Outlook: Rate cuts, yield gaps and a stock market running scared

Higgs backlash; Cable & Wireless  
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The Independent Online

THE LAST time short-term interest rates were as low as they fell to yesterday was 1955, or the year of my birth, which I can't help but see a certain portentous significance in. But for those interested in investment trends and what they tell us about the wider economy, something potentially far more important also happened yesterday. For the first time since the late 1950s, the so-called reverse yield gap reversed back again.

The last time short-term interest rates were as low as they fell to yesterday was 1955, or the year of my birth, which I can't help but see a certain portentous significance in. But for those interested in investment trends and what they tell us about the wider economy, something potentially far more important also happened yesterday. For the first time since the late 1950s, the so-called reverse yield gap reversed back again.

What this means is that the historic dividend yield on shares became worth more than that on long bonds, or to be more precise the contrary movement of shares downwards and gilts upwards meant that by the close of play the gross dividend yield on the FTSE All Share had risen 4.34 per cent while the yield on a 10-year gilt had fallen to 4.22 per cent.

One way of interpreting this event it that it is just an aberration, born of an excess of international tension and bottom of the market despair over the outlook for equities. The more alarming way of looking at it is that it really does mean something. Rightly or wrongly, the market is starting to price in a deflationary economic outlook where profits and dividends will be hard to maintain let alone grow and where risk-free assets such as gilts therefore command a premium.

Personally, I don't accept that this is the long-term future for our economy but I do think the odds on an outright recession have shortened dramatically in recent months to evens or less. A quarter point off interest rates is neither here nor there when they are so low already, but the fact that it was so unexpected is powerfully indicative of panic.

You'd have to be blind not to have noticed that the economy has deteriorated sharply in recent weeks, but still there's a suspicion that the Monetary Policy Committee knows something the rest of us don't. We'll find out soon enough. The Bank of England publishes its Inflation Report next week when we can expect a significant downward adjustment in the Bank's outlook for growth.

Only a few months back, everyone thought the next move in rates would be up, so as to check apparently out of control consumption and house prices. Today we can be pretty sure that rates have even further to fall before they turn up again, and that point may be a long way off.

Higgs backlash

I've yet to come across a business leader with anything positive to say about the Derek Higgs report on the role and effectiveness of non-executive directors. This is a shame. While I can understand why so many chairmen and chief executives are concerned, it's hard to know why they are getting so hot under the collar about a set of proposals which are both undemanding and, in the long-term, should greatly improve the performance of their companies.

The Sarbanes-Oxley Act, which may require all companies with shares traded on an American exchange to submit themselves to American rules and regulations on corporate oversight, is a far more serious assault on international corporate liberty than Mr Higgs' mild mannered and entirely reasonable set of recommendations. Sarbanes-Oxley is legal imperialism at its worst and should be utterly rejected. Even the Americans are beginning to realise it.

The Higgs report by contrast won't have any statutory authority. Nor is it intended that companies be required to follow its code of practice on non-executive directors, only that they explain themselves when they don't. That hasn't stopped the griping. There are two main concerns. One is the requirement to appoint a senior, independent non-executive director, a move many existing chairmen see as a challenge to their own authority and position.

The other is that non-executives meet independently of the rest of the board and the chairman, which is viewed by many as potentially divisive. The idea that the chief executive should not be allowed to become the chairman, and that executives are barred from moving into non-executive positions in the same company, is also widely seen as inappropriately harsh and possibly quite damaging, as such people would have a high level of knowledge about the company they are charged with overseeing.

But just to repeat the point, nobody is saying that the new code should be followed in all circumstances, only that companies seek a dispensation from their shareholders when they don't. This is absolutely as it should be. Like many others, I've found myself wondering why it is that corporate assets seem to be worth so much more to the owners of private equity than they are when publicly quoted.

Why is it that Philip Green, KKR, Apax and all the others can afford to pay a premium to the stock market price and still make huge amounts of money out of companies that struggled to go anywhere as publicly quoted entities? A large part of the answer, I would suggest, is corporate governance. In private equity there is a unity of purpose between management and owners which is often lacking in publicly quoted companies.

High-risk strategy, poor quality management and undeserved executive excess can prosper in the publicly quoted sector in a way that would be impossible in private equity. The reporting obligations on publicly quoted companies are huge, but direct accountability to shareholders remains poor, allowing underperformance to persist sometimes for years on end.

This is what the Higgs review is trying to address and we have to hope it succeeds, for the way the capital markets are developing, the gulf between the owners of share capital and its users grows wider by the day. The volatility of share prices, with stocks increasingly traded through exotic derivative instruments for short-term gain, is further undermining accountability to the extent that there is now almost total divorce.

In these circumstances, it is essential that the long term holders and custodians of capital have access to decent channels of communication and representation on company boards. Derek Higgs has suggested some acceptable ways of achieving this aim. Our business leaders would be well advised to support them.

Cable & Wireless

Richard Lapthorne, Cable & Wireless's new chairman, is right to give Richard Li, son of the legendary Hong Kong financier, Li Ka-shing, the brush off. That Mr Li junior is but a shadow of his father can be taken as read, but this would not be a good reason in itself for refusing to talk to him.

One very good reason, on the other hand, is that there is no certainty he would make an offer even if Cable & Wireless were to allow him the due diligence he demands. Another is that the mooted price of 100p a share would be rejected out of hand by any half-way decent adviser.

At that price, Mr Li could pay for his bid out of C&W's mountain of cash alone. The business assets, which are overall cash generative despite the disaster of Global, would be in for free. Mr Li would argue that £1.5bn of the cash is in escrow against a potential tax liability, but the chances of it becoming payable remain remote.

Mr Li's approach shouldn't be treated as entirely frivolous. He seems to have the backing of Texas Pacific, which would take over the running of Global leaving Mr Li's PCCW to manage the regional interests. Mr Li is much more interested in pursuing the glamour of the deal than the daily slog of management, but he's got some good people around him and there's little doubt that in conjunction with Texas Pacific, he could make C&W work again.

But so too can Mr Lapthorne, who'd be mad to open his books up to a competitor with no guarantee of a bid. If Mr Li is serious, he'll need to show shareholders the colour of his money. Otherwise his approach is so much hot air.

jeremy.warner@independent.co.uk

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