Exchanges plunge on oil price jitters

Profit warnings - a reliable indicator of looming corporate problems - are on the increase

Stock markets across Europe plunged yesterday as another batch of profit warnings compounded fears that the recent gains in share prices had been overplayed.

Stock markets across Europe plunged yesterday as another batch of profit warnings compounded fears that the recent gains in share prices had been overplayed.

Shares in London led the collapse, with the FTSE 100 hitting its lowest level for more than four months before mounting a fragile recovery. The blue-chip index closed down 80 points, narrowly avoiding the ignominy of a third 100-plus drop in just five trading days

The FTSE 100 is caught in a mini-bear market. In less than three weeks the top-tier index has lost 600 points or 9 per cent, close to the 10 per cent analysts deem as a correction.

The optimism during the dying days of August, which took the FTSE 100 to a peak for the year of 6,798 on 4 September has quickly evaporated.

The chill autumn wind blowing through the trading rooms of the City and Canary Wharf has a variety of causes. But the words of the lips of many analysts and strategists are "hard landing". There is a growing fear that the US economy, which is accelerating at a blistering pace, may not, after all, achieve a gentle slowdown to a more sustainable growth rate. The alternative, a hard landing, would mean a sharp recession, rising inflation and higher interest rates - a dangerous cocktail for the corporate sector.

Steve Russell, UK strategist at HSBC in London, which forecasts the FTSE 100 at 6,900 by the end of the year, said: "There are worries about what will happen to the global economy and the growing realisation that it has past its peak and is on a slowing path."

At the centre of the worries is the rising oil price. As Hamish McRae shows on page 21, previous spikes in oil prices have triggered global recessions.

For equity investors the main concern is the impact of a rising oil price on corporate margins and profit growth. "Rising oil prices are not good for equities," said Neil Williams, global strategist at Goldman Sachs.

The first threat to the corporate sector is the impact of rising raw materials prices. In the UK this is exacerbated by high street competition which, as a survey from the Confederation of British Industry showed yesterday, means companies cannot pass the impact on to customers via prices rises. The second negative consequence is to push up interest rates as central banks fret about mounting inflationary pressure. This discourages consumer spending.

HSBC, which estimates an oil price of $35 a barrel will take 2 per cent off corporate profits, said there was likely to be a rotation between sectors.

The losers would be companies with a high sensitivity to oil prices but an inability to pass that on through higher prices. These included engineers, chemicals, airlines and transport firms. By contrast the winners were businesses that do not depend on oil and could raise prices - pharmaceuticals, luxury goods and support services.

Tony Jackson, equity strategist at Charterhouse Securities, said oil had already hit these sectors. Share prices in basic industries have fallen about 5 per cent, engineering and machinery 7 per cent and electricity 10 per cent.

Jeremy Batstone, director of NatWest Stockbrokers, said the doom and gloom scenario was overplayed. He did admit NatWest's year-end forecast of 7,400 was "challenging".

He said not only was today's economy less susceptible to oil inflation than it was 30 years, but a rising oil price might even be disinflationary. With competition preventing price rises, firms would respond by cutting back of capital spending, so reducing inflationary pressure in the labour market and supply chain.

"Once investors start to realise the inflationary impact is fairly muted, they will have to think about the alternative - that it brings forward the point at which interest rates will fall."

He said the unknown factor was when sentiment would change and investors would buy into the dips. "After all, who wants to catch a falling knife."

Charterhouse's Tony Jackson, who predicts a year-end FTSE 100 of 6,750, was not convinced it would be good news if the oil price depressed demand. "We are already seeing third-quarter profit warnings both here and in the US."

The roll-call of warnings reads like a list of the great and the good of American industry. In September alone, there have been warnings from telecoms carrier Sprint, paintmaker Sherwin-Williams, automation group Rockwell International, chemicals behemoth DuPont and Net consultancy iXL Enterprises.

These have had a direct knock-on effect in the UK. Sprint's warning yesterday cut 5-10 per cent off stocks such as Telewest, British Telecom, Cable & Wireless, Vodafone, Colt Telecom and Energis. ICI was pole-axed by Sherwin-Williams, while Invensys suffered thanks to Rockwell's warning.

According to Ernst & Young, the accountants, the number of profit warnings rose in the second quarter for the first time since the end of 1998. Richard Coates, E&Y's turnaround partner, said: "The petrol crisis will affect the figures for the third quarter and we would expect some more profit warnings as a result of that. People were unable to get to shops, for instance."

According to Morgan Stanley Dean Witter, the investment bank, an increase in profit warnings is a good indicator of "troubled times ahead". Richard Crehan, its equity strategist, said although most recent warnings had come from New Economy stocks, there was pick up in warnings from cyclical consumer and industrial stocks.

"Given the rise in oil prices and the rise in global interest rates, we would take it as an early warning signal for the most cyclical stocks," he said.