Jeremy Warner's Outlook: Foreigners see a bargain in UK stock market

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The Independent Online

This week, UK shares reached a new record high, finally superseding the peak they achieved at the turn of the century. Come again? OK, OK, so the index that reached its new peak was, in fact, the FTSE 250. Made up of companies whose earnings substantially and in some cases wholly come from Britain, the FTSE 250 has been flirting with the record for some months now.

This week, UK shares reached a new record high, finally superseding the peak they achieved at the turn of the century. Come again? OK, OK, so the index that reached its new peak was, in fact, the FTSE 250. Made up of companies whose earnings substantially and in some cases wholly come from Britain, the FTSE 250 has been flirting with the record for some months now.

Yet the much larger FTSE 100, which is populated by multinationals, still stands at just 71 per cent of its peak. Perhaps regrettably, the FTSE 100 accounts for 80 per cent of the total value of UK quoted companies. The FTSE 250 is just 18 per cent, so it has little impact on the overall value of the UK stock market. None the less, the FTSE 250's soaraway performance does rather explode the myth that the relative underperformance of the UK stock market over the last eight years compared with stock markets in other developed economies is down to anti-business policy by the Labour government, over-regulation, and the decision to abolish the tax credit on dividends.

I don't want to act as an apologist for the Government, but I've never found this argument convincing. The relative performance of the two indices seems finally to explode it. More than a half of earnings in the FTSE 100 come from overseas, whereas in the FTSE 250 it is only about 35 per cent. If it was Labour that was doing the damage, logically the 100 should be outperforming the 250.

In fact, the real causes of underperformance are vastly more complex. For instance, nearly a quarter of the total value of the UK stock market is accounted for by just four companies - BP, GlaxoSmithKline, Shell and Vodafone. The vicissitudes of these stocks have virtually nothing to do with the UK economy, even though all four companies are domiciled here. Rather they are ruled by forces, incompetences and sentiment that are global in nature. Three of them are in any case run by foreigners.

The FTSE 100 is dominated by sectors which are international in nature - pharmaceuticals, telecoms, financials and mining - whereas the 250 is much more domestically orientated, property, retailing and housebuilding all being sectors which performed exceptionally well last year.

There are other factors too which lead to the conclusion that the underperformance of the UK stock market is more a structural than a political phenomenon. If it were all down to Labour policy, as sometimes suggested in the City and the Tory press, then earnings would be flat or lower than they were when Labour came to power.

Since the value of the stock market has barely moved in that time, valuations should be correspondingly the same or higher. In fact they are lower. Indeed, in the 250, valuations are significantly lower. The earnings multiple on the 250 has fallen from 25 to 19 since 2002, despite the rise in the index, this because earnings have been storming ahead.

So if in fact corporate profits are rising, how to explain the relative underperformance versus the US and Europe? The abolition of the tax credit on dividends has obviously made UK equities less attractive than they were, but the more important reason in my view is structural selling by the big pension funds and life assurers.

This in turn has quite a bit to do with increased solvency regulation, though much of this is international in nature rather than imposed unilaterally by the UK. However, the bigger influence is simply the fact that the UK has a much bigger funded, final-salary pension sector than Europe. Since the late 1950s, pension funds have been substantial buyers of UK equities. Now that these funds are maturing and closing, meaning that liabilities must be matched by the "safer" assets of bonds and cash, they are wholesale sellers.

Indeed, with the retail investor still substantially out of the stock market, the only significant source of buying for the UK market is from overseas investors. Strange that it takes a foreigner to recognise a UK bargain, a fact confirmed by Office for National Statistics figures yesterday, which show inward investment by overseas investors and companies on a strongly rising trend. For them, at least, Britain seems an attractive place to be. As Labour sails towards another landslide victory at the polls, that seems to be the judgement of voters too. The reality is that the UK economy has rarely been in better shape, even if the stock market as a whole is still in the doldrums.

Leaden Standard

What a shower the companies that make up the long-term savings industry are. Yesterday brought news of another cut in "bonuses" from Standard Life, just the latest of many. "Bonus" is the term life funds use for what is only the investor's just rewards. Like much else about the long-term savings industry, the word bonus is in truth a con, for it implies that you are getting that little bit extra. Actually it is only the rate of return, but like so much else about this industry, it is designed to obfuscate.

As Standard Life pointed out yesterday, even after the latest bonus cuts, the payout on a 25-year endowment involving premiums of £15,000 would still be £51,220. That equates to an annualised return of 8.7 per cent, which is not bad even if you would have done better by simply tracking the stock market. Yet this is 18 per cent less than you would have got had your policy matured a year ago. Indeed, at the present rate of decline in bonuses, it will be less than five years before the annualised rate of return sinks to little more than the rate of inflation.

Those who took out a policy 25 years ago are still doing quite well. Those who took one out more recently will do appallingly on present projections. Once Standard Life floats on the stock market, there won't be even the prospect of a windfall to look forward to.

These days, the big life companies sell very little in the way of conventional with-profits business. With-profits has been too discredited by the sins of past. Instead the industry concentrates on more transparent, easier to understand products such as unit linked bonds. Yet the approach is still essentially commission, rather than customer driven and it may be no guarantee against future mis-selling.

The savings industry remains light years away from being the customer-orientated dynamo it ought to be. Indeed there seems to be a case of almost total market failure here. The only thing that seems guaranteed to make matters even worse are the Sandler proposals for a prescriptive, simplified suite of savings products, as dictated by the Government. You'd do better literally sticking your money under the mattress than investing in one of these.

No more aid, please

Great news! Nissan is to invest £223m on a fifth model at its Sunderland car plant, safeguarding 1,000 jobs, and all because the lady loves to hand out regional selective assistance (RSA). It is debatable how big a part the £5m bung from Patricia Hewitt really played but the Trade and Industry Secretary herself is in no doubt it was instrumental. Goodness, there must be a general election in the offing.

As it happens, the Nissan sweetener is precisely the kind of state aid that would be banned in future if Europe's new Competition Commissioner, Neelie Kroes, gets her way. She wants the aid budget re-directed from well-heeled multinationals in wealthy states to small companies in poorer ones.

There is a strong case to be made for abolishing subsidies altogether. A bad investment does not become a good one simply because the taxpayers of one country are prepared to subsidise it more heavily than those in another. But as long as EU member states have aid budgets to play with then this beggar-thy-neighbour mentality will remain.

Next up for RSA is likely to be MG Rover, which would like some state aid to oil the wheels of its Chinese rescue deal. MG Rover is just as entitled to seek government support for Longbridge as Nissan is for Sunderland, even if the Phoenix four that run it in the manner of a private fiefdom would seem a less deserving cause. They had better get a move on before Ms Kroes sticks her spanner in the wheel.

jeremy.warner@independent.co.uk

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