Shares point to bust at the end of the long boom

UK growth; Railtrack gloom; Cable & Wireless
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The Independent Online

As these pages explained yesterday, there are two very different views in the City right now about what is happening, or about to happen, in the UK economy. One view, which broadly reflects the Government's position, is that everything is basically fine, that despite the dramatic slowdown in the US, UK growth will continue robust both this year and next, with inflation remaining in abeyance.

As these pages explained yesterday, there are two very different views in the City right now about what is happening, or about to happen, in the UK economy. One view, which broadly reflects the Government's position, is that everything is basically fine, that despite the dramatic slowdown in the US, UK growth will continue robust both this year and next, with inflation remaining in abeyance.

This is, of course, the sort of position that any Government which prides itself on its economic performance and is about to face a general election is pretty much bound to hold, but to be fair, it is not an entirely political one. Sir Edward George, Governor of the now independent Bank of England, was also sanguine this week in his view of the economic outlook for the US and, by implication, elsewhere. He described the situation as less alarming than it had been.

Well maybe, but that doesn't seem to be what investors think. For another view of what is going on, just look at what the capital markets are saying. Even for Britain, they are beginning to signal a far from sunny disposition, if not outright recession. Of course, the capital markets are not always right. As last year's technology bubble demonstrated, financial markets invariably overshoot, both on the upside and the downside. The ebb and flow of investment sentiment put them in a more or less permanent state of exaggerated optimism or pessimism.

When things were last really bad in the immediate aftermath of the Russian debt crisis of 1998, Gordon Brown, the Chancellor stuck to his guns, refused to accept there would be a recession and carried on regardless. In the end it was he who was right, not the stock market.

However, this time around it's a bit different. The present bear market in equities has been on a slow burn, dating back to a year ago when the dot.com bubble began to burst. The big technology companies, telcos and telecommunications equipment manufacturers initially claimed they were immune, and for a while the markets believed them. Now we know they are not. Growth in the New Economy has slowed to a standstill, and in some areas, it is bombing.

Last week's industrial production figures for the UK showed a 30 per cent slump month on month in New Economy production, which admittedly owes something to seasonal factors but none the less must set even the Chancellor's alarm bells ringing. Everywhere there is belt tightening and reigning in.

This is how the business and investment cycle works, and to believe that Britain can buck the trend is cloud cuckoo land. As the good times roll, investors, bankers and managers become progressively more oblivious to risk until eventually they start to believe that risk and the business cycle have been abolished entirely.

Inevitably they end up over extending themselves, and when the scales finally fall from everyone's eyes, the reverse process sets in. Investors stop investing, bankers stop lending, businesses stop spending and start cutting back, consumer spending begins to dive, and so on and so forth. Down the ages, this has been the pattern and after the longest boom in American history, it is happening again. Britain is behind the US, but not by far.

The problem that Tony Blair and his Chancellor have got as they survey the economic landscape for clues on their electoral prospects is that the stock market isn't just some casino in the sky, divorced from and largely irrelevant to the real economy. The capital markets are part of the fabric of the real economy, they determine its future, and their over exuberance in the good times is often a large part of the mischief in the bad. The Chancellor likes to think he's abolished boom to bust. Come, come. Human nature is not so easily quashed.

Railtrack gloom

Better late than never, Sir Alastair Morton's grand "strategic agenda" for the railways finally shunted out of the sidings yesterday, nine months after it was first supposed to have appeared. Train spotters will have noticed that this is not the "strategic plan" we were initially promised. That, along with the detail of how the network will cope with an expected 50 per cent increase in passenger numbers and 80 per cent rise in rail freight in the next decade, will have to wait until the autumn.

The delay has at least worked in favour of Sir Alastair and his Strategic Rail Authority in one sense. In the intervening months, the obstacle blocking the line otherwise known as Gerald Corbett has been safely removed. Had Fizzy still been in charge of the signal box then it is certain Sir Alastair's £60bn vision for the network would not have received the warm welcome it got yesterday from Railtrack.

The SRA's agenda or plan, call it what you will, essentially involves stripping Railtrack of its responsibility for modernising the railway and hands it instead to a shiny new fleet of "special purpose vehicles" - private sector consortia harnessed to public funding.

It is easy to see why Gerald grumbled at the prospect and why Railtrack's investors took fright yesterday. The less Railtrack's balance sheet is used to support the enhancement of the network, the smaller becomes the asset base on which it can earn a return, and the duller it becomes as an investment.

Mr Corbett's successor, Steve Marshall, takes a more pragmatic view of what is possible for Railtrack given the railway's changed circumstances. But as even he pointed out to Sir Alastair yesterday, the idea of special purpose vehicles as a means of financing improvements to an operating railway remains unproven.

The practical problems look daunting. Chief among them is how Railtrack will continue to operate the network safely and efficiently while another company needs access to carry out major improvements. In an industry which is beset by fragmentation, special purpose vehicles could also be a recipe for further blurring of the lines of command and control.

Cable & Wireless

CABLE & WIRELESS is one of the stronger players in Internet Protocol, but it is none the less suffering alongside everyone else from the over capacity created during the boom. Prices are being slashed across the board, even though volume is still growing strongly. The C & W share price was hammered accordingly yesterday after investors were told just how bad the situation has become.

For afficiandos of the C & W story, yesterday's profits warning contained one absolute peach - the news that C & W is going to take a near £4bn exceptional gain on the disposal of its controlling stake in Hong Kong Telecom to Richard Li's Pacific Century CyberWorks. At least they are good at doing deals, you might have thought, even if the trading environment is rotten. You would be wrong. The exceptional gain is taken just on the cash element of the deal. The stock element has yet to be recognised.

In fact, the sale of HKT was one of the great corporate stings of all time, on C & W that is. C & W got some cash out, but the bulk of the price was in the candy floss of Pacific Century stock, which has been in free fall ever since. Was there a collar applied to this deal to stafeguard against such a slide? No there was not, amazingly. Not for nothing are the Chinese known as consummate deal makers. Mr Li and his team must have seen C & W's chief executive, Graham Wallace, coming a mile off.

Outlook@independent.co.uk

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