10/12/2008

Why you cannot rely on "the market" to sort themselves out

There are still some people around who believe that "the market", the "free economy", in short, capitalism, can fix itself, can run without government help, it stops monopolies, creates competition and that prices are set according to demand and market conditions. Patently, as the panic in world markets show, this is untrue.

Perhaps though, for me, the stupidity of "the market" was shown on Friday. Whilst some might say that banking stocks could expect a hammering (although with a government guarantee this still seems daft), there were some stocks that the market abandoned which shows the holes in free market thinking.

Take, for example, Severn Trent water, whose share price on Friday was down more than 6%. Why were shares in this company down ? Will people in the Severn Trent area have to take less baths ? Will people in the area they cover suddenly stop drinking water ? In many ways Severn Trent might actually sell more water as people rely less on the bottled variety.

So why were their shares down 6% ? Because the market is stupid.

3 comments:

Anonymous said...

Please don't write about things you don't understand.

"banking stocks could expect a hammering (although with a government guarantee this still seems daft)"

It's not daft at all. The government guarantee will come with costs attached and those costs will be borne mainly by the equity shareholder. The government's failure to spell out the costs led the market to assume the worst.


Severn Trent and other utility stocks fell for the simple reason that the market knows the government is desperate for money to shore up the banking system and that increased tax on the utility sector is one likely source of such income.

Incidentally, I don't recall anyone claiming that capitalism "stops monopolies". As a matter of fact, the real liberals among us see competition law as an important role for government.

Anonymous said...

And Sainsbury make record profits and were down a similar amount even though supermarkets (and utilities) are good stocks to own in recessions.

yes, the market really does not work.

Anonymous said...

This is not meant to be a dig but I'm guessing your subject isn't economics.

The reason that a swathe of seemingly unrelated industry stocks, such as utilities, are under pressure is that they are also carrying unusually large amounts of debt. Some of these debts are short term and are coming up for re-negotiation. The new credit will be more expensive than before and that's assuming they can find anyone willing to lend them anything in the current market.

Normally utilities are ultrasafe* but the fact that many were bought using large chunks of cheap credit, in a way not previously seen, means they are subject to the same level of uncertainty as any other business that is currently looking for credit.

I don't know about Seven Trent, but Thames Water was recently sold and it's likely (again, I am not aware of the specifics in this case) that the transaction created a lot of debt for the company (think Manchester United).

Peter Hain, in today's Observer, made the point that the utilities & transport are areas that will need to be watched very carefully over the next few months.

*steady, reliable income with relatively fixed, known costs.

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