Jeremy Warner's Outlook: The domestic economy may be faltering, but the stock market is having a ball. How come?

Extrapolation can be a dangerous thing; Boots refuses to repeat guidance

The economic news none the less seems unrelentingly gloomy. The economy is growing at its slowest rate in 12 years, inflation is rising, fed by sky-high oil prices, and according to a CBI survey, the high street is suffering its worst trading conditions since records began 22 years ago. The gloom was compounded yesterday by the latest Nationwide survey, showing that house prices fell for the second month in succession in September, reducing the annual rate of house price growth to a barely perceptible 1.8 per cent.

If the economic news is so bad, how come the stock market is so buoyant? One reason is that stock market investors are looking through the present soft patch to an assumed resumption of growth later this year and next. Yet no one is that confident about the UK economy next year, and if house prices went into a nosedive, then all bets would be off. There might even be a recession.

No, the real reason the stock market is rising is that it is as much influenced by the international economy as the domestic one. Outside Europe the outlook remains reasonably good. According to HSBC, as much as 60 per cent of the FTSE 100's revenues come from overseas. The UK outlook is therefore not the dominant influence. The market has also been buoyed by the high weighting it gives to oil and mining stocks, both of which have been driven higher by the boom in commodity prices.

The FTSE 100 is only a weighted average of different constituents. Dig down and you find that those stocks most heavily exposed to domestic cyclical factors - retailers in particular - are down in the dumps. Yet perhaps strangely, the FTSE 250, which represents the next biggest 250 companies after the FTSE 100 and is more exposed to the vicissitudes of the UK economy, has done even better than the FTSE 100. It sailed through its turn of the century peak yonks ago, and remains close to its all-time high.

So here's the main reason why the stock market is so buoyant. Corporate profits are buoyant too, not so much because economic growth has been good, but because on the whole corporate costs and risk are much better managed than they used to be. With cash coming out of their ears, companies are beginning to engage in a frenzy of takeover activity. Mergers and acquisitions are back at near peak levels. If companies are not spending the money on each other, they are giving it back to shareholders through stock buy-backs and other forms of capital redemption.

As the stock market rises, the problem of ballooning pension-fund deficits begins to recede too. Many companies have in any case used the deficits as a bargaining tool for reducing their liabilities, either by persuading employees to accept less or pay more by way of contributions. Add to all that the fact that equities continue to look good value against almost any other asset class and it is easy to see why the stock market should be in such fine form, despite the deteriorating domestic economy.

There has been a sharp pickup in sales of unit trusts in recent months, so even the small investor seems to be getting the message. This is generally a bad sign. Perversely, mutual sales are at their best when the stock market reaches its peak and at their worst when it is down in the dumps. Small investors would do much better to play it the other around, but that's not the way the unit trusts industry markets itself. Still, the bull run looks to have further to go yet before it reaches its zenith and collapses into the depths again. For that to happen, investors have to be convinced there is a global economic downturn in prospect, not just a UK one. Few believe that just yet.

Extrapolation can be a dangerous thing

David Hockney's mother lived to be 100, and according to the artist, pretty miserable she was about it too in her later years. This was one of the lines of argument advanced by Mr Hockney this week in his campaign against the Government's planned ban on smoking in pubs and public places. Better to smoke yourself into an early grave than live to a painful old age, seemed to be the nub of the argument. Well, it's a point of view, I suppose, but the reality is that your chances of living into your eighties and even nineties is improving all the time.

That at least is the finding of The Continuous Mortality Investigation, a research organisation backed by the actuarial profession. This concludes that the mortality rate improved by about 30 per cent between 1994 and 2002, or, to be more precise, 30 per cent fewer men die within a year of having reached the age of 65 now than was the case in the early 1990s.

This is a pretty dramatic improvement which continues, though at a deteriorating rate, right into people's seventies and eighties. Of course, we already knew that people were living longer. This latest research puts some hard numbers on the phenomenon. Extrapolating from these figures, a 65-year-old man may now expect to live on average until he is 86 years and seven months, an increase of three years on the previous figures.

The implications for the insurance and pensions industry are potentially dramatic. Annuities will cost a lot more to provide than many in these industries had assumed or planned for. The costs of the state pension system, unless reformed, will also rise markedly, as will the pension costs of public sector workers, which are mostly financed on a pay as you go basis.

Actuaries specialise in extrapolating future trends from past ones, but because no one can predict the future it frequently doesn't work out as it is supposed to. By assuming a continuation of the rates of investment return that existed in the 1980s and 1990s, the profession helped create both the crisis of unfunded pension deficits and mortgage endowment shortfalls.

On longevity, the actuaries seem determined not to be caught napping again. Yet I wonder how reliable these predictions of ever-improving mortality really are. As likely as not, the present generation of retirees is as privileged in its life expectancy as it is in its pension benefits.

There is a limit to how far medical science can keep pushing out the boundaries of longevity. Smoking is on the wane, but lack of exercise, poor diet, excessive drinking and drug taking is very much on the increase. Far from improving into the indefinite future, longevity may well be on the decline again 30, 40 years from now. Not a pleasant thought, but at least Mr Hockney might be cheered by it.

Boots refuses to repeat guidance

Richard Baker, the chief executive of Boots, has just learned the first lesson in managing expectations: just don't do it. Earlier this year, he said the group expected to achieve sales growth of 0 to 2 per cent this year. That guidance was not withdrawn yesterday, but nor was it repeated. With first half sales down 1.3 per cent on a like-for-like basis, and the trading environment now apparently worse than ever, Mr Baker will struggle to come anywhere close.

Still, compared with many other retailers, this is not a bad showing, even if now half way through his five-year turnaround strategy, Mr Baker might have hoped to be showing more progress. According to industry rumours, Marks & Spencer is down 13 per cent in womenswear. Retail turnarounds are tough at the best of times. In this environment they are proving well nigh impossible.

j.warner@independent.co.uk

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