Wall Street fails to share Greenspan's concern

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The Independent Online
So finally someone in authority in the US has dared to say it - that Wall Street is horribly overvalued, or to put it in the same way as Alan Greenspan did, stock prices have become infected by an "irrational exuberance". Mr Greenspan, chairman of the Federal Reserve Board, is not the sort to use words lightly and he must have known markets would take his remarks very seriously. Whether he anticipated that reaction would be as limited as it was is another thing. In the end the damage to share prices in London was rather worse than those in New York. In the scale of things, both setbacks barely look like more than a hiccup.

How could this be? The chairman of the Federal Reserve, no less, warns of the dangers of an overvalued stock market, referring directly to the parallels with Japan before the Tokyo market dramatically corrected itself, and virtually nothing happens. Furthermore Mr Greenspan hinted as strongly as he could that share price inflation of the sort that has gripped Wall Street these past five years would in future be taken into account in determining monetary policy. In other words, he would actually put up interest rates to choke off Wall Street's ponzi-type assent into the heavens.

Still no reaction. Wall Street falters a little, falling back to the level it was at three weeks ago, but that's where it stops. There's every chance that come Monday, the Dow will just shrug its shoulders and continue on upwards. So much for the power of the Federal Reserve. It seems that Mr Greenspan will have to be as good as his word and actually put up interest rates if he really wants to stop this insanity.

The Fed's concern about inflated Wall Street share prices first surfaced in May when, according to a summary of its deliberations, Fed officials "questioned the sustainability of the performance of the stock market". Since then the Dow has risen another 15 per cent. Off the record, Mr Greenspan has been briefing like Topsy, again using this word "exuberance" and making it clear that he would like to see less of it. Just a few weeks back, for instance, the Wall Street Journal carried a piece reporting the Fed's growing concern about the soar- away stock market. It must have been based on a briefing by Mr Greenspan since it even used the same language as he did yesterday. All to no avail. So he went public. Again nothing. Just what does a man have to do!

To see why the Fed is so worried, just look at the figures. On virtually every measure you care to take, share prices are now more highly valued than they have ever been. The yield is now lower at around 2 per cent and the price/earnings and price to book ratios higher than at any stage this century, which let it not be forgotten has included three great crashes.

But the statistic I find most compelling is that, boosted by the runaway bull market and huge inflows of cash, the capitalisation of the US stock market is now well over $7,000bn - a figure equivalent to a record 100 per cent of US gross domestic product. Never before has it reached this level. Before the crash of 1987 it was still only 65 per cent. Even before the much more serious crash of 1929, it rose no higher than 84 per cent. I know that the corporate sector is now clawing in a greater proportion of the world's wealth than ever before, but this cannot be right.

The problem is that even if the Fed does believe the market has reached a dangerous level of speculative excess, it is not easy to do anything about it. Raising interest rates just for the purpose of pushing down stock prices risks triggering a ghastly financial crash. An investment bubble, once pricked, tends to deflate rather rapidly. Furthermore, the rest of the US economy does not seem to justify a rise in interest rates. So for the time being all Mr Greenspan can do is jump on his soap box and thump the table. He's right, of course, but since when did being right mean anything to financial markets.

It is hard to imagine a company more devoid of corporate purpose than BAT Industries. There it stands, a throwback to a bygone age in which diversification into unrelated businesses was thought a perfectly acceptable and legitimate management exercise. Not for BAT modern day management concepts like "focus" and concentrating on "core competences". Despite some tinkering after that ridiculous but well intentioned "Ahoy there" breakup bid from Sir James Goldsmith and Jacob Rothschild in the early 1990s, little has really changed; BAT has stuck with its two wholly different businesses of insurance and cigarettes.

Nor has it any intention of changing. That in any case is what Martin Broughton, the chief executive, said less than two months ago at the time of the last set of results. BAT would only demerge if it resulted in significant cash flow benefits, and thus far he could not see how that would be the case.

What, then, to make of well-sourced rumours this week that BAT was indeed thinking of demerging its Eagle Star, Allied Dunbar and Farmers insurance arm as part of a separate merger of these interests with Commercial Union or some such other large rival insurance concern? On the face of it, this variant of the demerger option might make sense where a straight demerger wouldn't, for it would enable the company to take advantage of the international trend in consolidation of financial services and insurance. As a result demerger might add some value for shareholders.

BAT explored the idea quite extensively but ultimately this proved one of those deals destined to end up in the dustbin, for apparently all talks have now been terminated. So does it make sense for BAT to go this route? Ironically, what makes sense for BAT may not necessarily make sense for its insurance business. My view has always been that demerger is a good thing in its own right, for it does indeed bring about greater responsibility and focus in managements. In the short term, the benefits of this are intangible, but over the years it can make a very sizeable difference.

As for merging the insurance operation with another large insurance concern, it is hard to know whether this makes sense without knowing what's proposed. But the general case for big is beautiful is as unproven in insurance as in any other industry. The business of selling insurance is undergoing very rapid and radical change. Most insurers have quite enough on their hands already in terms of cost-cutting, reorganisation and reskilling, without having to deal with the trauma of a big merger.

Some insurers, such as John Robins, chief executive of Guardian Royal Exchange, have gone so far as positively to rule it out. So BAT may be barking up the wrong tree by offering up its insurance business to the fashion for merger and consolidation. Demerge by all means. But demerge to merge again? That's perhaps not such a good idea.

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