On the Monopoly board one of the dullest properties to buy was always the utilities. They didn’t cost much but they gave a pretty rotten return. How strangely quaint that seems now. Utility companies around the world have been the fashion of the year with these apparently dull assets attracting more interest than virtually any other sector. The search for hidden investment returns and undervalued assets certainly seemed to turn the heads of many investment managers and especially those in private equity.

Research from PwC underlined this in a report last week, showing the astonishing growth in the value of mergers and acquisitions of utility companies. In 2005 this was $196 billion but even this huge sum was dwarfed by last year’s tally of $298.8 billion. Obviously some of the headline names such as Iberdrola’s bid for Scottish Power ($24bn) and Eon’s bid for Endesa ($27bn) were significant deals but it may well that there are more yet to come – especially across European borders.

What is of particular note is the growth in the number of deals in mainland Europe which in the past has not been well known for its corporate dealing. In fact quite the opposite as many nations have been acting in a very protectionist manner in that you can go and buy “Johnny foreigner’s” assets but you can’t touch ours. Both the French and the Spanish have been guilty of this either directly or by implication and it will an interesting test of the resolve of the European Commission in not only trying to ensure that there is a clear and level playing field for all companies in all countries, but also as to their ability to act against the energy oligarchs that have built up such a monopolistic position in the market.

It is now widely accepted that these behemoths are anti-competitive and have suppressed effective price competition for consumers both corporate and private. Those in the firing line are Eon, RWE and EdF – but now the EU commission is casting its eyes on the sector with Competitor Commissioner Nellie Kroes threatening to break up the companies.

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Last week’s inflation report just confirmed what most had been expecting – inflation is rising and the key concern is whether this impacts on the pay round demands over the next few weeks. The obvious answer is yes and I suspect there are going to be some interesting disputes coming through in the next few months, especially in the state related areas – if not a Winter of discontent, at least a Spring of strikes and suspensions; I understand that London tube workers are already asking for an 11% increase, for example. The effect on the Bank of England will be to continue the rate pressure and 6% won’t seem as impossible as it might have been just a few months back. The effect on the Pound will flatter to deceive, with it being rated as a high yield currency despite growth figures starting to weaken.

Perhaps it is worth noting the comments from the S&P rating agency that the UK has seen the sharpest deterioration in public accounts anywhere in Europe over the past 6 years and now stands below those of Greece, Romania and even Georgia! They noted that a budget deficit of 3% of GDP was “disturbingly high” for a country at the top of its economic cycle and that the UK had “failed to take advantage of the global boom to put its fiscal house in order”. Enjoy India, Mr Brown.

Speaking of warnings, we should also note Mr Bernanke’s comments about the future for US funding with the anticipated higher costs of an ageing population – it is worth recalling that when Mr Bush came to power the US had a $127bn budget surplus – it now has a $339bn budget deficit. Someone else who failed to put their house in order!

Sadly with the Japanese holding their interest rate on the Yen at 0.25% (at least for the moment, as this may change next month) there seems little respite for Sterling but, at least for investors, it does provide an opportunity to buy assets outside Sterling at far better value – a good base probably for a globally spread portfolio for some years to come.

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My colleague John Hatherley pointed out a particular story which may be lead to an interesting turn of events in the Middle East. Russia has been supplying Iran with some state of the art surface to air missiles. Nothing necessarily unusual, until you consider some of the comments made by hawks about “taking out” the Iranian nuclear capabilities. At the least this could be regarded as a demonstration of Russia tweaking America’s nose. It is the result of such political events that could disturb the current state of international complacency - and with it the much lower oil price. It would appear that certain hedge funds are still betting on the price getting weaker and selling the oil price short. When everyone thinks in the same direction, then there is every chance that the opposite can occur – beware the consensus. 

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And finally……with only a few weeks until the Chinese New Year, what better way to celebrate the start of the Year of the Pig than with a major advance in pig breeding. It seems that the Northeast Agricultural University in Harbin have bred three transgenic pigs. This has been achieved by injecting a fluorescent green protein at the embryo stage and the result has been to produce “Day-Glo” pigs you can see in the dark. Marvellous, an end at last to “can’t find the bacon in the fridge” misery. Next - why not allow them to fly?

Have a good week,

Justin A. Urquhart Stewart
Director
Seven Investment Management