The Big Question: Does the rise in the stock market herald a boom in the economy?

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The Independent Online

Why all the excitement?

For share prices, stock traders and investors in the UK, the only way is up. The FTSE 100, the famous index of the leading companies on the London stock market, has scored a fresh five-year high for the sixth day in a row. Yet unemployment is rising and the economy is slowing.

Do share-price movements reflect the real world?

The answer, as ever with economic questions, is "yes" and "no". It's certainly true that share prices are going great guns. The London stock market has risen in an almost unbroken line since it hit a low in the immediate run-up to the 2003 invasion of Iraq, to close yesterday at 6,172.4, its highest since 2001.

On the other hand, the index is still well short of the all-time high of just short of 7,000 points struck on the final trading day of the last millennium. The five-year high is relative to the market in 2001 when the market was in a free fall, following the terrorist attacks on September 11. The 9.4 per cent gain so far this year has been outpaced by many European rivals.

It's true that the UK economy is slowing. Economic growth over the summer quarter - from April to June - was estimated at 0.8 per cent. It was then revised down to 0.7 per cent. Some forecasters believe that the first estimate of growth in the third quarter that ended in September and will be published on Monday could show a number as low as 0.4 per cent. To put that in context, economists believe that the long-term trend for the economy is growth of around 0.6 to 0.65 per cent. Unemployment has risen by 280,000 over the last year

Again there is a positive side. Employment is at a record high level, house prices are rising and consumers are happy to borrow and spend on the high street.

So, what are these figures telling us?

Share prices generally tell what investors think will happen six or so months into the future. More specifically, it says where they think company profitability is going. There is certainly no disconnect there. Net rate of return - the amount of money that companies are making as a proportion of their assets - is growing at a record pace. It rose at an annual rate of 14.7 per cent in the second quarter, the fastest since 1989. Before that they only measured it once a year and on that basis there is no higher figure since records began in 1965.

The FTSE 100 is heavily weighted towards companies that make their profits overseas. More than half of their incomes come from abroad - and that proportion is rising. The latest figures from the International Monetary Fund show that the world economy is on track to post annual growth of 5.1 per cent this year, following 5.3 and 4.9 per cent in 2004 and 2005. Next year may slow - but only to 4.9 per cent. In fact the world had not seen four unbroken years of growth above 4 per cent since the early 1970s.

Some of these companies are not even British firms. Mining companies from all over the place - Xstrata from Switzerland, Antofagasta from Chile and BHP Billiton from Australia. The latest addition to the FTSE 100 is Kazakhmys, a recently privatised copper miner in the former Soviet republic of Kazakhstan.

Are we benefiting, then, from globalisation?

Depends what you mean by "we". Certainly the City of London is. While London is a preferred choice for companies looking to raise money, especially in the wake of the security-driven controls put on companies operating on Wall Street. But share prices have been driven up by a spree of mergers and acquisitions of UK companies by overseas rivals.

Figures published just yesterday by the United Nations' Conference on Trade and Development (Unctad) showed that Britain was the preferred location for foreign investment - bar none. Overseas investors poured some $165bn (£85bn) into the UK in the form of takeovers, new investments - building a factory - or expanding existing investments. The spree has seen a list of the blue-chip UK companies fall into foreign hands - Allied Domecq, the airports company BAA, the phone company O2, BOC and Pilkington. The London Stock Exchange itself may soon be snapped up by a European or US rival, while Centrica, which owns British Gas, was at one point going to be snapped by the Russian government, of all people.

What does it tell us about the economy?

It shows that the stock market is being driven by the free movement of vast sums of money looking for the best profit opportunities around the world. Thanks to the actual demolition of the Berlin Wall and the "virtual" removal of the Great Wall of China that separates some 1.2 billion people from the rest of the world, the supply of workers in the market economy has doubled. This has massively increased the options for capitalists looking for workers to do their bidding.

While this process has helped lift living standards among the poorest in the world and rewarded - possibly to a gross extent - owners of capital and their executives, the people who have been squeezed are those in the middle - blue- and white-collar wage slaves. As the Government's own investment agency admits, the average weekly wage rose by just 2.8 per cent last year - a real increase of just 0.6 per cent after taking account of inflation.

What happens next?

While the stock market's fortunes might be made abroad, the fortunes of the economy are still broadly made at home. The economy has been sustained by consumers' willingness to take advantage of historically low levels of interest rates. But with interest rates, utility bills and until recently, petrol prices, all rising, consumers may be forced to cut their spending. Meanwhile the strength of sterling could stymie the nascent recovery in UK exports. And the stock market? Opinions vary across the City. Clem Chambers, chief executive of stocks and shares website ADVFN, has a simple aphorism: "All you have to know is whether it is going up or down. If you don't have a view on that you shouldn't be in the market. Look at the market and it's going up."

Does it matter if UK plc and the FTSE diverge?

Yes...

* Companies that come in buy or invest in the UK can leave as quickly - it is less reliable than domestic growth

* Free movement of capital that does not deliver rewards to the workers can leave to growing resentment, which its own malign side-effects

* A booming stock market may simply camouflage major problems in the domestic economy until it is too late.

No...

* Being an attractive destination for investment will have knock-on benefits for jobs, skills and growth

* The City of London is a money machine. Financial services provides almost 9 per cent of GDP growth

* Taking measures to limit would simply put in the same camp as US politicians who black any takeover by an Arab company

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