George Pitcher: UK market looks for the upside of the downturn

Profit warnings on opposite sides of the Atlantic have produced opposite movements in share prices, reflecting a major difference in market moods, says George Pitcher

There are signs on both sides of the Atlantic that advertisers have not heeded the patriotic call to spend their way out of recession. There always were flaws in the Bush-Blair line that if we didn’t carry on as normal, spending in the shops and going about our business, we would be handing a victory of sorts to the terrorists in their attempts to bring down Western capitalism.

One of those flaws was that advertisers were always going to pull major ad campaigns in the wake of September 11, on grounds of taste if nothing else. The usual relentless cheerfulness of advertising has obviously seemed singularly inappropriate.

Another flaw, as WPP Group’s Sir Martin Sorrell and others have been quick to point out, was that advertising was entering a worldwide recession in any event, before the attacks on the US. In a sense, the terrorists chose their moment well to make it appear that they were inflicting major harm on the West’s economies.

As paradigms of the advertising downturn, media groups Pearson and AOL Time Warner demonstrated last week what that downturn looked like – with very different effects on their respective share prices.

Pearson, which owns European newspapers The Financial Times, Les Echos and Expansion, warned that it expects a “dramatic drop in advertising revenues” in the wake of September 11. The FT alone could see profits fall by as much as 40 per cent, from the &£211m posted in the year to last December. Expect the gutters to run pink in the New Year.

The FT Group aims to hold its margins at a reasonably healthy 15 per cent by cutting costs – a contribution to Pearson’s promise to maintain dividend growth at above the rate of inflation. This may go some way towards explaining why, on the dismal news of a profits warning, Pearson’s shares rose by 42p to 770p.

Although the relative strength of Pearson’s education business also helped, it seems that what we are also witnessing is the London stock market’s expectation that the economic downturn is likely to be relatively short-lived and that the UK is, in any event, better placed than the US.

That comparison was made evident by AOL Time Warner’s concurrent warning that it anticipated no recovery in advertising revenues for the rest of the year (a modest projection by any standards – at the very least the first half of 2002 can be expected to be dismal) and that it could provide only the roughest estimates of performance for next year.

In contrast to Pearson, however, AOL’s shares fell by eight per cent, landing at $30.81 (&£21.32) on the news. And unlike Pearson, where rays of hope could be discerned through the gloom, AOL revealed that it was suffering across the board, in cable networks, publishing and Internet services. The truth is that market conditions were exacerbated by the events of September 11, rather than materially changed by them.

Those conditions are characterised by economic contraction, tempered in the UK by optimism, while in the US the downturn is steepened by pessimism. The London markets are saying it’s going to get better – New York is saying it’s going to get worse first.

But within this generalisation, there is one alleged cause for optimism that should generate alarm. A rally in the London market last week was sparked by a perceived resurgence in interest in the beleaguered technology, media and telecommunications (TMT) sector. The FT-SE 100 index put on more than 120 points – 2.4 per cent – on the back of encouraging news from computer companies IBM and Intel.

Good news is likely to be clutched at at the moment. And it is good to see that the computer giants, in stark contrast to some other companies in the sector, are robust enough to have weathered the storm. But let’s not forget that it was the TMT sector that was almost single-handedly responsible for last year’s advertising boom.

That boom came to an end in spectacular fashion with the dramatic deflation of the dot-com bubble and the puncturing of the ridiculous valuations that had been ascribed to telecoms companies. In short, advertising rode an unreal and unsustainable market in 2000.

There is nothing unreal or unsustainable about IBM and Intel. But the TMT sector depends on the kind of innovative technologies that attract, rightly, the small corporate pioneer. This is, by its very nature, dangerous investment territory.

In this context, it is worth recording that the Dow Jones Index in New York recorded three-figure gains on the back of the IBM/Intel reports – and it was in the US that the silliest TMT valuations were to be found during the boom times.

To underscore this point, it is also worth recording that the best performing stock sectors of last week were once again the likes of IT hardware and software, while the worst performers were to be found in defensive, “old” economy sectors.

What I’m saying is that we might well see an apparent recovery in the fortunes of advertising as a consequence of a new vitality in TMT. I’d add that the lessons of recent history should indicate that recovery hopes pinned on the TMT sector are likely to be dashed.

George Pitcher is a partner at communications management consultancy Luther Pendragon


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