Don't bet on a revival in equities any time soon

Dead cow in a bun
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The Independent Online

With the FTSE100 share index at a new 34 month low, could this be the moment to plunge back into equity markets? Well, don't bet the ranch on it quite yet, would seem to be the answer.

There are essentially two reasons for believing the bear market has got further to run, and no, the prospect of recession is not one of them. As this column has consistently argued, a British recession, as technically defined by two successive quarters of declining GDP, continues to look unlikely and, even in the US, the odds are against it.

What is true, however, is that we can expect at least another year, possibly several years, of sluggish growth, and in some sectors, notably telecommunications and technology, there will be a lot more pain before things start noticeably to improve. But that doesn't mean the whole economy is going to follow these bubble sectors down the pan.

What is also true is that earnings expectations are still too high and that even with the market 25 per cent off its turn of the century peak, valuations continue to look excessive by historic standards. So that's reason number one for thinking the bears will not be beating a retreat any time soon. The second is a related one – that after such a prolonged period of excessive returns from equities, there's bound to be a reckoning and a countervailing period of poor returns. Or as Barton Biggs, Morgan Stanley's veteran equities strategist puts it: "A 20-year bull market with spectacular excesses that created stupendous fortunes out of thin air cannot be corrected by a one-year bear market". Quite so.

Return to mean theory, or the law of averages, doesn't always hold good. The world is a complex place with an irritatingly unpredictable habit of constantly inventing new averages and new means. But with equities, it has never yet failed on any kind of long-term analysis, and there is no good reason for believing it is about to now. Remember the "new paradigm" of the New Economy, a golden age of never-ending low inflation and high growth? As we now know, the internet did not succeed in suspending the usual laws of economics. The business cycle remains intact and so, therefore, does return to mean.

By the same token, however, there is no reason to believe we are on the verge of one of those really serious bear markets, like the 1970s or the 1930s, where earnings multiples collapsed to single figures. Growth may be slowing to a snail's pace, but interest rates and inflation are low too. Only in the telecoms, media and technology sectors is there any sense of companies being seriously overstretched financially. So a long period of poor returns, yes, but not financial Armageddon.

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THE ENGLAND football team is doing considerably better than its cricketers, and so, by the look of it, is Centrica's football mad Roy Gardner, who has been trouncing his cricket sponsoring opposite number at npower on doorsteps up and down the land.

British Gas, the name by which Centrica is known to consumers, has just overtaken npower as Britain's biggest domestic electricity supplier, with 5 million household customers. What's more, he has achieved it at a cost which makes the prices paid by npower to buy market share look about as ridiculous as England's middle order. It costs Centrica an average of £35 to sign a new customer. By contrast, the last deal npower did, the purchase of Northern Electric's supply base, cost £270 a customer.

Of course, it is much easier to build an electricity business cheaply when you start off with the kind of monopoly position and installed customer base that British Gas already had in the energy market. Even now, five years after the gas market first began to be liberalised, British Gas still commands nearly 70 per cent of the domestic market. Centrica reckons it can get to 7 million UK electricity customers comfortably. It is also intent making big inroads in telecoms, where its target is a 10 per cent market share, and even in water, provided it can find the right deal and the right partner.

But that, as they say is the easy part. Mr Gardner's dream of repeating his UK success in the North American and European markets will be a lot harder and a lot more expensive to achieve. Centrica is gunning for 10 million customers in the US and 5 million in Europe. At least half those will have to be bought with serious money.

In Europe, the slow pace of deregulation could hamper Centrica. In the US there is the familiar danger of overpaying for poor businesses – a trap which UK companies have fallen into time again. Shell, which is no soft touch, decided this week to pull out of the US retail electricity market because of volatile prices and the uncertain economic outlook. Investors should be monitoring Mr Gardner's overseas ambitions very closely indeed.

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DIAGEO HAS got itself into a frightful pickle with Burger King. While the drinks side of the group seems to be firing on all cylinders, Burger King continues to wilt, which is hardly surprising what with BSE and our increasingly health conscious eating habits. The art of good management, however, is to take note of the trends and adapt, and in this department Burger King has been a lot slower off the mark than its larger competitor, McDonald's. There's no point in beating about the bush. Burger King has been a quite poorly managed business all round.

All this is causing indigestion at Diageo, which has been trying to get shot of the chain for more than a year now. The once promised demerger looks off the menu until at least the end of next year, while the business is sorted out, and Diageo can't sell it before then without incurring a Whopper of a tax bill.

Burger King's new chief executive, John Dasburg, is due to give us his "vision" for the post-millennial Burger King in November, but it will have to be quite a plan adequately to address a burger market which looks to be in structural decline. Burger King's results yesterday showed underlying sales falling 4 per cent in the US and 9 per cent in Europe. The task is as much about managing decline as anything else.

Burger King has been slow to see all this. Unlike McDonald's, it has failed to reduce its dependence on the traditional hamburger through product innovation. McDonald's has also been smarter in diversifying away from burgers with its purchase of a stake in Prêt à Manger. It has even opened "Golden Arch" hotels in Europe and McCafe coffee bars in the United States. Burger King looks about as cutting edge as a Wimpy bar by comparison

The burger has always been a more deeply rooted part of American eating culture than it has ever been here, so Diageo is probably right to think that returning Burger King to American ownership is the right path, whether that be via a trade sale, buyout or a demerger. Even so, the chain will eventually have to make some sort of an attempt to reinvent itself as a post-millennial healthy eating choice, as McDonald's is trying to, and that's not going to be easy with a name like Burger King. If the company was called "Dead Cow in a Bun", it could scarcely have less appeal.

j.warner@independent.co.uk

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