Jeremy Warner's Outlook: Iran's underestimated threat to markets

After a week away from the office, I'm more convinced than ever that the most immediate threat to the health of stock markets is neither the slowing world economy nor even the ongoing credit crisis. Rather it lies in geo-political developments, and in particular the tinderbox that is the Middle East.

Equity prices have so far proved remarkably resilient to the shocks that have been thrown at them. Even the summer credit crisis, one of the severest of its kind, has been like water off a duck's back. Only a fool would think the crisis that has gripped debt markets entirely over, yet the FTSE 100 is now back to where it was before the turmoil began.

Likewise with the ever-rising oil price, which, adjusting for inflation, is now close to where it was during the great oil price shocks of the 1970s. This, too, has failed to have any notable effect on the overall value of equities. Dig down into the detail of share price movements and, of course, it is a very different picture, with the companies and sectors directly impacted by these disturbances quite badly affected.

Yet the big picture is one of still buoyant stock markets. The reasons for this are well rehearsed. Normally, any slowdown in the US would send a chill through world markets. This time around, the traumas of the American economy are being offset by self-sustaining levels of growth in emerging markets.

Developments in the international economy are mirrored in Western stock markets, many of whose major constituents are companies with global exposure. For instance, more than half the profits of the FTSE 100 comes from overseas.

If even a US slowdown, a soaraway oil price and one of the worst credit crises in living memory cannot derail the bull market, what might? One possibility is a sharp slowdown in emerging markets, and in particular some sort of a hiatus in the Chinese development story. The now-extreme imbalances that have built up around the Chinese economic miracle make an eventual setback virtually inevitable.

Yet the threat which markets have paid insufficient attention to is that of American military intervention in Iran. The US armed forces are already far too stretched for a full-scale invasion, and in any case, even the trigger happy President Bush would think this a bridge too far. Yet he is not alone in his determination to prevent Iran from getting the bomb, which may now be no more than two to three years away.

Targeted bombing to disrupt or destroy Iran's nuclear ambitions is therefore a real possibility, notwithstanding America's already heavy military commitment overseas, and might even command the support of a number of the Democrat presidential hopefuls. After what happened in Iraq, intelligence can no longer be used as the pretext for such action. Yet the Iranians don't help themselves in this regard. There may eventually be an incident of Iranian connivance in attacks on US troops in Iraq serious enough to provide a decent enough excuse to send in the missiles.

However well-executed and smart the targeting of nuclear facilities, the effect on markets would probably be catastrophic. Indeed, the Iranians' best defence may be the brutal assessment of economic consequences that advisers will already have served up to the Bush administration.

The oil price, already at levels which in previous cycles might have tipped the world economy into recession, would go through the roof, stock markets would be rocked, business and consumer confidence would nosedive. The Fed has had to fight hardall summer to preserve financial stability. This might well be the straw that breaks the camel's back. We seem to have survived the credit crisis, but if this is to be followed by a fresh crisis in the Middle East, it would merely be out of the frying pan into the fire.

Nobody can know the future; the outlook for markets is always going to be in the hands of politically determined decisions of this sort. Yet investors under-estimate the threat of an Iranian strike at their peril. The Washington mood music points to just such an intervention, a view shared by a number of Wall Street veterans. Many investors chose not to believe the US would be stupid enough to go to war in Iraq, despite mounting evidence to the contrary. Markets may be making the same mistake over Iran.

Golden goodbyes for Stan the Man

"Who's next?" is the question on everyone's lips following news that Stan O'Neal is stepping down as chief executive of Merrill Lynch. Yet though it would be plain daft to rule out other defenestrations, Stan the Man does seem to be something of a special case – and there is no reason to believe other sub-prime-scarred bankers will feel similarly tempted to fall on their swords. If Chuck Prince, chief executive of Citigroup, also takes the bullet, the sub-prime crisis will only be the pretext for perceived deeper failings in his leadership.

As for Mr O'Neal, his position became indefensible. The scale of the sub-prime losses that he allowed Merrill Lynch to expose itself to almost defy belief, and can only be explained by a lack of understanding of credit risk more generally. Merrill Lynch should have stuck to its roots in broking. Instead, Mr O'Neal tried to ape the success the likes of Goldman Sachs was achieving in high-risk trading. Lacking the skills and traditions to cope, the strategy predictably failed.

Mr O'Neal then compounded these mistakes by first hopeless underestimating the scale of his losses, and then going off on a jolly of his own, and without reference to the board, attempting to hammer out a merger with a rival bank. The lesson is an old one – stick to your knitting.

That sinking feeling at Northern Rock

Let us lay one myth about Northern Rock to rest. This is the one, much touted by potential bidders for these assets and for some reason regularly parroted by the financial press, that the company is worthless. The sooner it's put out of its misery the better, everyone says. It's an outrage that the shares are still trading. They should be delisted to prevent the scandal of this false market persisting a moment longer.

All this is, of course, very helpful to self-interested bidders but a travesty for shareholders. The likes of Paul Myners and others would not be putting their names to potential bids if they thought the company a basket case. In fact they expect to make a shed load of money from it. The less they pay, the more they will make.

What obviously is the case is that the assets are indeed worthless unless a cheaper way of financing them can be found than the Bank of England and Treasury facilities. Both the Government and the Bank are also keen to disentangle themselves as quickly as possible.

Their desire to be off the hook may mean they'll accept a deal at almost any price. Anyone able to finance the loan book on reasonable terms therefore has the chance of a bargain. One of the deeper ironies of the situation is that the source of this finance may indirectly end up being the discount windows that the Federal Reserve and the European Central Bank have so freely provided to distressed credit markets, but the Bank of England has refused to put in place for our own.

Northern Rock may not have been in trouble had these facilities been available in Britain. Northern Rock is not intrinsic-ally worthless. But it is if the Government and the Bank of England choose to make it so. Or choose to hand its value to vulture capitalists on a plate.

Takeover censure for Standard Life

It takes some doing to be censured twice in a single day by the Takeover Panel. But this is the dubious distinction achieved by Standard Life, whose chairman Gerry Grimstone should know the rules as well as any. He was once a senior corporate finance director at Schroders.

j.warner@independent.co.uk