Jeremy Warner's Outlook: Rose asks for time as M&S disappoints again

Cult of equity
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The Independent Online

Will Philip Green make a renewed bid for Marks & Spencer? Personally I doubt it, but that doesn't let the M&S board off the hook of having to justify turning down Mr Green's £4 a share. Regrettably there was very little in yesterday's trading update that came anywhere close. City expectations for M&S's Christmas trading period were never high, but by any standards the numbers announced yesterday were dire. Total like-for-like sales were down 5.6 per cent in the six weeks to 1 January, with clothing and homeware down a stomach-churning 8.5 per cent.

Profit hopes have been likewise dashed. These were as high as £800m for this year when Stuart Rose, the new chief executive, gave his strategy presentation last July, and even as recently as November, when M&S last gave a trading update, the consensus forecast was for £700m. Guidance yesterday was that in fact pre-tax profits won't be any higher than a range of £600m to £625m. Nor was the company's explanation of how this had come about entirely satisfactory. Significantly more stock was carried over into the end-of-season sale than was the case the year before, which, together with an estimate for the impact on the Easter sale, has necessitated a stock write down of £40m.

But this doesn't fully explain why profits have fallen so far. Mr Rose insists that the situation would have been even worse but for the company's two Christmas Spectaculars, where prices were knocked down 20 per cent. It's hard to see how. By his own admission, the two discounted days together only added £10m to normal sales, which in a business as large as this one scarcely makes any difference at all.

Whatever. Mr Rose asks not to be judged by these numbers, which he can still reasonably pass off as the legacy of the old regime. On one key aspect of strategy - stock control - he seems to have made significant progress, with forward stock commitments down 25 per cent on a year ago. In theory, this will give him more flexibility to adapt to changing fashions, which in recent years has been a key failing for M&S. He's right to insist there will be no change in strategy. The present one must be given time before it can be judged. It would be ridiculous to announce the strategy on Monday and then tear it up and start again if it wasn't working by Thursday.

But if there aren't at least some green shoots showing through by Easter, than questions can reasonably be asked. Right now he's selling off the previous regime's stock. By Easter it will be largely his own, and although he's said there will be no sales improvement in M&S's 2005/06 financial year, he'll need to show some evidence of a turnaround soon if investors are not to lose faith, and start demanding more radical surgery than presently contemplated. Of course, Mr Rose has to be given time to prove himself, but not too much. When you turn down £4 a share, the pressure is very much on for instant results.

Cult of equity

I don't normally comment on the scribblings of other journalists, but Sir Samuel Brittan, for years the Financial Times' chief economic commentator (though no longer), is more of an institution than a journalist, so his musings are fair game. In his column yesterday, he chose to reflect on what the headline writer called "the long death of the cult of equity". This is apparently only the second time Sir Samuel has ventured into discussing the stock market during a career spanning well over 40 years. In itself this must be some kind of an achievement for a financial journalist.

It soon becomes apparent why, for Sir Samuel doesn't seem to understand the first thing about stock markets. His starting point is a painstaking analysis of the long run, real rate of return on equities. Once you adjust for inflation, he discovers, even the US stock market shows a compound rate of return since the beginning of the last century of only 1.9 per cent, while the long-run average for the UK market is nothing at all. Leaving aside the little matter of dividends, which if added back in would improve these numbers by at least 3 percentage points, this is no more than a statement of the blindingly obvious.

Stock markets go through cycles, with the gains of each bull market mostly wiped out by the subsequent bear market. Here the operative word is "mostly", for over time equities have historically always outperformed inflation if dividend income is taken into account. Of course, if all you do is hug the index all your life, you'll do passably well but you're never going to hit the jackpot, which is why the trend to index tracking, inspired by the bull market of the 1990s when any old fool could achieve spectacular returns, is so flawed.

Successful stock market investment has always been about intelligent stock selection - that, and getting your timing right. The most consistently successful stock market traders tend to be those who enter the wave late and leave it early. Yet even accepting that most people don't have the time or expertise to trade in this manner, equities are still a better performing asset class over time than almost anything else. The one possible exception is property, but again the overperformance of property is a comparatively recent phenomenon that may not stand the test of time.

Equities, on the other hand, self-evidently do, even on Sir Samuel's numbers. The long-run rate of return on equities is hugely better than government bonds, whose value tends to get destroyed by inflation, and is also considerably better than cash, which again is prone to be devalued by inflation if left for too long under the mattress. Equities, on the other hand, give the investor an inflation-proofed stake in economic growth. They are, of course, inherently more risky than bonds and cash with less chance of getting your money back when things go wrong (just think about Marconi to see why), but that is precisely why they carry a better long-run rate of return. That extra return is what investors demand for the risk of holding equities.

Still, no one would disagree with Sir Samuel that the cult of equity has indeed suffered a severe setback. In my view this is less to do with the bear market of recent years than the demographics of an ageing population and the death of the final-salary pension scheme.

Throughout the 1950s, 1960s, 1970s and 1980s, the big occupational pension schemes were the mainstay of the British stock market. As they grew in size and stature, their appetite for UK equities became insatiable. What's more, the outperformance of equities lulled the corporate world into a misplaced belief that pensions could be financed at relatively little cost provided they put most of their money into shares. As these pension funds mature and close, forcing trustees to match liabilities with less risky assets, they've become big sellers of equities, a trend reinforced by the nannying solvency requirements of financial regulators.

That's put significant selling pressure on the UK stock market, creating something of a vicious circle. The longer equities remain depressed, the bigger the pension fund deficits, which in turn further undermines the equity value of the companies who are saddled with them. This is one of the primary reasons why the UK stock market has so badly underperformed other developed economy equity markets in recent years. No other G7 country has such a big, funded pensions industry.

There's no telling when this process might end, but eventually the selling pressure from pension funds and life assurers will be outweighed by the buying of money purchase savers, as the old final-salary schemes give way to defined contribution arrangements.

That Sir Samuel has suddenly noticed that equities aren't doing terribly well any more would seem as good a signal as any that the tide may finally be turning.

jeremy.warner@independent.co.uk

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