David Prosser's Outlook: A nail-biting advent on the high street

Why it's time to call lenders' bluff; Bargains on the stock market
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The Independent Online

Now that door number one on your advent calendar is open, it's time to start playing everyone's favourite Christmas game: chicken on the high street. Who'll lose their nerve first this year? Will retailers really be prepared to wait for a last-minute rush of Christmas shoppers? Or will they cave in to those courageous consumers and start cutting prices sooner rather than later?

In the former camp is Stuart Rose, chief executive of Marks & Spencer, who insists that shoppers intend to spend big this year and that there's no need for retailers to panic. Mr Rose last week pleaded with his opposite numbers on the high street not to start cutting prices any earlier than necessary Christmas shoppers may leave it late this year, but they will be along eventually, he insists.

However, not everyone is so convinced that all good things come to those who wait and there is certainly no shortage of reasons to think that this year's festive season may prove a major disappointment for retailers.

Not least, the GfK/NOP consumer confidence figures published yesterday made pretty scary reading for the retail trade. People now feel less optimistic about their prospects over the next year and about the outlook for the economy as a whole. Most worrying of all for retailers, the area of the survey where confidence seems to have deteriorated most seriously is the extent to which consumers are willing to make major purchases ever greater numbers of them are simply not.

It is clear from the company results that have been published in recent weeks that a consumer retrenchment has already begun. Almost every business with exposure to the consumer to have reported over the past month has complained about slowing sales and warned of even slower times to come. The DIY chain Kingfisher and the pubs group Mitchells & Butlers said exactly this on Thursday.

It's possible, of course, that next week's meeting of the Bank of England's Monetary Policy Committee may provide just the shot in the arm that retailers need, in the form of an earlier-than-expected interest cut. But a reduction remains unlikely until the new year. With inflation running at a little over 2 per cent, the Bank's target level, the room for manoeuvre is marginal. Salary inflation is also still running at higher rates than the MPC's more hawkish members would like.

Where does this leave the Christmas retail season? The answer is that those doom merchants who warn of festive failures on the high street every year have more reason than at any time in the recent past to be right this time around.

There's also a timing problem. Christmas Day falls on a Tuesday this year, which gives consumers a long weekend to do all their Christmas shopping leaving retailers with a horribly nervous wait to see if a rush materialises.

In other words, while Mr Rose is a brave man, consumers once again hold the upper hand this year. Those who leave Christmas shopping for a few weeks yet can expect most retailers to blink first, with all sorts of discounts, price cuts and special offers.

Why it's time to call lenders' bluff

Retailers aren't the only constituency desperate for an interest rate cut. The mortgage lenders' trade body, the CML, yesterday added its voice to the growing campaign for an early reduction. The CML's argument is that in the absence of a relaxation in monetary policy, the financial markets will remain troubled "dysfunctional" in lenders' terms and mortgage providers will find it tough to raise funds. Since only half the mortgage loans made in the UK are financed from savers' deposits, with the rest raised on the money markets, that could squeeze the funds available to borrowers, the CML warns.

It's not an edifying picture. But mortgage lenders can't simply be given a blank cheque. Remember, the reason Northern Rock got into trouble was that its business model placed too much emphasis on funding mortgage advances from the money markets when these froze, the bank was totalled by a liquidity crisis. The CML now seems to be saying that its members need an interest-rate cut in order to prevent a very similar business model coming unstuck.

It's not entirely fair to characterise the CML's argument in this way. Funding 50 per cent of mortgages through the markets is a much less aggressive stance than Northern Rock took (three-quarters of its funds were raised this way). Still, policymakers can be forgiven for not taking too sympathetic a view of lenders' current plight.

Would a major slowdown in mortgage lending cause major damage? It certainly wouldn't do the housing market already under increasing pressure any favours, but there are plenty of people who believe a correction (though not a crash) here would be no bad thing. Borrowers looking to remortgage, particularly from the very cheap rates they took out two or three years ago, might also suffer, though they are not facing the level of interest rate increases that have caused US borrowers coming to the end of cheap-rate deals so much trouble.

In one sense, the argument is academic. If the MPC cuts rates next week, it will do so because it judges that the risk of lower economic growth outweighs the dangers lurking on inflation not because mortgage lenders have demanded a reduction.

Still, policymakers must be careful. The Bank of England's approach to the credit crisis, at least at first, was to concentrate on the issue of moral hazard bailing out stricken financial institutions would encourage further undue risk-taking in the future, it rightly argued. That argument applies as much to interest rate cuts as it does to injections of liquidity into the money markets.

Bargains on the stock market

Why have Western stock markets not been hit for six by the global credit crisis? The FTSE 100 rose again yesterday, back to within 200 points or so of the year's high, and despite credit-related setbacks in recent months, equities have repeatedly overcome short-term tumbles to come back stronger.

Well, here's a radical explanation for the seeming mismatch between stock market movements and the never-ending drip-feed of gloomy financial news: shares are cheap.

Many investors set great store by what might appear to be quite trite trading rules. One of the most accurate of these indicators is a handy little measure known as the rule of 20. It's a very straightforward guide to valuing a stock market if the price earnings ratio of a market and the prevailing rate of inflation add up to more than 20, shares are over-valued. If the total is below 20, the reverse is the case.

Right now, the UK trades on a PE of around 11.5. Depending on whether you use the CPI measure of inflation around 2 per cent currently or the RPI around 4 per cent you get a total score of 13.5 or 15.5. Either way, shares in this country look attractively valued.

Not all investors will feel comfortable with such simple yardsticks, but it's worth pointing out that the rule of 20 has been unnervingly accurate in the past. It works because when inflation rises, interest rates generally go up too, depressing share prices (in other words, PE ratios fall to compensate for higher inflation). Similarly, when inflation falls, so do rates and equities prosper.

Just to throw things forward, equity bulls should note that the Footsie would need to rise above 7,000 for the first time ever for the rule of 20 to begin to be a worry. That would mean the market finally moving above the high recorded so tidily on the final day of 1999. With credit-related troubles dampening sentiment, it may take a little time to get to this level but don't bet against a breakthrough in the new year.

d.prosser@independent.co.uk

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