The return of interest rates will change business financing

To say 2022 was a tough year is an understatement. Early optimism that there would be a roaring global economy driven by recovery from the pandemic was crushed by Russia’s war in Ukraine and re-start of the cold war. The global economy has been impacted through sanctions, blisteringly high inflation in food and energy and volatility in global politics. The affects in the developing world are extreme and could lead to famines and energy poverty. On top of all of this is the world’s 2nd largest economies continuing fight with the pandemic, adding to the complexity of the global macro picture.

In financial markets the effect on global equity and bond markets has been huge. Global equities declined by approximately 20% last year. In the UK the very largest shares only held ground in aggregate due to a strong dollar boosting sterling returns and the huge profits from global energy and resources prices soaring. In domestically orientated small caps share prices were hit hard. Globally technology and growth stocks have seen some of the largest falls as the cost of equity has risen. Bond yields have soared raising the cost of servicing pandemic-inflated government debt piles and halting activity by corporates as they sort to manage leverage and cash.

While the world is almost certainly in a better place than many feared, the backdrop is complex. Nonetheless we expect corporate activity to pick up as businesses return to their plans. Finance costs have moved back to levels associated with the early noughties. We believe the critical action point for management and shareholders is to test existing financing arrangements with different scenarios and explore options for a future which looks likely to suffer from volatility for some time.

We believe the change in finance costs is likely to rebalance the mix of equity and debt used to build businesses. VC and PE investors increased debt costs will impact returns, meaning lower valuations for vendors as these investors stick to their return hurdles. When interest rates start to level off liquid public equity markets, where debt is used less aggressively, are likely to become more popular again with those seeking to realise value or build a business.

Johnathan Barrett

Director, Research Analyst, Media & Digital