- The Washington Times - Sunday, January 26, 2003

LONDON, Jan. 26 (UPI) — January in London and in the gray, overcast sky and the intermittent drizzle and the raw rather than bitter cold you can see the justice in Dickens' memorable opening to "Bleak House," the description of a place "gone into mourning, one might imagine, for the death of the sun."

It was fog that Dickens used and, later in the same book, rain as symbols of prevalent gloom and injustice: the injustice of a legal system and a society that crushed many.

Dickens lays the fog on thick. "Fog everywhere. Fog up the river … fog down the river, where it rolls defiled among the tiers of shipping and the waterside pollutions of a great (and dirty) city. Fog on the Essex marshes, fog on the Kentish heights."

One hundred and fifty years later the fog is in the London stock market. And we can see how right the stockbrokers were when, seven years ago, they said the sunny market could go on breaking records. (Just as, no doubt, the record-breaking housing markets, in Britain and in the United States, can go on to do now.) Friday the Financial Times stock exchange index — the FTSE 100 or Footsie, the main stock index in London — set a new record by falling for the 10th consecutive day — the first time it has done so since, not Dickens' day, unfortunately for so historic a market, but since not so distant 1984, when the index was established.

The cumulative drop in the FTSE 100 takes it to its lowest point since December 1995. The fall since the beginning of 2000 is extraordinary: in London the bull run of the second half of the 1990s has been wiped out. The London stock exchange has fallen harder in the past two years than its European and trans-Atlantic rivals. Taking end-1999, when most stock markets were close to their peak, as our starting point, the FTSE 100 is now down by 48 percent. The main U.S. index, the Dow, is down by only 29 percent over the same period.

Why this should be is itself interesting. In the past two troubled years ,the U.K. economy has tended to perform more strongly than the U.S., French and German economies. In 2001, when the U.S. economy grew by just 0.3 percent, the U.K. economy grew by 2.0 percent. This year the U.K. economy is expected to grow by about 2.5 percent, at least on a par with U.S. growth and much better than anything that can be expected in France and Germany. So why is the London stock-market gloom murkier than the gloom elsewhere?

Perhaps it is overdone. The London-based Financial Times seems to think so. "U.K. investors should be swallowing their disappointment and getting back into equities," concludes Philip Coggan, one of the newspaper's commentators. Falling interest rates and bond yields, Coggan argues, suggest that equities' time has come. "A yield of 3.8 percent (on the FTSE at Thursday's close) was just 0.2 percent below the return from cash and half a percentage point below that from government bonds," Coggan writes. "A price-earnings ratio of 17 was not cheap," he goes on, "but reflects a dismal recent profit performance."

But why should corporate profits in the U.K. improve now?

U.K. economic growth does not convince. Part of the reason is that it looks all too American, with huge dependence on the consumer, on soaring house prices, on mortgage lending used to finance spending, on low interest rates, on fiscal policy, and all the while manufacturing contracts. The economy is imbalanced and wobbly. It may go down — and need to go down — before it can rebalance again. This means that corporate profits, already under pressure, are not going to recover soon. It is hard to see any reason now why equity investment in the U.K. should suddenly be a good idea — other than that the market is at a seven-year low. But what goes down can go further down: that should be remembered.

And there are plenty of reasons to suggest that the U.K. market may fall still further. There are the domestic economic imbalances and certain problems to the West, where U.S. President George W. Bush is keen to head east, with well over 100,000 U.S. troops.

War in Iraq is a huge risk for financial markets and Western economies. We have written extensively on it before and won't dwell on it again now. Instead, being a Londoner and gloomy, we shall dwell on other chilly fog rolling in from the Atlantic.

The London market is catching cold on icy U.S. winds. The low interest rates that Coggan refers to in London are lower still in the United States, where they ought to be of help to corporations, shouldn't they? With corporations' financial costs being reduced by low interest rates, their profitability and ability to reward investors ought to be increased. But an analysis from Ian Morris, HSBC's U.S. economist, suggests this is not the case, pointing out that "interest payments as a proportion of (corporate) profits remained exceptionally high through 2002 despite all the talk about debt cutting … The interest to profit ratio is now 32 percent — a touch higher compared to the level at the start of the recession in 2001."

Morris adds that the burden of that debt is in some regards greater now than in the past because of the deflationary economic environment. Inflation is not going to erode the real value of that debt. Nor, it would seem, is rapid growth going to permit corporates to grow their way out of their debt burdens.

And corporate debt is only part of the problem. Consumer debt has been rising rapidly in the United States and the United Kingdom, not least because of the housing boom that has been created by ultra-low interest rates. The burden of debt is going to hang over both corporates and consumers in the next few years in both the United Kingdom and the United States.

So where are we? Normally you don't see far through gloom. It brings the opposite of perspicacity. But London's stock market gloom would seem to have element of prescience. Though any comment now from Bush suggesting war with Iraq may be delayed or not happen at all would provoke a stock market rally, the time does not seem right to put money into equities. And the fundamental reason for that has little to do with the likely war.

The fundamental reason is that both Britain and the United States remain mired in a pernicious fog that follows the 1990s stock bubble. Neither economy has yet rebalanced, and the huge fiscal and monetary effort to avert recession means that new imbalances have appeared, above all in house prices and consumer debt, and that not much more can be expected in terms of policy easing. Neither the U.K. nor — still more so — the U.S. stock market has yet touched bottom.

What would Dickens say? We fear it was about the U.K. equity market and not the Court of Chancery that Dickens was writing when he wrote (in "Bleak House") that it has "its decaying houses and its blighted lands in every shire, which has its worn-out lunatic in every madhouse and its dead in every churchyard."

In other words, we don't think it's a good time to put money into equities.


Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected]

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