Jeremy Warner's Outlook: Share prices ride out the credit storm

Now Branson wants to add Rock to Virgin; Stealing the Tories' clothes on tax
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The Independent Online

Is Mervyn King's much-criticised refusal to bail out credit markets going to be vindicated after all? With share prices in London again trading at close to their recent highs and in many parts of the world at an all-time record, it seems reasonable to re-ask Jim Callaghan's immortal question: crisis, what crisis?

Even the most seasoned observers of stock markets confess themselves to be amazed by the apparently blasé way in which share prices have been able to disregard one of the worst credit dislocations in living memory. What's going on here?

The main answer lies in the continuing economic boom in Asia. Look for the stocks which have led the bounce-back in share prices since mid-August and they are, in the main, those with some sort of Far Eastern, or emerging market, exposure – mining stocks and telecoms in particular. Vodafone's $11bn acquisition of Hutchison Essar in India, much criticised at the time as too expensive, is now beginning to look positively inspired.

Publicly traded share prices long ago ceased to be a mirror for what was going on in individual, domestic economies. This is particularly the case with the London Stock Exchange, which is perhaps the most internationally orientated stock market in the world with well over half the profits of the FTSE 100 share index coming from overseas.

No fewer than six of the FTSE 100's constituents are mining finance houses, heavily influenced by the boom in Asian demand for metals. Three of the index's other major constituents are oil companies, which are similarly influenced by rapid economic growth in Asia. Yet even London share prices cannot remain entirely immune to what's going on in the US and European economies, and here the outlook is for a marked slowdown in growth, certainly next year and possibly for several years thereafter. What's more, one of the long-term consequen-ces of the crisis in debt markets will be to make credit both scarcer and more expensive. This is already apparent in both corporate and mortgage lending.

The key point, however, is that it is really quite unlikely there will be a recession. As long as this remains the case, then corporate earnings – the main determinant of share price valuations – ought to show resilience. Companies heavily exposed to the consumer economy in the UK will no doubt suffer. Those with links to the housing bonanza may also have had their day. But well-capitalised larger caps with reliable dividend streams are beginning to take on safe-haven characteristics. The rise of the sovereign wealth funds – the subject of a report yesterday by Merrill Lynch – provides further long-term support for share prices. European equities should be a particular beneficiary as these funds diversify emerging market savings away from their traditional home in dollar assets. Not good news for the dollar, whose past strength has relied heavily on big inflows of foreign capital, but another plus for London share prices.

The crisis in credit markets is by no means over, so there is plenty of scope for further short-term volatility in stock markets as more dead bodies are unearthed. But the longer-term outlook remains favourable.

Now Branson wants to add Rock to Virgin

At first sight, the City struggled to take news of Richard Branson's stated interest in Northern Rock seriously. They'd call it Northern Virgin, said one smart arse, if that wasn't a contradiction in terms. Yet provided Sir Richard can come up with the goodies, what's proposed is actually not such a bad idea. Certainly he seems to have some impressive backing, even if virtually all the important detail has yet to be announced. Is he prepared to pay up, or is he, like JC Flowers, another nickel and dimer hoping to take advantage of the crisis to get the assets for nothing.

At root, Northern Rock is still essentially a sound business, though obviously it is hard to argue this point of view given the debacle of recent months. Yet the under-lying loan book is of high quality. The problem is that nobody other than the Bank of England is prepared to lend Northern Rock the money to finance it. As soon as this lending famine goes away, then the company is worth something again. With a big balance sheet behind it, Northern Rock would be back in business.

The consortium says it may be prepared to inject the thick end of £1bn for a controlling stake in the business. Sir Richard's own contribution to the party would be the Virgin brand and the assets and management of the current Virgin Money business. As a trusted name, Northern Rock is toast, so the introduction of Virgin theoretically provides a neat solution to the evident rebranding challenge.

Virgin has had big ambitions in the UK mortgage market ever since recruiting Jayne-Anne Gadhia from her previous position as managing director of Royal Bank of Scotland's mortgage business. Jumping into bed with Northern Rock immediately gives Virgin nearly 10 per cent of the UK mortgage market.

So it all makes sense. The main unanswered question is, as ever, price. The consortium refers to buying in at a discount to the current share price and seeking a Rule 9 waiver. This is the rule that obliges any acquirer of more than 30 per cent of a company's equity to bid for the rest. The consortium wants control, but for the Rock to soldier on as an independently quoted company.

It's the size of the discount and the extent of the dilution that everyone wants to know about. This is not just some Friday afternoon fishing expedition, says the consortium. We have a plan. But what are the terms? These are said to depend on how much it costs to refinance the loan book. Citigroup has made an offer in this regard, but there are undoubtedly alternatives.

Whatever Sir Richard comes up with, it must be an improvement on the sort of nonsense proposals for taking on Northern Rock we've seen to date. Many of the mooted rival solutions amount to little more than run-off, while all of them in present form look like attempted theft.

The presence of Sir George Mathewson, former chairman of Royal Bank of Scotland, lends the Virgin project a credibility it wouldn't otherwise have. Good luck to Sir Richard. This is the best news they've had at Northern Rock since the whole sorry saga began. Northern Rock seems to have a future after all.

Stealing the Tories' clothes on tax

The Chancellor was widely accused of stealing Tory ideas on taxation for this week's mini-Budget. There is nothing wrong with this. If an idea is a good one, then there is no reason why the Government shouldn't copy it. There is no copyright on ideas. What's more, governments that want to stay in power have to bend with public opinion. There is no point in ideologically clinging to the principle of penal rates of inheritance tax if you are going to lose the election for doing so.

Rather, what's wrong with tax policy is its extreme politicisation. All tax systems should aspire to fairness and simplicity. Constant tampering for political ends has made the British tax system the very reverse. The Tories haven't yet offered any kind of a credible alternative to this meddling. Indeed, everything they have come forward with so far is just more of the same, which is what makes their best ideas so easy for Labour to steal. The game is simply one of robbing Peter to pay Paul, of finding ever more byzantine and gimmicky ways of bribing the voters with their own money.

Are not the public getting fed up with all this posturing? So many of our decisions have become based on the way we are taxed, prompting multiple distortions in market behaviour. This cannot be right. Curiously, David Cameron has not yet tried to make political capital out of the overall tax burden, or not much anyway. It's about time he did, for if there is no monopoly any longer on ideas in tax policy, there can at least be a clear demarcation line in public debate over how heavily the burden should fall.

j.warner@independent.co.uk

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