Author Archives: India Riordan

Fiscal vs Monetary Policy: The UK’s Dilemma.

“In this jittery environment – there could be no reasons for more jitters”

Despite the IMF chief’s call for no “more jitters”, the sacking of the UK’s Chancellor on Friday (14/10), alongside a further fiscal policy U-turn, dashed their hopes of steady progress. But, how did we get here?

Kwasi Kwarteng’s mini-budget announcement in mid-September had a ‘pro-growth,’ ‘expansionary’ headline, but caused concern due to its financing and lack of approval by the Office for Budget Responsibility (OBR). The potentially unsustainable budget deficit, and the expansionary fiscal stance which conflicted with the Bank of England’s (BoE) deflationary policies led markets to price in higher interest rate rises, therefore reducing the price of gilts (government bonds).

However, panic spread due to pension funds’ heavy collateralisation through gilts, leading to calls for more collateral, and a mass sell-off of gilts by these funds. This sparked a downward spiral, causing further falls in gilt prices and igniting fears of a ‘run.’

Therefore, to prevent mass defaults on pension funds, and safeguard the finances of connected banks, the BoE stepped in and purchased these gilts, reducing the yield (i.e. the interest rate). But, like many G20 Central Banks, the BoE is tightening monetary policy to ward off inflation. Hence, this move served to undermine their credibility and muddy their inflation-targeting objectives. The announcement that the BoE would stop this bond-buying procedure on Friday should have re-established their policy tightening strategy and credibility, ultimately helping to re-stabilise market expectations. However, the sacking of Kwarteng, and the U-turn on the mini-budget, including a backtrack on the proposed decline in corporation tax, meant that a gilt sell-off re-started and prices fell, while currency markets remained turbulent. Truss’ fragile position as Prime Minister is likely to continue driving financial instability.

Alleviating This Uncertainty Via Communication

There are multiple issues stemming from this crisis in policy, but some uncertainty could be resolved through communication. Despite having no other option, Andrew Bailey (Governor of BoE) put himself in a difficult position on Wednesday by announcing the termination of gilt-buying on Friday. As long as the action was taken, the power of strong communication is illustrated here, as this helped stabilize expectations, and shore up BoE credibility as an inflation-targeter. On the other hand, Kwarteng’s failure to pre-warn business leaders about the mini-budget scared markets, unraveling the negative shocks. Furthermore, these shocks were amplified as he reportedly did not communicate certain elements with cabinet ministers, and failed to include the OBR.

Until Friday, there appeared to be coherence between No. 10 and No. 11, however Bailey’s “you’ll have to ask the Chancellor,” response to questions regarding Kwarteng’s absence from an IMF meeting, and early departure from the conference on Thursday, highlighted growing tensions between the BoE and UK politicians; giving further insight into the conflict between fiscal and monetary policy in the UK.

The Blame Game: Not So Independent.

While the past few weeks have seen monetary and fiscal policy work in opposite directions, Georgieva’s comments that fiscal policy should not undermine monetary policy illustrated the importance of the latter. That said, the Bank of England’s actions following unreasonable fiscal policy illustrates the opposite of this, unbalancing the see-saw of whether fiscal policy should support monetary policy (or vice-versa). Meanwhile, the independence and credibility of the BoE has been threatened, both by fiscal policy, and the risking of moral hazard through its recent buying of gilts. This illustrates a need for strong communication from monetary and fiscal policy makers in order to regain stability and transparency. Ultimately, if we are to learn from the 1970s, monetary policy needs to be allowed to lead, with politics stepping in to support those who will be hurt. This forces a dilemma for myopic politicians regarding the seemingly correct (in the long-run), but unpopular action to take.

Yesterday’s (Monday 17/10) events seemed to be taking this route, with financial markets stabilizing. On the other hand, some argue that the new Chancellor went too far, and that through tearing up Truss’ entire ‘manifesto,’ he is now the de-facto Prime Minister. Furthermore this has led to calls for a general election and stemmed questions of whether credibility can ever be restored to Truss’ leadership. Again, the lesson may be one of communication, but only time will tell whether trust can be regained once this breaks down – and until that point, political instability will continue to undermine the financial and monetary stability of the UK.

The Pharma Industry: Where next?

