Jeremy Warner's Outlook: It's October, the month for crashes, yet the market's bout of nerves may be justified

A third bidder pops up for Drax;
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The Independent Online

For stock markets, October has always been the cruellest month. Some of the stock market's worst crashes have occurred in October, from the great crash of 1929 to the final sell-off in the bear market of 1974, the crash of 1987 and the mini crash of 1998. The present correction in equity markets hardly bears comparison with any of these near apocalyptic events, yet it is quite unsettling enough for those of us who thought equities set fair again in a prolonged bull market.

With corporate profits apparently booming, what's spooked the markets this time around? The curse of October may for the superstitious seem explanation enough, yet it's plainly not the whole story. No, the real explanation is the re-emergence of inflation, which is limiting the ability of policymakers to tackle a pronounced slowdown in growth with lower interest rates. Indeed in the US and the eurozone, central bankers are making it plain as a pike staff that they will raise rates regardless of the economic costs if the present oil-inspired surge in prices persists. This is particularly the case in the US, where interest rate rises in each of the next three months look inevitable as the Federal Reserve finally moves to get a grip on inflation. Even our own Monetary Policy Committee seems now to be showing a surprising degree of unanimity in resisting calls for further rate cuts to deal with slowing growth.

According to minutes of the last meeting, released yesterday, members agreed that a tighter policy might become necessary if there was any sign of the present surge in energy prices feeding through to second-round effects in the shape of rising inflationary expectations and higher wage demands. To date, equity markets have been able to take the surging oil price largely in their stride. It now appears that the effect may be rather more significant than generally thought.

Rising oil prices are both deflationary and inflationary at the same time - deflationary because they take money out of people's pockets that would otherwise be available for spending on other things, and inflationary because they drive up costs and therefore prices all round. To respond to a deflationary influence by jacking up rates might seem perverse, yet experience shows that failure to do so can result in an inflationary spiral.

All this damages the outlook for corporate profits, the ultimate determinant of stock-market valuation. You might have thought the fall in the FTSE 100 yesterday bad enough, but it wasn't nearly as bad as the plunge in the mid-caps index, which has been trading at close to its all-time high. The MPC minutes did not make for encouraging reading. Alongside concern about the risk to growth runs a determination to keep inflation well within its box. Mervyn King, the Governor the Bank of England, has already made clear where he thinks the priority lies. Other MPC members seem largely to share his view. For stock markets and policymakers, it is going to be a nerve-racking couple of months.

A third bidder pops up for Drax

Another day and another bid for Drax, Europe's biggest power producer. The market has not been this electrified since British Energy very nearly went belly up three years ago. It was plummeting wholesale electricity prices which almost spelt the death of British Energy, and it is soaring prices which explain the inordinate amount of interest in Drax from rival power companies and private-equity firms.

The company has now received three bids in the region of £2bn and it has rejected each and every one, insisting that Drax will be worth a lot more when it lists on the stock market in December.

Directors base this assertion on the price at which securities linked to Drax's debt trade in the over-the-counter market. But since this is an illiquid market, and since the market maker for many of the trades is Deutsche Bank, which also happens to be Drax's financial adviser, it is hard to gauge whether the price accurately reflects the value of the company.

The latest suitor to make an approach is International Power, supported by its Japanese partner Mitsui. The price is twice what International Power offered to pay for Drax two years ago and, unlike the two other bidders, it comes in a mix of cash and equity so that the banks and bondholders which own Drax can share in the upside should power prices continue to surge.

With the Met Office predicting a 60 per cent chance of a very cold winter, it seems reasonable to bet that the 4,000 megawatts of power which Drax churns out from North Yorkshire is not about to drop significantly in price. Yet it would be foolish of the Drax board to overplay its hand. Already there are claims that the board is resisting a private sale because its directors stand to make a lot more money by floating the business.

Drax insists it merely wants to obtain a fair price for the company. To that end it has invited the bidders to make their best and final offers by early next month. The Drax board has done well to engineer an auction for an asset which could easily fall in value in the future, given the vagaries of the wholesale power market and the ever-increasing environmental curbs on fossil-fuelled generation. It would not pay to be too greedy.

Roche: a blessing or a curse?

Roche, the Basel-based pharmaceuticals giant which makes the only effective treatment for bird flu, is on a roll. It's not just Tamiflu which is putting a rocket under sales. The company also lays claim to a number of other revolutionary new treatments with billion-dollar sales potential, including Avastin, a treatment for colon cancer, and Herceptin, hailed as a potential cure in some patients for breast cancer. Both were developed by Genentech, in which Roche has a two-thirds stake.

Group sales in the third quarter surged 17 per cent, and by the look of it there's a lot more growth to come. Such a success would to most of us look like something worth celebrating. Regrettably, that's not a view shared by the UN Secretary General, Kofi Annan, and others who accuse the drug companies of profiteering from the misery of the sick. How wrong can you be?

The contradiction that lies at the heart of the pharmaceuticals industry is that it needs to generate substantial profits to advance the process of drug discovery, yet whenever it finds a miracle cure or treatment there's enormous moral pressure to distribute it for free or at prices affordable for all. Patent laws, which in most cases have a seven-year expiry date, ensure that eventually this happens anyway. The question has always been to what extent drug companies should be allowed to profit from their inventiveness in the meantime.

The latest battleground is Tamiflu, which Roche's chief executive, Franz Humer, seems to be handling with some skill. There is as yet no pandemic, so to demand that the product immediately be made available for generic production seems premature. There is no good reason why Roche shouldn't be allowed to profit from precautionary stock building by governments. Mr Humer promises swift action to let others manufacture the drug should the need arise.

Even this is thought of as inadequate by some Asian countries in the front line of the bird flu threat. Yet if the free for all demanded were applied as policy in all cases of medical need, there would be no Tamiflu or Herceptin in the first place. It's money that drives the development of all these treatments; without it, we would be back in the dark ages of a humanity consumed by illness.

In Britain, the Office of Fair Trading has bizarrely announced an investigation into the pharmaceutical price-regulation scheme. It meddles at everyone's peril with a system which almost uniquely in Europe has managed to strike the right balance between allowing decent levels of profit in return for high levels of investment in British research and development. We may as a consequence pay a bit more for our drugs, but it also helps position us at the forefront of this high-growth industry.

j.warner@independent.co.uk

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