US slowdown hits markets

IT was too good to last. When London shares soared 125 points early yesterday, they had rocketed nearly 700 points in a week. Wall Street had bounced even more, helped by hopes that the US economy was recovering strongly.

Delete strongly. On first estimates, US national output rose only 1.1% in the quarter to June, half what was expected. Last year, the US grew just 0.3%, not the 1.2% it first believed. In fact, it was in recession for the first nine months.

It then bounced back with 2.7% growth in the final quarter 2001 and 5% (not 6.1%, as first believed) in the three months to March. The OECD weighed in with a gloomy forecast for the eurozone, seen as growing only 1.25% this year.

The US swings are exaggerated by its quarter-on-quarter measure. But the underlying message is inescapable. Over the winter the US economic engine wheezed into life, helped by interest rate cuts and an end to industry's run-down of stocks. Now it appears to be slowing again. The Federal Reserve's Beige Book says the latest growth is 'modest and uneven'.

Since it is the US that drives the world economy, this is worrying. The estimates may be revised upward, but the news from industry is also dim. The purchasing managers' index, 58.2 in May, slumped to 51.5 in June. 'US recovery is looking anaemic,' says Gerrard economist Simon Rubinsohn.

This is not so good for the dollar, which has been enjoying a recovery against the euro, pushing it down below 98 cents. It is not good news either for savers hoping for a respite from low interest rates. There seems no early case for a rise in the US Federal funds rate, which has been nailed to a 1.75% floor for eight months. There is even talk of another cut.

At home, the Monetary Policy Committee seems likely to peg rates at 4% again today. Retail sales are growing at the slowest rate for 18 months, says the CBI, which said the High Street boom 'seems to be over' as consumers finally ease off, worried by their debt burdens.

The CBI reckons sales, which were running 6% ahead of last year, have slowed to a more sustainable 3.5% to 4%.

We do not need to get too gloomy. Most Western world economies are still growing, slowly. But just as last month's huge share falls were overdone, the sudden rally looks fragile.

Friend in need

THOSE who feared the worst for Friends Provident may have forgotten that the insurer hauled in £1.6bn when it floated last year. Stock market losses may have eroded that, but the group was able to expand its operations in the six months to June, with life and pensions sales 17% higher at £845m and operating profits ahead £36m to £161m.

'Sales up, margins stable, balance sheet robust, good acquisitions,' says chief executive Keith Satchell. Signalling confidence, he lifted dividends 5% to 2.45p, and hopes to pay 7.35p for the year.

Taking over Royal & Sun Alliance's investment side doubled the group's assets to £66bn. Satchell says fears insurers are being forced to sell equities are 'exaggerated'.

That is the good news. The bad news is that no one with £66bn assets can escape when markets crash. Friends' £161m surplus was wiped out by £356m investment losses, and after all charges it lost £224m for the half year - before July's market crash.

It is sharing its pain with customers. Bonuses on with-profit policies are being cut by 6%, making an 11% fall since April. A 25-year endowment policy, with £30,000 paid in, now returns £73,000, down from £77,000 in April, £82,000 in January and £106,000 four years back. Others are slashing bonuses - Axa recently, Royal & Sun Alliance soon. This is tough for savers but does counteract to some extent fears that insurers will collapse. Why should they, if they simply pass the pain on to their policyholders?

The better than expected sales figures lifted the shares 7 3/4p to 140 3/4p, valuing Friends at £2.4bn. The dividend yield is over 5%.

Independent analyst Ned Cazalet is worried about Friends' capital, arguing that its free assets are bolstered by £600m of 'future profits' and another £600m from hiving off endowment liabilities to foreign reinsurers. Satchell says 'The first is a genuine assets, the second a genuine transfer of risk'.

Insurers' accounts are already complex enough. Clearer rules on 'financial engineering' are needed. The Financial Services Authority has just issued a paper on the issue.

Meantime, insurance shares will only be a buy when the last bears have slunk back into the woods.