As Covid-19 returns to being an endemic disease, the pandemic has taken a back seat in recent weeks as other, more pressing crises come to the fore. While certain pharmaceutical companies benefited greatly from the pandemic, as illustrated by Astrazeneca’s 41% rise in revenue for 2021, the irony holds that the industry failed to gain in equity markets as much as firms in other industries (E.g. in hospitality/catering), from the re-opening that they enabled. That said, in the US alone the Pharma industry is valued at approximately $2.8 trillion. Given this, alongside the impressive speed of vaccine developments, and the heightened importance placed on what pharmaceutical firms can offer by the pandemic, the potential for growth exists if it can be capitalised on. The pharmaceuticals industry is highly volatile and hugely speculative, with history illustrating that news of final-stage trials, testing success, or acquisitions, can cause huge share price swings. Therefore, this article is meant to be a conversation-starter, and provide food for thought, rather than provide any investment advice or know-how, regarding what is next to come for the pharmaceuticals industry. 

A Deep Dive Into Some Pandemic Performers:

Astrazeneca: Potential to grow

AstraZeneca’s development of the Covid-19 vaccine broke headlines in late 2021, leading the company to become a household name. While the firm’s promise of providing vaccines at cost boosts its ESG commitments, since November 2021 it has backtracked on this policy, taking minor profit from advanced economies, but remaining not-for-profit for low-income countries. This is an understandable policy not only as Covid-19 begins to become endemic, but also for Astrazeneca’s own business model (its core vaccine rivals Moderna and Pfizer have always sold Covid-19 vaccines at a profit). Despite this policy, Astrazeneca’s revenues were still very strong in 2021, meaning that in February 2022 they increased the annual dividend for the first time, as sales are forecast to be just as strong, if not stronger, for 2022 – notably from new cancer and kidney disease drugs, alongside its research into rare conditions. The latter of these stems from Aztrazeneca’s acquisition of Alexion Pharmaceuticals in July 2021, which would serve to boost its experience in rare diseases. Interestingly, from 7,000 rare diseases today, only 5% have treatments that are certified by the FDA, illustrating the room for growth and development within this sector, something that Astrazeneca is certainly capitalising on. While this suggests promise to this firm, the earnings per share (EPS) have dropped to very low levels (0.04), meaning there may be concerns towards future profitability, particularly in a competitive, volatile market – and one where fast development and adaptivity is required. Furthermore, the price to equity ratio is (by historical standards) very high, suggesting the share price is overvalued, and further signaling that the market has concerns about Astrazeneca’s future profitability. Therefore it is worth exploring whether this is a common trend among other Covid-19 vaccine suppliers. 

Pfizer: Consistently strong performer

Having paid a quarterly dividend for more than 83 years, and increasing this by 25% for the past 5 years, Pfizer was performing strongly prior to the Pandemic, which only certified its status as the world’s leading pharmaceuticals company (by revenue) in 2021. Furthermore, its stronger EPS, at 3.83, alongside its much more promising price-equity ratio (compared to AstraZeneca’s), symbolise that perhaps some pharmaceuticals firms are emerging out of the pandemic in a better position than others. Pfizer are utilising some of the lessons learned during the pandemic to complete its aim of delivering 25 drug breakthoughs by 2025. This ambition is possible due to Pfizer’s size, meaning that while the Covid-19 vaccine was a boost to revenue, it did not have as significant an impact compared to its core rivals. This diversification and broad range of interests means that Pfizer has a lot of room to grow with fairly minimal risk. Meanwhile, its strong ESG awareness and policies illustrate a focus on sustainable growth, alongside solid investment opportunities in an age of impact investing. Finally, Pfizer’s partnership with BioNTech in vaccine development is symbolic of the collaborative possibilities held by the firm, illustrating further room for growth and opportunities for research and development.  

Moderna: Vaccine-focussed

This is in contrast with Moderna, which saw a colossal rise in revenue between 2020 and 2021, from $803 million to $18.5 billion, largely driven by its Covid-19 vaccine development. However, this illustrates its dependency on the vaccine’s development, which, as the Pandemic begins to subside, risks impacting revenue drastically by 2023. Furthermore, Moderna are striving to replicate their Covid-19 mRNA vaccine success into other areas, focussing on adapting and developing vaccinations with a similar technology. However, this lack of a broad base is highly risky, particularly in pharmaceuticals, where trials may not be a success. Therefore, the question of whether Moderna can continue performing into the future depends on whether it is able to adapt and perhaps diversify its interests slightly, to ensure its ability to compete with its major rivals.  

