Jeremy Warner's Outlook: HBOS is delivering, but when the boss has gone what does Hornby do for an encore?

Gas prices: a case of too little regulation; Emerging markets: the exogenous threat
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The Independent Online

James Crosby, the chief executive behind the renaissance in the affairs of the mortgage bank HBOS, leaves for pastures new this summer. After such a spectacular run-up in the share price, is this the sell signal that investors should be looking for? The zenith in a company's affairs is frequently marked by a change in management regime. Might that be true in this case too?

There was little sign of it in the numbers announced yesterday, other, perhaps, than in the slippage apparent in the mortgage book. Halifax is meeting its targets on share of new mortgage lending; where it seems to be failing is in customer retention, which doesn't presage well for future profitability.

Still, for the time being this is a comparatively minor concern in an organisation which otherwise seems to be firing on all cylinders. The strategy of attacking the soft underbelly of more dominant suppliers in current accounts, small business lending, insurance and long-term savings continues to pay rich dividends, with a good few years of growth potential left in it yet before it starts to run out of steam.

For Andy Hornby, Mr Crosby's successor, this is a glass half full, rather than half empty. The addition of a further 50 high street branches at a time when most other retail banks are closing theirs, demonstrates a confidence in the formula that few can match.

Nonetheless, there will come a time, possibly sooner than the market expects, when the targets are achieved and the growth begins to stall. What then for Mr Hornby? As things stand, a major overseas acquisition is a definite no no for an organisation which prides itself on its capital discipline. But nor does Mr Hornby want to end up another Lloyds TSB, with nowhere left to turn.

Gas prices: a case of too little regulation

Who is to blame for spiralling energy bills, the latest examples of which come from Powergen, Britain's second biggest energy supplier? The lazy explanation, frequently cited by both the regulator and the suppliers, is the scandal of Europe's unliberalised energy markets, which are alleged deliberately to have starved the UK of cheap sources of supply. Yet we should perhaps look first to the mote in our own eye.

Plentiful supplies of cheap offshore oil and gas have lulled these islands into a false sense of security over our energy needs. Now, as these supplies begin to run dry, we are having to pay the price.

Throughout the 1990s, producers were profligate with what should have been treated all along as a scarce resource to be used sparingly and wisely over time. Instead, they over supplied, driving prices to artificially low levels bound to encourage overuse. This in turn led to a "dash for gas" where great swaths of pre-existing electricity generating capacity were made uneconomic by this apparently limitless supply of cheap feedstock.

With a large part of Britain's generating capacity now wholly reliant on gas, there is some evidence to suggest that these very same producers are deliberately restraining output so as to drive prices up. In any case, Britain is becoming ever more reliant on more expensively priced imported gas.

These flaws in the system have little to do with the monopolist Europeans, but rather are largely down to the deregulated nature of our energy markets. A scarce resource has been squandered in pursuit of short-term, market-driven profit.

In the meantime, insufficient provision has been made for the growing depletion of our offshore sources of supply. Failure to put in place long-term supply contracts and storage capacity has left us cruelly exposed to volatile market prices, particularly at times of peak demand.

Why would the Europeans want to sell to us from their own stored supplies of gas when their priority must be to service their own customers at tolerable prices first? They've had years of reliance on imported energy, and have invested in storage and long-term contracts accordingly. It's a bit like asking someone who has saved his lunch because he knows he won't get any supper to give you some of his because you've already scoffed your own.

In energy supply at least, the short termism of the market does not appear to have served us well. The current energy review must address this failing as a matter of urgency.

Emerging markets: the exogenous threat

A visitor from Mars would need only to glance at the performance of emerging market equities over the past three years before yelling "Sell!". Up and up they have gone in a manner which has left past peaks far behind and made the performance of stock markets in more developed economies look pathetic by comparison.

Experience teaches that what goes up like a rocket comes down as a spent stick, so even acknowledging that many of these countries will continue to be the fastest growing economies in the world for many years to come yet, is this not a bubble in the making, or, more worryingly, a bubble already made and about to burst?

Typically, stock markets correct sharply after such a sustained bull run, yet the case for further gains continues to be powerfully argued. Emerging market equities may already have shown spectacular gains, yet by Western standards they remain inexpensive.

On average, the discount is still about 25 per cent. Earnings are also growing at a much more rapid rate than is typical in developed economies. If equities are both cheaper per se and showing much higher levels of earnings growth than their Western counterparts, then even allowing for the political, currency and financial risks, the case for further support is a strong one.

What's more, the bulls argue, the risks are in any case far lower than they were. Since the emerging markets crisis of the mid to late 1990s, most of these economies have embarked on root and branch policy reform. Banking systems have been bolstered, and foreign currency reserves rebuilt. The risk of calamity has as a consequence been massively reduced.

Even so, there are obvious concerns. Interest in emerging markets is caused at least in part by excess liquidity in the West, which in the search for yield has been driven into ever more high-risk assets. Emerging markets are also the new big thing, rather in the way that technology and the dot.coms were in the late 1990s. Investment fashion alongside easy money can be a particularly deadly combination.

The reassuringly strong fundamentals, moreover, are in large measure just a function of booming commodity prices. If these were to go into reverse, many emerging market equity prices would suffer accordingly. Paradoxically then, one of the biggest threats to the buoyancy of emerging market equities comes not from these economies themselves, but from America.

This bizarrely makes the US housing market perhaps the most important bellwether available of emerging market equity risk.

Commodity price spikes generally contain within them the seeds of their own destruction. Historically, they have proved highly inflationary, which has eventually caused policy makers to tighten interest rates, leading to a downturn in economic activity and a slowing of demand for commodities. This time around, there has been surprisingly little in the way of second round inflationary effects from rising oil and commodity prices, which has enabled central bankers to keep rates low and growth strong.

Just how long this happy state of affairs might last is one of the $64,000 questions in economics today. It is also one of the reasons emerging-market strategists watch the US housing market so closely. If this begins to fall off a cliff, then the fragile ecosystem that sustains the present environment of strong economic growth will in all probability go with it.

As money is pulled back from the peripheries to the centre, it will be the emerging markets that get hit worst. Or as John Lomax, emerging markets equity analyst at HSBC, puts it, "the risks are much more exogenous than endogenous". You have been warned.

j.warner@independent.co.uk

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