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Stock markets and company accounts – remarkable recovery or more pain to come?

Stock markets might have recovered but company’s accounts aren’t all so optimistic. We look at some examples and what it could mean for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Global stock markets are back above where they were at the start of the year. Given the scale of recent disruption to businesses and economies that’s surprising to say the least.

While we hope markets are right and we’re in recovery, there’s a lot that suggests otherwise. Recessions and record unemployment aren’t recovery like qualities. And having just finished a busy reporting quarter, company accounts aren’t all indicating recovery either.

This article is not personal advice. If you’re not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Lending a helping hand

Over the last few months we’ve seen quite a few businesses offer clients a helping hand. Discounts, fee and rent pauses have been a common theme across the market. InterContinental Hotels, Rightmove, Auto Trader and Domino’s all offered help to clients facing temporary lockdown closures.

McDonald’s has also been helping franchisees out, and we think it’s worth taking a closer look. Over the last six months it deferred collection of rent and royalties totalling $800m. Together with lockdown’s hit to earnings, that meant cash flowed out of the business in the most recent quarter – compared to a near $1.3bn inflow last year.

In theory it’s a no brainer. McDonald’s has deep pockets and if it can use them to help franchisees stay in business, then its long run business should be protected.

But there’s a murkier result, complicated by the fact that while McDonalds hasn’t been collecting the cash, it’s still recognising the revenue. Not necessarily a problem as long as it can collect it in the future and as it stands McDonald’s expects to get most of it back in Q3 and Q4.

The risk is that franchisees finances aren’t in a good state and further lockdowns make matters worse – meaning they’re unable to pay some or all of the delayed fees. If McDonald’s thought there was a risk in franchisees not paying up, we’d likely have seen provisions for bad debts this time round – accounting for revenues that might not actually be collected.

There’s no sign of this yet, but it’s something we’ll be keeping a very close eye on.

Banks not banking on it

The banking sector tells a different story. Provisions for clients to default on debts are rising rapidly and suggests the industry is bracing for tougher times to come.

Impairments occur when a firm’s assets are now deemed to be worth less than they’re recorded on the balance sheet as. For banks the biggest assets are loan books. What we’ve seen in recent results is banks becoming less confident that they’ll ultimately get paid back all the money they’ve lent out – highlighting the strain coronavirus is putting on company finances. As you can see from the below banks expect things to remain tough for some time.

Company First Half 2019 impairment (Bn) First Half 2020 impairment (Bn) Full Year impairment expectations
Barclays (£) 0.9 3.7 Increase year-on-year but Second Half lower than First Half
HSBC ($) 1.1 6.9 $8bn-$13bn for the full year
NatWest (£) 0.3 2.9 £3.5-4.5bn for the full year
Standard Chartered ($) 0.3 1.6 Increase year-on-year but Second Half lower than First Half
Lloyds (£) 0.6 3.8 £4.5-5.5bn for the full year

Source: Most recent company announcements.

Only time will tell if bad debt expectations are justified. But the scale of the write downs is certainly telling a very different story to the market recovery.

What does this mean for investors?

Companies and consumers are living with more uncertainties than ever before. Further lockdowns and gradual reduction of government support schemes are real risks to things getting much worse rather than better.

Against this backdrop it’s easy to see how the stock market isn’t necessarily a good indicator of how economies are faring.

Given these uncertainties investors should be prepared for the value of their investments to go in both directions. That’s not to say don’t invest, but considering a strategy to invest regularly over time, should help smooth the bumps ahead.

How coronavirus has changed the way we look at shares

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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