Johnson & Johnson: A more streamlined approach

In a differing strategy, Johnson & Johnson (J&J), like many large firms, have recently decided to streamline operations and heighten their focus through divesting multiple sections of its core business. This could see a profits increase, as is anticipated next year. Notably, while morally contentious (potentially impacting its ESG ratings), J+J recently divested its talcum powder business into its own company (which subsequently filed for bankruptcy), reducing the impact of its asbestos-related liabilities on profits. Additionally, plans to make its consumer health unit a standalone entity next year would leave the company focussed on pharmaceuticals and medical equipment. The latter gained increased sales of almost 18% in the last year, and the former is also one of the firm’s fastest-growing units, illustrating the potential for growth when focussing on these sectors. Furthermore, J&J are currently inundated with late-stage clinical trials, meaning that imminent breakthroughs are highly possible, providing the potential to rack up profits in the coming year. 

What to Watch: 

Given that pharmaceuticals stocks have slightly outperformed the overall market over the past twelve months, it is unsurprising that the above companies are not the only strong contenders in this promising industry. Alongside Pfizer, which has held a strong 12-month trailing total return, other firms, namely Amphastar Pharmaceuticals and Intracellular Therapies, the latter of which focuses on neurological disorders, with a particular focus on Alzheimer’s Disease (illustrating strong room to grow in an aging world), have shown high momentum in the past year, with the possibility this could continue. Furthermore, Dynavax’s revenue grew 897.8% in the last year, a firm that specialises in immunotherapy. Given this, alongside its interest in vaccine production, Dynavax could capitalise on the lessons learned over the Pandemic, namely regarding immunology and vaccine production, to continue this path towards revenue growth. 

In a dynamic and well-contested market, growth and a focus on research & development are crucial for Pharma firms, and drawing on lessons learned from the pandemic to ensure adaptability and innovation will be key. Additionally, given the presence of potential lawsuits, alongside the long-term focus (due to the amount of time taken to create a new drug) for many pharmaceutical companies, ESG considerations in this industry are particularly key, and should be at the forefront of competitive firms’ decisions. Thus, the pharmaceuticals industry still has a lot of room to grow, and as long as firms can capitalise on this, perhaps streamlining their R+D in a particular area, while ensuring strong ESG commitments, then the industry shows a lot of promise.

Shoring up Businesses in the Face of Inflationary Pressures

Annual inflation hit its highest point in twenty years in November 2021, with consumer prices up 5.3% year-on-year. EY reckon this trend could be lasting, with inflation expected to average 3.3% next year. Considering the EU target inflation rate of 2%, the severity of these figures is clear. Similar statistics are seen internationally, with the European Central Bank (ECB), Federal Reserve (Fed) and Bank of England all preparing to quash inflationary pressures over the coming months. For example, the Bank of England recently announced increased interest rates to 0.25% , the Fed has signalled to end their bond purchases (heightened during the Pandemic) in March and plan to enact three interest rate rises during 2022. In a differing response, the ECB will continue bond purchases for at least 10 months, before scaling back the procedure. They also ruled out raising interest rates next year, illustrating the ECB’s viewpoint that inflation should fall in 2022. With these actions taken by various central banks in mind, businesses ought to prepare to minimise the potential costs of inflation.

Reasons Behind the Rise 

McVities’ recent announcement that some family favourites such as Hobnobs, Jaffa Cakes and Penguins could see price increases of up to 5% illustrates the direct impact of these inflationary pressures on consumers’ pockets. The UK Managing Director at Pladis Global, owner of McVities, attributed this to Covid-induced staff absences and the rise in input costs, with double digit percentage increases on ingredients such as cocoa beans, alongside higher labour costs.

