Make hay while the sun shines……

Like many of you, I have been reading quite a lot lately about the state of the global economy, in particular the serious problems facing Europe, United States and elsewhere. With so much information coming at us daily, I often ask myself what does it all mean and how will it affect retail business owners.

Whilst I’m not an economist, nor an investment advisor, I have attempted to paint a picture as to how I see the future. Most of what I am saying is pretty much common sense, however I thought I’d share my views.

I hope you find them both interesting and helpful.

Cheers

Michael

In the United States quantitative easing (printing money on a mass scale) has been initiated by the US Federal Reserve to effectively devalue the US dollar and make the currency more competitive, so as to stimulate the economy. In my view this has both positive and negative consequences for the US, however in terms of Australia the action has artificially strengthened the AUD. As far as the retail industry is concerned this has been fortuitous as the majority of retail merchandise is imported, so in relative terms, the cost of goods are far less expensive than they were 10 years ago when the AUD was worth USD $0.60-0.65. Some of this upside has of course been offset by softer retail sales which have been pretty sluggish over the past few years, however compared to retail in Europe and the US, things aren’t too bad here in Australia.

The other major stimulant that central banks all around the world are employing (including our own) is interest rate reductions. We are currently experiencing record low rates, not so good for self funded retirees who are reliant on high cash returns, but very good for young families with mortgages and very good for business. But how long will this last and how can we take advantage of the situation?

Well remember that the short to medium term goal for governments all around the world is to keep stimulating their economies by devaluing their currencies and decreasing interest rates. Last week we saw Japan announce that it too was going to crank up quantitative easing to an entirely new level, so as Japan, US and other major economies keep printing money on an unprecedented scale, inflation is sure to follow. Whilst we all understand that is the actual goal, the central banks are trying to do it in such a way that it is controlled and doesn’t get out of hand. The average cost of living has increased to some extent, however it really hasn’t increased to a great a degree as yet (at least in Australia). However there are some economic forecasters in the US and elsewhere warning that inflation is coming in a big way and when it starts, it will come as a global tidal wave, rather than a slow trickle. That being the case, central banks (including the Reserve Bank of Australia) will move quickly to keep a lid on it, so what does that mean? Yep, you guessed it… a sharp increase in interest rates. When this will precisely occur is anyone’s guess, certainly with US GDP figures released recently showing disappointing growth and continued dramas unfolding in Japan and Europe, I don’t expect anytime soon, but who knows.

What happens if the genie gets out of the bottle and inflation soars? Credit would suddenly become scarce again and interest rates would sky rocket. Remember that the official cash rate in Australia today is 3%, what would a 2% or 3% increase do to people’s mortgage payments, what would it do to your business loan re-payments?

Now imagine if that rate goes up to 16% or 17%. Surely that isn’t possible, rates couldn’t rise that high could they? Remember the late 1980’s and early 1990’s. In January 1990, the official cash rate reached 17.5% in Australia. That was the official interest rate, so commercial lending rates were even higher! Back in early 1991 when I wore a younger mans clothes, I purchased a near new Commodore and was paying 15% interest on the loan – at the time I thought it was a good deal, can you believe that?

So what does this all mean to a retail business owner and how can you take advantage of the situation? In simple terms it means “make hay while the sun shines”. Whilst retail sales remain sluggish, the fact is the cost of capital is unbelievably low and the Australian dollar is unusually very strong, but these conditions won’t last forever.

Here are few thoughts I think are worthwhile considering, but please remember I am not an economist, nor an investment advisor, so these are purely my views only;

Think about your business’ capital requirements in terms of upgrading your shop fitout, back of house, plant and equipment. Regardless of whether you are a small or a large retailer, why not take the opportunity to re-invest and upgrade your operations while the cost of borrowing is inexpensive. With the AUD being so strong, any equipment purchased overseas should be cheaper than ever. Of course be prudent and try not to over extend yourself, but if you need to borrow, make sure that you lock in a low interest rate as it really won’t get much better than this.

If you are negotiating a new lease with a large national landlord, you will find that they are currently offering generous fitout contributions. Larger landlords are able to do so as their cost of capital is generally lower than what you or I could access, so make sure you factor this into your lease negotiations wherever possible.

When negotiating a new lease (or a renewal) try to negotiate the lowest possible starting rent. I know it goes without saying, but landlords are more flexible at present, so make sure you shop around a little and don’t simply accept their first offer.

Avoid market rent reviews and annual escalations geared to the consumer price index. Both review mechanisms are effectively tied to the economy and in a high inflation environment (which it could be within the next 5 years), the last thing you need is large increases in your rent. It would be more prudent to negotiate modest fixed increases such a 2 or 3% annual reviews.

Notwithstanding my first point, try to keep your gearing as low as possible. Pay down debt wherever you are able, including your own personal debt.

We live in an extraordinary time, a period of uncertainty, perhaps a little fear, but also a time of opportunity – To quote the ancient Romans, Carpe Diem……..(Seize The Day) !