentless bonhomie.

Not this year. The mood was sombre, the restaurants had spare tables and even the beachside hotels had empty rooms. But not everyone was gloomy. To the continental investors the British commercial property market is starting to look attractive.

The same happened after the 1990s property crash when the Germans piled in and made a killing by buying up London. I am not saying that UK property values have yet stabilised, but they are not going to halve again and there are enough potential buyers and funds starting to prepare the groundwork to suggest that we are close to the bottom.

The Germans are again at the front of the queue. They may have lost confidence in their own economy, but the arbitrage between the euro and sterling, combined with tax-free gains, is again starting to look compelling. This may all be far too early, and there is still a lot of unpleasant news to come, but more people are beginning to use the word opportunity than I have heard in a long time.

john.waples@sunday-times.co.uk

http://business.timesonline.co.uk/tol/b ... 908407.ece