The vaccine rollout and the economic recovery is also releasing pent-up demand from the pandemic, causing demand to outstrip supply in the economy and prices to rise; this is also known as demand-pull inflation. Another view, as McVities shows, suggests that weakened supply due to labour shortages, aggravated by Covid-19 induced absenteeism and the new Omicron variant, could be driving inflation. Other supply-side issues include the rising costs of core ingredients, perhaps due to supply chain disruption (as a result of the pandemic). This is known as that cost-push inflation, whereby an increase in the costs of wages and raw materials is passed onto consumers in the form of higher prices, is boosting inflationary pressures even further. The rise in inflation can be viewed from both the demand and supply-sides, illustrating its pervasiveness.

Costs of Inflationary Pressures on Firms 

Rising costs due to inflationary pressures means rising uncertainty amidst a backdrop of an already unstable trading environment. This means that firms are less likely to invest in research and development, alongside technological changes for longer term production, hence negatively impacting long run growth rates. Furthermore, the impact on profit margins is ambiguous, and dependent on whether firms will be able to pass higher input costs on to consumers. The more price elastic a good/service is (i.e. if consumers reduce their demand a lot, given a small price increase), then the less likely a firm will be able to pass their rise in costs onto consumers. In this event therefore, profit margins for businesses are likely to fall, a clear cost of inflation on business owners. Additionally, the current business environment, with large staff shortages and absenteeism, means employees have stronger negotiating power regarding their wages. Therefore, despite both the Bank of England and the ECB suggesting there is little current risk of a wage price spiral, labour costs for firms could rise, thus aggravating this fall in profit margins. Ultimately, the costs for firms encompasses the uncertainty of the trading environment, and the resulting impact on long-term growth, alongside the potential fall in profit margins – the extent of which is dependent on the price sensitivity of their consumers. 

Shoring up Businesses

With inflation clearly upon us, it is vital for firms to be aware of their business’ sensitivity to price changes. Despite being a challenge to accurately calculate, awareness of a products’ price elasticity, alongside forecasted and current inflation means that firms can be better placed to react to any price changes and minimise the impact on profit margins. Additionally, awareness of competitors can also help firms respond to rising inflation; if the competition raises their prices, it becomes easier for smaller firms to increase their prices without losing too much demand. Thus, awareness of the competition’s actions, alongside a focus on the business’ unique selling point to make it stand out from the competition, are vital to reduce the impact of inflation. With much of inflation because caused by shortages on the supply side, international diversification can reduce supply chain risk and diminish the impact of rising costs. Indeed, the evaluation of supply chain risk alone, alongside analysing the necessary responses to these risks, can help prepare firms, enabling them to better respond to crises once they arise.

Furthermore, issuing debt can allow firms to diversify their financial portfolios in a way that reduces the impact of rising prices. Since inflation erodes the real value of money, businesses ought to reduce their cash holdings and instead buying capital assets or equipment that promote long-term growth and help businesses ride through the uncertainty. The ability to take out a loan to fund these investments depends on interest rates. Despite the Bank of England’s announced rise in interest rates to combat inflation, rates still remain low; the ECB, for instance, has thus far decided to keep rates at their low. Hence, as long as rates do not rise further to combat the inflation, businesses will be able to pay back their loan cheaper relative to what they borrowed it at. If this loan is used to promote long-run growth through solid investments, then businesses could use inflationary pressures to their favour. Furthermore, stockpiles could be used as long-term buffers, better preparing firms for the rise in inflation. Additional long-term buffers could be sought through locking-in long term contracts at current prices – taking advantage of futures markets to reduce the costs of inflationary pressures.

Ultimately, for businesses to respond well to the current pandemic-induced inflation pressures, forecasting and preparing for all scenarios, alongside acknowledging their competition, price sensitivity, and reassessing their investments is crucial to shore themselves up against rising prices.

Levelling Up the Labour Market and the Impact on Firms

Britain’s recent fuel crisis, owing more to a shortage of lorry drivers rather than fuel itself, symbolises the wedge between supply and demand for labour within the economy. While the fact that the number job vacancies in Britain between July and September rose to above one million for the first time could be due to a fall in migration since Brexit, a walk around Dublin – with vacancy signs in almost every shop or restaurant window – shows that this labour market shortfall might not be nation-specific.

