Jeremy Warner's Outlook: Stock market plunges. Just a temporary loss of nerve, or something a little more serious?

The politics of pensions reform; BAA: How high can Ferrovial go?
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The Independent Online

The sponsors of the Rosneft IPO cannot have anticipated yesterday's plunge in the stock market when they opted to delay the shares listing, yet their decision none the less seems prescient.

All of a sudden, stock market investors are losing their nerve. Yesterday's 2.15 per cent plunge in the FTSE 100, mirrored by indices around the world, was the biggest one day fall in ages and seems to mark a return to the sort of volatility that came to define the last bear market. It is always dangerous to read too much into a single day's trading but many see yesterday's correction as a harbinger of a more generalised outbreak of anxiety in financial markets.

Many readers have accused me in recent weeks of being far too sanguine about the world economy and the stock market. Guilty as charged, though I decline to accept the label of complacency. The causes of yesterday's nervousness are obvious enough. The world economy has been growing like topsy for four years now, and so have global imbalances.

What's more, though inflation as judged by the official numbers appears still to be largely under control, take a look out the window and in the playground outside it is quite plainly running amok. The price of goods has been falling, but the costs of assets, raw materials and some services are still roaring ahead.

With the price of goods kept low by rapid Asian industrialisation, all the excess liquidity created by central bankers to keep developed economies afloat post the terrorist atrocities of 11 September has gone into consumption and asset prices instead. Rapid economic growth in the East has also put a rocket under the cost of oil and other resources. Central bankers have responded by moving into tightening mode. Investors are beginning to worry about a hard landing.

Yet for the time being, I'm sticking with my sanguine view. Bull markets generally need a trigger, an event, or a giant pin that pricks the bubble, to bring them to a close, and so far we haven't had one. Equity valuations continue to look reasonable. The economic expansion is quite plainly set to slow, but bar a complete collapse in the dollar there is as yet little reason to think it about to fall off a cliff. My own guess is that we've got a year or two left of the present cycle, which will climax in a great outpouring of Chinese exhibitionism and hubris at the Beijing Olympics in 2008.

The politics of pensions reform

Forgive my scepticism, but how real is the reported reconciliation between Gordon Brown and Tony Blair on pensions? With Labour's rating plummeting in the polls, the Chancellor is said to have abandoned his objections to restoration of the earnings link - albeit with the target date set two years later than that proposed by Lord Turner's Pensions Commission.

As our report on page 49 reports, Lord Turner also seems to have won the debate on the national insurance rebate, which is to be clawed back for the purposes of further beefing up the basic state pension. Hurrah! Common sense seems to have prevailed.

Yet committing to something that might happen some time after the next election - always assuming Labour wins the next election - costs nothing. When push comes to shove, and people begin to realise that restoring the earnings link will in the long run require quite substantial increases in taxation, will anyone be quite so keen on the idea?

Restoring the earnings link won't eliminate means-testing, though it will possibly help prevent its spread to the majority of pensioners. The later it is done, the less effective it will be in keeping pensioners off other forms of benefit.

Indeed, though the Pensions Commission reckons its proposals could just about live with a two-year delay, anything more would risk undermining the whole endeavour, since by then the basic pension will have shrunk to too small a proportion of average earnings to make it a meaningful sum of money. Those without other forms of provision would still need to fall back on the state for additional benefit to keep body and soul together.

Still, the Government needs a boost and pensions are an easy way of getting it, the more so as it doesn't cost anything until the other side of the next election. Even then, the manoeuvre can be achieved relatively painlessly by applying the savings derived from equalising women's pension age with that of men to restoring the earnings link. By the time the full tax implications of this commitment begin to kick in, which will be from 2020 onwards, both the Prime Minister and the Chancellor will already be drawing their own pensions and be beyond past caring.

BAA: How high can Ferrovial go?

Is Ferrovial about to jack up its offer for BAA? Contrary to the impression given by yesterday's Outlook, this has not yet already occurred. My reference to the Ferrovial consortium's 830p-a-share bid was, regrettably, just a mistake. In fact, the offer still stands at 810p a share. All the same, in raising the offer I was only inadvertently pre-empting the obvious. With the stock market price still glued to round about the 840p mark, there will plainly have to be some sort of an increase if the Spanish construction company and its partners are to succeed.

What is becoming clearer is that there is to be no regulatory intervention in this tussle, though again clearance has yet to be announced. There are no competition issues of any significance for the Office of Fair Trading to examine, and although both the Civil Aviation Authority and the Government have expressed concern about leverage, they appear quite powerless to act. The law doesn't require the CAA's consent for a change of ownership to occur.

However, the law does oblige the CAA to have regard to any course of action by the operator that might be against the public interest, and to ensure that investment is made in airport infrastructure in a timely enough manner to ensure that demand is met. Perhaps curiously, these powers cannot apparently be applied pre-emptively in the event of a change of ownership. If the CAA does have concerns about excessive debt at Ferrovial, then it is not until after the change in capital structure has become a fait accompli that it can begin to do anything about them.

Even so, the powers may have some indirect consequences for the offer. The threat that the aviation regulator will eventually flex its muscles crucially affects the amount of money Ferrovial might put on the table. The CAA is already reviewing the price caps imposed on landing charges at BAA. These days, BAA derives more income from other commercial activities, such as airport shopping and parking, than it does landing charges, but these sources of income too are taken into account.

Ferrovial insists the degree of leverage contained in its bid is irrelevant; since the regulator allows a return to be made on any new investment, Ferrovial has just as much incentive as the BAA old guard to deliver on new infrastructure. However, in determining the price caps, the regulator will take account of the lower cost of capital derived from increased leverage, and reduce the caps accordingly. If the CAA senses the assets are being sweated to service and pay down debt, then it will be even harder on BAA's new operators.

For equity holders in the Ferrovial consortium, the endeavour might already seem high risk enough. They must be reconciled to putting up a bit more capital than they already have, but perhaps not much.

The bankers will be equally cognisant of the regulatory risk. They won't want to go much further either, especially after the lessons of National Air Traffic Services, which essentially went bust because of excessive debt. The upshot is that Ferrovial may struggle to get to £9 a share. The CAA cannot block the Spanish pretenders, but it can limit what Ferrovial is capable of bidding, which may amount to much the same thing.

j.warner@independent.co.uk

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