City’s troubles aren’t over despite stock market’s resurgence

 
Allister Heath
THERE is a strange feeling in parts of the City, one that feels suspiciously like euphoria. No wonder: the stock market keeps going up, with the FTSE 100 hitting its highest level since 2000 yesterday.

Forget about Westminster politics: this is the biggest story in town. Rising markets are an astonishing elixir: they deliver happiness all round and inevitably cheer even the most miserable of souls.

Companies are finding it easier to raise more money, banks, lawyers and advisers to pocket fees, wealth managers to deliver large returns for savers and investors to boost their wealth. The government’s stake in the nationalised banks is going up in value, and its stake in Lloyds Banking Group is in the black, meaning that it could make a profit (barring opportunity cost) were the bank reprivatised at current prices tomorrow. George Osborne will also be hoping for an increased take in capital gains tax from all of this renewed activity.

Everybody is happy – especially given that it is all happening in the context of a renewed bubble in the bond markets (with yields still at stupidly low levels), surging house prices (helping those who already own a big home, and the government’s stamp duty revenues), and a general sense that the UK economy is through the worst. Of course, not all assets are gaining in value: gold and silver are down, and commodities including oil are also lower than they were.

But despite all of this good news, there are plenty of reasons to worry – and also structural changes that mean that the wealth effect from the stock market’s resurgence won’t feed into the economy as quickly.

For a start, an asset price recovery at a time of near-zero base rates, massive quantitative easing, huge provisions of central bank liquidity and generally subsidised credit is not really real. Of course, corporate profits are at extremely elevated levels, and on many price to earnings measures equity prices are not overvalued, or only barely so.

But even though the markets may go on rising for a while, it is obvious that the foundations for at least some of these high profits and strong valuations are made of clay. At some point, interest rates will go up, in the UK, the US, Europe and even Japan, be it in a year or in five, and when that happens asset prices – equities, bonds and property – are bound to collapse.

Those who believe that “things are different” this time around were the same people who were wrong during the dot.com bubble, wrong during the sub-prime bubble and will be proved wrong following the bursting of the current cheap money bubble. Crucially, however, corrections are all about timing – and at the moment at least, the markets appear to be on a roll.

In the short term, the good news is that investors will feel richer, so may spend more; and some firms may soon start hiring staff, or hiking their pay. But bankers are now all on deferred bonuses, and their fixed salaries have gone up and their variable pay has gone down, which means that they won’t feel the impact of their firms’ enhanced workload and profits in the same way.

The stock market’s resurgence may also lull the City into a false sense of security. London’s financial services industry remains under intense threat, with the Eurozone’s economically destructive, counter-productive and extra-territorial Tobin tax set to hurt and the EU hell-bent on capping even more bonuses, forcing up basic wages and making institutions riskier rather than safer.

The City should enjoy the stock market rebound–but its troubles are far from over.