Supply Shortages

While Ireland’s job vacancy rate is not as high as in other European countries like Belgium (4.2%) or the Netherlands (3.8%), it rose nonetheless in Q2 of 2021 to 1.1% (from 0.7% in Q2 of 2020). However, perhaps most concerning is the OECD’s recent report which suggests Ireland will not recover to pre-Covid unemployment levels until the middle of 2024, putting its labour market rebound among the worst in Europe. This is likely due to labour market tightness alongside a fall in the job finding rate, with those unemployed prior to Covid only returning to their job search now. Meanwhile, this is aggravated by a reshuffle of the employed, as many have reevaluated their career paths, or find out their jobs no longer exist. In fact, in Ireland, almost 30% of the hospitality sector have moved into other job roles since the pandemic began. Ultimately, the current shortage of workers, most acute in hospitality, healthcare and agriculture, is likely to have a large impact on firms and businesses. To solve this mismatch between supply and demand, it is helpful to further explore the causes of this situation.

Why So? 

Covid-19 gave workers a chance to re-evaluate their job roles and career paths. Despite the fall in Scotland and Northern Ireland, the rise in nursing applicants in England this year illustrates a re-evaluation of career prospects and perhaps a wish for some to enter more rewarding job roles since the pandemic began. Higher expectations of worker satisfaction has caused a huge shift in the labour market as people move away from jobs which do not suit their lifestyle. The fact that the catering industry is particularly vulnerable to shortages is not surprising given the unsociable hours that bar staff and chefs work alongside the heated and stressful kitchen environment for minimal pay. Similarly, despite the evident shortage of truck drivers plaguing Britain, the UK has 600,000 people with an HGV licence who do not drive for a living. This is largely due to the poor working conditions, the negative health impacts of lonely work away from home, and poor pay that truckers face; all these factors are pushing many out of the industry.

The roles that people are shifting out of were arguably always unpopular. However, only now after the pandemic – in an economic environment of rising inflation – has the bargaining power shifted towards the supply of labour within these struggling industries. This suggests that those working in these industries have been under-remunerated for their work; only now can they bargain for higher wages as supply becomes scarce.

The pandemic has also uprooted the housing market, with house prices in rural areas increasing as people sought more green space during the various lockdowns. This means that commuting times for workers are rising, adding another factor to account for when applying for and accepting jobs; this also affects their willingness to work in certain job roles. Indeed, jobs in industries such as catering often require late nights, which, in the absence of nighttime public transport to rural areas, becomes an issue for those living outside urban districts.

Finally, the transition to a high-skilled economy is also a factor impacting the supply shortages. The ability for individuals to shift from a low to a high skilled job role can be challenging, particularly if firms begin asking for too much from candidates. For example, in Ireland the requirement that a waiter have their HACCP qualification, alongside 1+ years of experience is often seen, which is a huge barrier to entry for new workers. The mismatch between workers who think they have the right skills for a job and employer expectations means that firms are oftentimes inadvertently worsening their own supply shortages.

What Does This Mean for Firms?

These barriers to entry for roles which are facing particularly acute shortages are only furthering the labour supply crisis. This means that firms could be more proactive in filling the shortages. This would be through accepting unskilled or newer workers into the industry and train them with the necessary skills for a role. Therefore, firms could work to improve training programmes and lower their own barriers to entry to reduce the shortage.

Perhaps the most obvious way to address this shortage would be to increase wages and add additional benefits, such as a scheme rewarding/providing bonuses to non-salaried workers who work over-time for a firm. However, this rise in costs for firms is likely to exacerbate the current period of rising inflation. While consumers are likely to feel the pinch of this cost-push inflation, a rise in general cost of inputs for firms, many of whom’s balance books are already struggling post-Pandemic, is likely to bring additional accounting challenges.

While increasing pay for workers will help to bring the labour market to a new, temporary equilibrium level, whether through seeking capital replacements for labour, using their staff more productively and efficiently (while also maintaining staff health and welfare), being willing to implement new training schemes or changing their business structure, firms need to use innovation and knowledge of their business environment and industry in order to react to this changing labour market.

Creative Destruction: Gaining in strength?

Perhaps one of Schumpeter’s most revered theories is that of creative destruction. His argument that capitalism never stands still, with long-standing, inefficient processes decaying in the wake of newer, superior ones has stood the test of time well, and in the aftermath of a global pandemic, appears to continue in this light.

WFH – a trend, an improvement, or both? 

