Jeremy Warner's Outlook: Sub-prime fears still haunting markets

Insurers cannot be blamed for flood loss; M&S and the art of news management; Why business needs to win back trust
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The sub-prime mortgage crisis in the US returned to haunt markets yesterday, with the dollar plunging to a new low against the euro and a 26-year low against the pound. With customary prescience, the credit rating agency Standard & Poor's said it was putting $12bn of sub-prime-backed securities on notice for a downgrade (talk about being on the ball), while the retail sector was unsettled by second-quarter guidance from Sears below expectations.

The latest outbreak of nerves doesn't on the face of it seem to be any more serious than previous ones. But what is true is that they are becoming more frequent, and you have to wonder for how much longer stock markets can continue to ignore the risks of a serious slowdown in the US and world economies.

The dollar, which on most measures is now significantly undervalued against most other currencies, already seems to discount such a slowdown. Supported by still buoyant levels of private-equity activity and corporate profitability, equity markets refuse to concur. The sub-prime crisis is plainly on a long fuse, and it is still impossible to tell what sort of an explosion lies at its end.

However, the best guess has to be that, whatever it is, the world economy will survive the blast. There is no legislating against the propensity of stock markets to correct, or any way of predicting when these corrections might happen. But on any long-term view, equities still look the best bet there is on continued world growth. Looking through the present turbulence in the US, few would bet against that.

Insurers cannot be blamed for flood loss

Never mind Britain's woefully inadequate spending on flood defences, or the wholly inadequate drainage system that still exists in large parts of the country, there's always the insurance industry to blame for the misery of those devastated by last month's rainfall. Thus it was that representatives of the Association of British Insurers were summoned in for a dressing-down by ministers yesterday. Hazel Blears, the Communities Secretary, told MPs that she is taking the issues around insurance very seriously indeed.

Never let it be said that I'm in the pocket of the insurance industry, but as far as I can see, its behaviour has been close to exemplary in this particular case. Virtually all claimants have already been seen by a loss adjuster, all reasonable efforts are being made to find alternative accommodation, those with business interruption insurance are already receiving stage payments, and steps are being taken to ship in labour from overseas to ensure prompt repair to damaged property.

It will always be possible to find cases where the insurers are found wanting, but, on the whole, the response seems to have been speedy and fair. Of course, for householders without cover or business without interruption insurance, the situation is much bleaker. But then that is rather the point of having insurance companies. If you don't insure, then you are on your own. There is as yet no sign of insurers going back on their promise two years ago to continue insuring properties in flood-affected areas.

Rather easier to criticise is the Government's response to the extreme weather events that are becoming more commonplace. The Government underspent its budget on flood defences by £15m last year, while the extra £200m of spending pledged by ministers for the next three years is widely thought inadequate. A large part of the flooding in Hull was in any case caused by drainage systems overwhelmed by the quantity of rainfall.

This too will require more spending. The ABI estimates that the Government must spend £8bn more than it plans to on flood protection by 2020 if major mishaps of the type which occurred in the Thames estuary back in 1953, when 369 people died and large parts of eastern London were flooded, are to be avoided. Back then, this was a one-in-a-thousand-year event. Changes in weather patterns have transformed that probability to one in fifty. As the chart shows on page 44, the cost of insured losses from extreme weather events is rising exponentially worldwide. This is slightly deceptive in that so too has the size of industry, as growing economic prosperity expands the demand for insurance.

Even so, the weather is undoubtedly becoming more extreme. Rightly, insurers don't yet regard it as their responsibility to meet the cost of flood defences, and are determined that this point of principle should not be conceded. Yet if the Government cannot be persuaded to spend sufficiently either, something must eventually give.Either underwriters will stop insuring, or premiums will rise.

M&S and the art of news management

Marks & Spencer's trading update yesterday marks an unwelcome return of the old stock-market practice of managing expectations. In the worst instances, markets are prepared for bad news via a series of brokers' notes, through which expectations are massaged down to more realistic levels - the idea being that when the news is finally announced, it won't have so much impact.

OK, so in M&S's case, there was good reason to think that sales growth would have slowed considerably. The weather has been appalling over the past two months and with now five interest rate rises in less than a year there was bound to be some effect on consumption.

Yet the market buzz was that like-for-like sales growth had slumped to as little as 1 per cent in the quarter-year to 30 June. In these circumstances, the actual outcome of 2 per cent looked more than creditable, and the shares surged. Good old Stuart Rose. The Marks & Spencer chief executive had pulled it out of the bag again.

It is none the less a bit early to start popping the champagne. Admittedly, it is now hard to remember, but the weather in April was unusually warm, and therefore quite helpful to clothing retailers. So it is a fair bet that the past two months would have been much worse than the overall number for the quarter suggests. Mr Rose once said "weather is for wimps" after a string of retailers blamed unseasonable weather for their travails. Now he's not so sure. The only redeeming feature of recent weeks has been that he's sold a lot more brollies.

As he readily admits, the outlook is particularly uncertain right now. In contrast to many others, M&S has thus far resisted pressure to slash prices to shift stock, but if the weather remains poor and the interest rate therapy works as the Bank of England intends, then heavy discounting may soon become unavoidable. M&S still has its summer sale and August clearance to come. The cost of disruption from store refurbishment is also particularly high at the moment.

Still for the time being, M&S continues to outperform peers, making Mr Rose's insistence that the M&S recovery story hasn't run out of puff quite yet seem credible enough. The shares have already fallen quite a bit over the past two months. Thanks to news management, most of any likely bad news is probably already in the price.

Why business needs to win back trust

Richard Lambert was at his articulate best yesterday in highlighting the dangers of a social backlash from today's new super-charged global economy. If the director general of the CBI was less good at suggesting remedies, that is because there are none other than the obvious: more training, better education, better social safety nets, and so on.

Yet he also echoed a favourite and important theme where business leaders really do have the power to act; they need to do a whole lot more to persuade the public that they deserve to be trusted. The fightback must begin with private equity, which rightly in some respects is seen as in the vanguard of the inequalities and remoteness from ordinary people that the "new capitalism" referred to by Mr Lambert is giving rise to.

j.warner@independent.co.uk

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