The cuts and the private sector
The private business sector has mainly been positive about government cuts, even gleeful at first. But, as we have pointed out, the private sector will also be hit by the cuts – about 30 per cent of public sector spending goes to private companies.
Connaught, the social housing services provider, was one of the first to be hit, issuing a profit warning, followed by a drop in their share price. Recent reports have warned that the FTSE 250 company is in talks with its lenders and share prices fell by more than 80 per cent. Other companies with large government contracts are now feeling the pinch as well:
- IT provider Capita, regularly reported as “defiant”, saw its share price fall about ten per cent and a UBS report downgraded the company from “neutral” to “sell”.
- Earlier this month, Cable and Wireless shares fell 20 per cent after the company said that UK government cuts would force down the profits they expected. (It is not common for a company that relies on government spending to blame the government publicly for its difficulties.)
- Goldman Sachs and JP Morgan Cazenove have warned against Logica shares because the company relies heavily on government contracts.
It isn’t only firms with large government contracts that are going to be hit. The F.T. reports that investment bankers Execution Noble in a report on Investing for Austerity recognise the obvious – that cuts will hit growth:
“The UK government’s commitment to reducing the structural deficit raises the question of whether it is possible to cut debt via spending cuts and tax increases without significantly increasing unemployment and reducing consumption. Current economic forecasts suggest that it is. We take the view that a period of fiscal austerity will result in a lower level of economic growth than is currently being forecast.”
They are therefore recommending that UK shares generally are worse bargains than they look:
“Given our more pessimistic view on the UK economy we have reduced our expectations for the UK equity market in 2010. While we admit that on traditional metrics the UK equity market looks cheap, we believe earnings upgrades have peaked and expect incremental cuts from here. We have already seen evidence of how fiscal austerity measures and budgetary cuts have impacted a number of UK companies and we expect this to become more of an issue as the year progresses. As a result we have reduced our year end FTSE 100 target from 5950 to 5400 and no longer expect smaller companies to outperform.”
Perhaps some of the business figures who have been cheerleaders for cuts may start to recognise that, to coin a phrase, we’re all in this together.