A more obvious impact of the pandemic-induced lockdowns was the ‘Work From Home (WFH)’ situation, which many workers and students found themselves in. While evidence suggests that students and young graduates certainly wish for a return to an in-person normality, the technology, flexibility and heightened global interconnection that accompanied this WFH trend can be seen as a form of creative destruction. This is due to the replacement of older, less efficient, less flexible practices undertaken by offices with more productive, collaborative ones. With meeting participation increasing by over 2900% over the course of the Pandemic, the rise of Zoom neatly epitomises this creative destruction. Existing for almost a decade prior to the pandemic, Zoom’s overtaking of Skype, and other lower quality, more complicated platforms, coupled with a rise in global interconnectivity from which it prospered, illustrates that the foundations for creative destruction had been in place. However, it was the catalyst of the Pandemic that fuelled the eventual ousting of these inefficient processes.

Miracle Advances in Healthcare

Being a crisis in healthcare, the impacts of Covid-19 on the sector were always going to be large. As the world locked down, the personal profit from vaccines became huge, with many viewing vaccine development as the only sustainable way out of the crisis. Furthermore, for big pharma businesses, net profits from development were promising, as BioNtech’s expected revenues of €15.9 billion for this year illustrate. Thus, the fastest vaccine development in history (previously held by the mumps vaccine, which took four years to develop) followed, hailing what scientists proclaim as a new era of vaccine research. Much like the Work from Home technology, the knowledge of mRNA, alongside the ability to accelerate the testing and approval processes had been around for decades, yet a lack of funding and cooperation meant that such techniques and pace never came to fruition. Thus, the catalyst of a global pandemic rendered inefficient processes useless, in favour of more productive research techniques. While admittedly this research was far better funded than in the past, the lessons learned within the immunisation research sector, alongside the new-found ability to produce vaccines at such pace, and with new techniques, means that the creative destruction ought to last within the industry. This should heighten the efficiency and productivity of future research.

Similarly, the speed of drug development processes to aid those seriously ill with Covid-19 underwent rapid increases during the pandemic. Like with the vaccines, much of this came from the regulation-side, with approval and testing processes being fast-tracked, and the removal of unnecessary paperwork (recognised as inefficiency-inducing ‘sludge’) aiding this. Additionally, cooperation and parallel experimentation again played its part in heightening efficiency in the sector, a rise in productive techniques that many scientific researchers think will remain in a post-Covid world, further illustrating the impact of the pandemic on inducing creative destruction.

Online Shopping’s Anticipated Breakthrough

Where the biggest acceleration (rather than initiation) of creative destruction can be seen is in the retail sector, as many began relying solely on online shopping for everything from food to clothes to newspapers. Additionally, HSBC’s UK head of network noted that the closure of eighty-two of their branches between April and September 2021 was a result of the trends away from branch banking that were underlying pre-Coronavirus, with a decrease in footfall by a third in the last five years, and 90% of contact being completed remotely. This illustrates direct creative destruction at work in the retail banking sector. Furthermore, this shift to online shopping and banking has increased price and competitor transparency, meaning that allocative efficiency has heightened, bringing the market closer to its societal equilibrium, and meaning that firms must react to market trends to remain competitive – therefore increasing the sustainability of this creative destruction into the future.

Key Take-Aways 

The above processes illustrate creative destruction at work, reacting to the shock event of a global pandemic. The requirement in this instance of an event – Covid-19 – to accelerate, or even to consolidate and finalise this creative cycle could signal that Capitalism’s competitive processes were existent, yet running slow prior to the Pandemic. Taking a wider view, the extension of creative destruction to the public sector, notably with the impacts on healthcare and administrative/bureaucratic processes, ought to introduce a healthy level of heightened innovation and competition to sectors where this has previously been lacking. Whether the impacts of Covid-19 on heightened efficiency here will last remains to be seen, not-least for some areas of clinical research have been negatively impacted by the disruption of the Pandemic, yet many researchers, notably within immunology and drug development, are confident that the streamlined and productive lessons learned will be here to stay.

Furthermore, the sudden requirement for private firms to react and innovate, not only to compete, but in this case to stay financially viable means that lasting effects on firms includes an obligation to be sustainably efficient and inventive, with a new focus on pro-activity rather than re-activity to the next crisis, in order to remain profitable.