Outlook: Time to go back to traditional values

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The Independent Online
AS MARKETS go ever higher, investors grow steadily more exposed and nervous. Sensing the peak, they are more and more prone to bouts of panic, particularly in the most highly valued sectors of the market.

Since there appears to be no other explanation for Monday's late sell- off on Wall Street, we are forced to fall back on these psychological observations about the nature of markets.

After the heady gains of recent months, investors simply ran scared. Is this latest loss of nerve going to turn into a rout, similar to last Autumn's crash, or is this just another minor wobble?

As always, it is impossible to answer this question with any certainty, but one thing does seem clear - there is no good reason for markets to plunge into the abyss quite yet, and for that reason if no other, they probably won't.

Wall Street has so far survived the crisis of the Far East, Russia and Brazil, with only very temporary damage. War in Europe seems to have gone by largely unnoticed by financial markets and meanwhile, economic growth in the US shows no sign of abating.

Obviously it is the case that Western equity markets cannot keep growing indefinitely at their recent rate; eventually there must be a correction to bring them back to their long term rate of return of about 8 per cent per annum. Given the length of time they have outperformed that level, it is inevitable that eventually they will underperform it, possibly for a period of many years. As ever, the $64,000 question is whether that time has now arrived.

Once again, this seems rather unlikely, not withstanding the number of valuation warning bells now going off right left and centre. Over the last two years, Wall Street has nearly doubled, a level of gain similar to that which preceded the crash of 1929, and the average price earnings ratio has reached its highest ever level. Similarly, the dividend yield is at its lowest while the value of US stock markets as a percentage of the economy is more than ever before.

But are these good reasons for a crash? A crash needs a cause and it is in vain that one searches for one. In the US, the economic outlook continues to look benign, things seem to be looking up in Japan and even in sluggish old Europe, the outlook is hardly dire. Meanwhile, the old arguments about liquidity - where else can the money go except into Western equity markets - remain as potent as ever.

None the less, there is plainly something significant going on in markets right now. Over the last week or so there seems to have been a pronounced swing in sentiment away from overvalued growth stocks in the IT and life science sectors, and back towards neglected and more cyclical traditional industries. In the search for value, this seems a logical enough development. Indeed, it seems odd that investors have ignored these higher yielding stocks for so long. For most chief executives, it will also be an extremely welcome one.

AA conversion

THE de-mutualisation bandwagon rolls inexorably on. The RAC's motoring services division has already skidded on to the block. Now the century old Automobile Association is also examining its options with a trade sale the most likely outcome. Would it be worth it?

The first thing to realise is that any windfall pay-out would be relatively small. Unlike the RAC, where the crusty old members of the RAC club on Pall Mall stand to net a tidy pounds 33,000 each and ordinary members are left empty handed, the AA is a more democratic organisation.

Any spoils would have to be shared equally among all its 4.3m ordinary members, which at most would mean a paltry pounds 300 each. Given that the AA's rules require two thirds of its members to vote in favour of a change of ownership this might prove a difficult majority to reach. For it is questionable that a change of ownership would necessarily improve the group's fortunes.

In the banking sector, the mutually owned building societies have found it easy to undercut their converted peers on mortgage rates because they do not have dividend payments to make. This so called mutual dividend is not to be sneezed at. The question is whether it exists at the AA.

Most people regard the AA as a reasonably efficient service and its "surplus" of pounds 22m on sales of pounds 578m are reasonable for a not-for-profit organisation. The AA has fought hard for its 48 per cent market share and in doing so it has shown considerable commercial savvy.

But there are problems. The breakdown and insurance market is becoming more competitive with Green Flag and a host of other new entrants. In insurance products, AA's premiums may not seem exhorbitant but there are cheaper rates available for those prepared to shop around.

If the AA is being undercut by rivals that also serve the needs of shareholders, then the value of its mutual status has to be questioned. To be fair on John Maxwell, the AA's director general, the organisation seems to have recognised this by getting out of non-core activities like high street shops and concentrating on enhancing its core service. However, it may have to do more to demonstrate unequivocally that there really is a benefit to customers in remaining mutual.

Water charges

IAN BYATT, director general of Ofwat, last year demanded a one off cut in water charges of 15 to 20 per cent in his five year review of industry price caps. The water companies have since responded with their own business plans, which were published yesterday by Ofwat. Surprise - only one of them, Severn Trent, proposes any kind of reduction at all, while another, Anglian, wants an increase of more than 10 per cent.

On both sides, these are opening shot demands, negotiating positions from which some retreat may be possible. Even so, this is quite a gap and given the pressure on Mr Byatt to deliver a politically acceptable solution, he will be unwilling to give ground unduly. The question for the water companies is whether this is worth going to the barricades over by subjecting themselves to a Competition Commission investigation.

The last utility to do this was British Gas, and it ended up with an even worse outcome than that suggested by the regulator. Thames Water and others have in the past suggested a face saving compromise - the idea that mergers within the industry would yield the sort of cost savings that might allow such sharp reductions in bills to be pushed through - but the response from Mr Byatt has so far been quite negative.

Certainly the cards seem heavily stacked against the water companies. The experience of gas is that these one time state owned utilities are capable of delivering even on the most draconian of demands and still leaving something for the shareholders.

Mr Byatt's assumptions about return on capital are by no means outrageous given the absolute monopoly of most water companies and the present low interest rate climate.

The water companies would be foolish to expect any more than some minor concessions.