London stocks brush aside terrorist atrocities, but bigger threats loom large

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The Independent Online

Living with the fear of terrorist attack has regrettably become a fact of modern-day life, not just in the Middle East, but in developed Europe and America too - another unwanted by-product of globalisation, where distant grievances and fanaticisms can easily be transported, like a contagion, from one country to another. It sounds trite to say it, but Thursday's carnage is an almost daily occurrence in Iraq, and still life in that afflicted country manages to carry on somehow or other.

If the activities of al-Qa'ida or whatever group of fanatics lay behind Thursday's outrages were the only things the stock market had to worry about, then the FTSE 100 would be back at an all-time peak and the Bank of England could afford to lay off all nine members of the Monetary Policy Committee. There would be nothing for them left to do.

Unfortunately, there are far worse threats to the health of financial markets and Western economies than the activities of a few deranged fanatics. Some of these were discussed at Gleneagles this week, though understandably they ended up lost beneath the horror of the terror attacks. To that extent, the terrorists achieved their aim.

But once the dead have been buried and their killers hunted down, it is to these bigger issues, set against which the terrorists are just flies to be swatted away, that the headlines must return. Climate change and poverty in the Third World are the ones that managed to squeeze a few column inches of editorial space over the last few days. Yet, drilling down into the more esoteric forces that drive the global economy, some more immediate threats loom.

One of these is oil, the high price of which is already beginning to have a noticeably deflationary effect on economic activity. All over the world, from bond prices to consumer and business confidence, the lead indicators are flashing red. For five long years now, Western policymakers have sustained their economies on a diet of low interest rates and rising public expenditure. Ordinarily, such lax monetary and fiscal policy would have been highly inflationary.

That it hasn't may be largely down to the disinflationary effect of rapid Asian industrialisation. Consumers may now have largely reached the limits of their capacity to spend. If domestic debt is too high, then it doesn't matter how much further central banks cut interest rates to stimulate demand, it may not have much effect.

Global imbalances, both in trade and capital flows, have reached record proportions, with the US sucking in foreign goods and capital on a scale barely imaginable. It's an upside down world that has poorer, developing nations funding the expenditure of the world's richest nation. Common sense alone tells us it cannot be remotely sustainable. Eventually, all these anomalies - the high oil price, excessive consumption, the current account deficit - must logically self correct.

Both these issues - the high oil price and persistent, global imbalances - were highlighted in the G8 statement on the world economy, yet it was strikingly thin on confidence-instilling solutions. If these imbalances correct violently, it would make al-Qa'ida's lethal little display of pyrotechnics look a complete irrelevance by comparison in terms of damage to economic and financial stability. The longer these imbalances persist, the more difficult the hoped-for "smooth" adjustment becomes. "Balanced growth" is the aim, yet there is little enlightenment on how to get there.

Whatever next as 3i buys back shares?

Share buy-back announcements by companies flush with their own cash are two a penny these days, yet the one from 3i yesterday, detailing the purchase and cancellation of more than 400,000 shares, is worthy of more than passing interest.

As a quoted private-equity group, 3i has traditionally been viewed as just another investment trust, albeit a large one. Philip Yea, now a year into the job of chief executive, wants it to be seen as much more, and he seems to be making headway.

Investment trusts do not, on the whole, buy back their own shares at a premium to their net asset value. To do so wouldn't make any sense when nearly all investment trusts trade at a discount and in any case would disadvantage other shareholders. To pay a minority more than the underlying value of the trust's assets would be a kind of theft perpetrated on the majority. Yet that's precisely what 3i is doing with its share buy-back programme, sanctioned at the annual meeting earlier this week. The shares were bought at 683p a share, against a book value of about 600p.

The premium paid in part reflects the fact that the book value of the company's investment portfolio is already at a discount to its real value. 3i is an investor in privately owned companies, not ones whose shares are traded, so valuations are deliberately conservative to reflect the fact that the investments are largely illiquid.

Yet the premium paid also reflects the fact that the stock market is putting a value on 3i's management beyond that of the assets they manage. In essence, a value is being assigned to 3i's continued ability to find new high-growth investment opportunities to replace the old ones. In itself, it was quite an achievement to persuade the City that the company should be allowed to buy back shares at a premium.

Going the next stage and getting the City to see 3i in the same light as other financial services companies, so that it is the business and its rate of return that investors are valuing rather than just its underlying assets, is likely to prove a good deal tougher.

Yet logically, Mr Yea must be right in thinking this is how the business should be seen. The big high street banks trade on multiples of about twice book value, this because they consistently produce a return on equity around the 20 per cent mark. There's a sustainable business in there, so investors are prepared to value these companies at more than their assets would sell for.

Can 3i hope to achieve similar recognition? After the disasters of the technology bubble, 3i is beginning to regain its self confidence. Remuneration is again competitive with other private equity groups, and although 3i is a slightly different type of investor from the limited partnerships that tend to dominate the private-equity world, so are rates of return. Two years ago the company achieved 18 per cent. Last year it was 16 per cent. 3i will need a longer track record than that before it will buy Mr Yea's story, yet he has plainly made an excellent start.

Abbott does the decent thing

Abbott Laboratories was always on a hiding to nothing in resisting Brazilian demands for deep cuts in the price of the company's HIV drug. Drug companies claim they would have no incentive to develop new drugs if they are forced to provide them at or below cost, even if it is just to developing nations. Yet while intellectual property rights must remain sacrosanct, drug companies are also under a moral duty to provide life-saving treatments at affordable prices. They ignore this social duty at their peril.

j.warner@independent.co.uk

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