Outlook: Housing bubble troubles markets' Dr Doom

Baltimore madness; Acambis lesson
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The Independent Online

Tony Dye, Britain's perennially gloomy stock market pundit, has been at it again, only this time it's not a collapse in equities he's forecasting, but a housing market crash. Mr Dye, former head of Phillips & Drew Fund Management, was about four years too early in warning that the stock market was overheating, though he was proved right in the end. If the same holds true with his current prediction, we've a good few more years of booming house prices to look forward to yet before he's finally vindicated.

Tony Dye, Britain's perennially gloomy stock market pundit, has been at it again, only this time it's not a collapse in equities he's forecasting, but a housing market crash. Mr Dye, former head of Phillips & Drew Fund Management, was about four years too early in warning that the stock market was overheating, though he was proved right in the end. If the same holds true with his current prediction, we've a good few more years of booming house prices to look forward to yet before he's finally vindicated.

However, as regular readers will know, I think he's probably correct in thinking the boom must have reached its zenith. Indeed, I have to hold my hand up and admit to being a bit of a "Dr Doom" on housing myself. I've been predicting that house price rises will abate to zero and then begin deflating in real terms for at least two years now. My only comfort in being comprehensively wrong is that of good company. The Bank of England, no less, has been forecasting something similar.

The prime reason for believing otherwise is continued bullishness about the UK economy. Throughout most of last year, it looked as if the market would behave as the Bank of England predicted, with house price inflation gently falling to zero. That picture changed at the start of this year, when it began to sink into the collective psyche that the economy was set fair, at least for the next couple of years. House prices have as a consequence taken off like a rocket again.

The lesson would seem to be that as long as people are confident of continued prosperity, and credit is cheap and plentiful, house prices will continue to rise. Mr Dye thinks differently because he thinks the housing market has become a speculative bubble and must therefore inevitably correct. To this fundamental reason I would add another two. One is that the market has been given a further speculative twist by the buy-to-let phenomenon.

House prices have risen to such a degree that it is generally no longer possible to cover costs of buy-to-let (of money, repairs and council taxes) with rental income, leaving buyers wholly reliant on continued capital gain for their return. Rents are generally falling, because of the glut of buy-to-let property coming onto the market, but prices are still rising. That cannot be right.

The other reason is the continued rise in house prices relative to income, a ratio now at a record 5.3 times average earnings, according to Britain's largest mortgage lender, HBOS. The rising ratio is often justified because of the greater affordability of housing. The prospect of lowish interest rates and unemployment into the foreseeable future makes people more willing to take on greater levels of debt. Unfortunately, the affordability argument is largely illusion. Here's why.

Interest rates are not that low in real terms. Initial interest payments may seem low in relation to income right now, but because inflation is also low it will not erode the real value of the debt in relation to income as rapidly as it has done in the past. So in later years mortgage payments will absorb a greater proportion of the borrower's income than if inflation was high. For most borrowers, the real proportion of income absorbed across the lifetime of the mortgage won't be lower than it ever was.

Speculative bubbles don't tend to deflate of their own accord. Something generally comes along to puncture them, and right now it is admittedly quite hard to know what the giant pricking pin might be. My own view is that there is a good deal more inflationary pressure building up in the world economy than the "experts" think, and that eventually this will require rather steeper interest rate rises than generally anticipated. Money has been too cheap and too plentiful for too long.

That's what Michael Howard, leader of the Opposition, must be privately hoping, anyway. Forget Iraq, top-up fees, immigration and the rest, elections are much more likely to be won and lost on the health of the economy and, on this front, the housing market has become Labour's biggest Achilles heel. Housing has sustained the UK economy for four years now. As the housing boom runs out of steam, what's left to pick up the baton? Hello ... is there anyone out there?

Baltimore madness

Hard to believe, but back in the heady days of the internet bubble, Baltimore Technologies was briefly a member of the FTSE 100 with a stock market value of more than £5.5bn. Today it is just a small cash shell, yet despite the lessons of its disastrously value destructive past, and with just £24.7m left in the bank, the former internet security wonder stock hasn't entirely lost its appetite for cloud cuckoo land investment opportunities.

To this end it is planning to spend what's left on converting itself into a company selling wind, solar and wave power to business. A new board has been recruited for the purpose, but Baltimore has yet to say exactly what it is they are going to do. For all the detail we've been given, Baltimore might have described its purpose in terms similar to the defining prospectus of the South Sea Bubble - "a company for carrying out an undertaking of great advantage but nobody to know what it is".

With the shares trading at less than the value of the cash in the balance sheet, it is hardly surprising that the company has attracted the attentions of an AIM-listed vulture capital fund, Acquisitor, which has requisitioned an EGM to sack the entire board and replace it with its own slate.

Acquisitor is scarcely more specific about its plans for the company than the present board, but the central suggestion - that most of the money will be returned to shareholders with past tax losses used to purchase a small, related technology company - looks a good deal more promising than the clean energy magical mystery tour.

Baltimore scarcely helps its case by managing to print the circular to shareholders detailing the forthcoming EGM back to front. To make matters worse, it reveals that one of its new directors, Richard Eyre, won't be able to take up his post for another month because he's on an expedition to the North Pole. Presumably he's not there to investigate clean energy solutions.

After the disasters of the past, shareholders need a lot more convincing to back their company's plans. Bijan Khezri, the chief executive, has done a reasonably creditable job in salvaging something from the wreckage, but as a director at the time of some of the company's more unfortunate acquisitions he must bear his share of responsibility for Baltimore's history of value destruction. It's time he moved over and let someone else have a go.

Acambis lesson

There are not many of them, but Acambis, which only three years ago was still a British biotech minnow, is one of those companies whose prospects were dramatically transformed for the better by the terrible events of 11 September. Soon after, the US government placed a massive order with Acambis to supply 209 million doses of smallpox vaccine as a precaution against a possible bio-terrorist attack. Now it transpires that the vaccine, a form of which has been used for decades to immunise people against smallpox, can cause inflammation of the heart in a small number of cases.

The discovery, in the final stages of clinical trials, won't affect the initial order, but it is may damage Acambis's prospects of winning further contracts from the US or new contracts with other countries. Lower dosage alternatives may from now on be the order of the day. Biotech has always carried a high risk health warning to investors. Nobody knows for sure whether each successive generation of supposed wonder drugs are going to work until they enter clinical trials, where the barriers to market entry seem to get progressively steeper. Yet with such a well tried product, Acambis was thought of as relatively low risk. Yesterday's 13 per cent share price plunge shows that in biotech, there's no such thing.

jeremy.warner@independent.co.uk

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