Outlook: Little visibility for markets even after smoke of war clears

Have we finally seen the end of the long, long bear market? The FTSE 100 has risen for seven consecutive trading days, taking its climb since it hit a seven-and-a-half-year low last week to an astonishing 17.5 per cent. We are still down on the year, but not by much, and assuming the war continues to go well for the Anglo-American alliance, then that marker too may be passed early next week.

Parallels are already being drawn with the end of the bear market in the mid-1970s, when Prudential and others decided enough was enough and got together to ensure a sustained buying drive that would lift prices from their doom-laden low point. Actually, it's not quite the same this time around. Goodness knows that the institutions need the stock market to start rising, as Standard Life all too alarmingly demonstrated yesterday by admitting that but for the inclusion of future profits it would be below its minimum funding requirement.

But the big British institutions are not as powerful as they were then, and today markets are driven much more by global influences. The rally is in any case as much caused by a panic closing of short positions by hedge funds and others as sustained buying by the big savings institutions. That would give some reason to think the uplift might prove short lived. There are plenty of other reasons for caution too. The Iraqi factor is about to be removed from markets, but in the process, the Western alliance has suffered the most terrible beating, with possibly quite profound long-term macroeconomic consequences.

Globalisation, the great driver of economic growth and change this past 20 years, has hinged around co-operation between nations, not around military might and conquest. Furthermore, it has depended crucially on American economic prosperity, and here the prognosis with the budget deficit now ballooning alongside the existing current account one, doesn't look good. I think we have probably seen the bottom, because equities got so ridiculously low, but a rebound to former glories any time soon? I don't think so.

Pension meltdown

Britain's privately funded, final-salary pension arrangements were once the envy of the world. Over the past three years, they have become the mother of all liabilities and it is beginning to look as if their perceived gilt-edged qualities were always more illusion than reality.

New accounting standards mean that scarcely a day goes by without the emergence of another horrendous funding deficit in a major occupational pension scheme. For many publicly quoted companies, these deficits have become the primary determinant of the share price. Falls in the stock market become self perpetuating because they increase the size of the deficits, thereby increasing the amounts companies have to find to fill the gap and further undermining the company's prospects.

The potentially fatal size of the deficits for some companies has raised questions as to whether defined-benefit pension arrangements were ever such a good idea in the first place. That they act as a deterrent to labour mobility has long been a concern, but that they disproportionately benefit senior executives at the expense of other stakeholders, and have distorted the behaviour of stock markets has only recently come to be fully appreciated.

The 20-year bull market encouraged companies to believe that pensions were a relatively cheap deferred pay perk. As the surpluses swelled, many took pension fund holidays or failed to contribute as much as they should have done, thus inflating corporate earnings and further encouraging the upwind in share prices. Now we are seeing the mirror image of that process, with companies having to contribute more in order to honour their contractual obligations.

Companies have adopted a variety of different approaches to the problem. In growing numbers, they are closing their final-salary schemes and forcing new employees into defined-contribution arrangements where there is no long-term liability for the employer.

Unfortunately, this is no short-term fix, since the old arrangements are bound to have a long tail of liabilities that will take years to pay off. In more extreme cases companies have moved to close their final-salary schemes to existing members too, or had them wound up entirely. Alternatively they have sought to persuade employees to contribute more, tried to reduce the benefits or, as with Honda this week, increased the retirement age in order to limit the liability.

It's not just the bear market. Greater longevity and the abolition of the tax credit on dividends have combined with the shrinking stock market to produce the perfect storm. But there is another ingredient which is rarely given sufficient prominence. Most pension funds are just very poorly managed. Collectively their investment stance and decisions are governed by a set of conventions and risk management tools that are hopelessly out of date. That they found themselves far too heavily exposed to equities as the bull market peaked is a statement of the obvious, but why were so few steps taken to protect the value they had accumulated?

Why was it that while the super rich were switching out of equities into property, hedge funds, bonds and cash in order to protect their capital, the pension funds sat on their hands waiting for the storm to break over them? For institutions that are supposed habitually to avoid risk, they found themselves in the most high-risk situation of all, facing a once in a generation bear market of almost unprecedented longevity and ferociousness. Too late, they are now all making the necessary adjustments, just in time, very probably, to enter the bear market in bonds. Our money managers have a lot to answer for.

European dreams

To lancaster House for a dinner of such sumptuous excess that anyone would think we were visiting foreign dignitaries. Actually this was Denis MacShane, Minister for Europe, and Melanie Johnson, the Consumer Affairs minister, using up a little bit of the Foreign Office budget to update business journalists on economic reform in Europe in the run up to the European Council meeting in Brussels. It was their misfortune that they had arranged the dinner for the eve of war against Iraq, and as a result Mr MacShane found himself talking about little else.

Has not the breakdown in relations with France and Germany over Iraq set back the British agenda for economic reform in Europe for years, he was asked. There really was no sensible answer to that other than yes, but Mr MacShane is nevertheless drawing comfort from enlargement, which he thinks will be a galvanising force in driving European competitiveness and entrepreneurialism. The same used to be said of the euro, but as we now know, it has failed to be the catalyst for free-market reform in Germany and France that many of us had hoped for.

Ms Johnson claims that behind the scenes, excellent progress is being made and she cites the recent breakthrough on patents, allowing a much simplified and less costly cross-border system for the registration of inventions, to support her argument. All the same, from this side of the Channel it still looks as if the Europeans are achieving a lot more success imposing their agenda on us that we are on them.

Mr MacShane is sanguine about the present breakdown in relations with France, which he thinks a temporary thing. He may be right, but he's certainly going to have to earn his crust in the months ahead rebuilding bridges with the eurozone's two dominant economic powers. As for acting as a bridge between the US and Europe in the tit for tat of commercial and economic point-scoring that is all too likely to follow the war, he may find himself more like piggie in the middle than bridge maker. Never mind economic reform, the immediate challenge is that of restoring some semblance of diplomatic relations.

jeremy.warner@independent.co.uk