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What price Belgium?

• Robert Peston
• 9 May 07, 08:37 AM

Companies all over the world are going takeover bonkers. According to figures from Thomson Financial 鈥� whose parent, as chance would have it, is buying Reuters for more than 拢8bn 鈥� mergers and acquisitions worth just under 拢1000bn have been announced so far this year, which is about 30% more than in the last record year of 2000 (on a pro-forma basis).

If trends persist, some 拢3000bn of global companies would be bought and sold this year, which would be the equivalent of buying the state of Belgium 15 times over (if you assume Belgian can be acquired for a price equivalent to one year鈥檚 annual output or GDP 鈥� though I don鈥檛 suppose King Albert ll is a seller). Announcements of deals involving British companies as either buyers or bought total some 拢235bn since 1 January.

It鈥檚 proof that the animal spirits have returned to boardrooms and have also infected the acquisition committees of private equity houses. According to my banking chums, the next great British name to agree to be taken over will be EMI (probably by One Equity Partners, the private equity arm of JP Morgan).

This deal mania is also powering the stock market. Until last night, Wall Street had enjoyed its most consistent run of up-days since before the Great Crash 鈥� the Dow Jones Index closed higher 24 out of the previous 27 sessions, the longest winning streak since July 1927. The Dow is at record levels and the broader S&P 500 index is within a few points of its record set in March 2000.

In the UK, the FTSE 100 is approaching 6,600 and is nearer to its high of 6930.2 (set on 30 December 1999) than looked remotely possible just a couple of months ago when shares were distinctly wobbly.

What鈥檚 driving the market, is sentiment (no investor wants to miss out on the bull-market run) and liquidity (predatory companies and investors have more cash than they know how to use). The paradigmatic manifestation of this, according to traders, is that many hedge funds have taken off their downside 鈥減rotection鈥�: many are no longer hedging out 鈥渕arket risk鈥� in the way they normally do, for fear of missing out on the big gains.

There鈥檚 a hint of irrational exuberance in the air. That won鈥檛 surprise those of you who have observed the concerns of the Chinese authorities that their economy 鈥� the engine of the world 鈥� may be growing too fast, who have noticed the problems in the US housing market and who have worried that UK house prices could also turn negative with damaging consequences for consumer confidence.

Shares in British firms certainly don鈥檛 look screamingly cheap, as shown by this disturbing chart drafted by analysts at Morgan Stanley (download Excel file). It shows the median ratio of share-price to earnings (the PE ratio) for the 350 biggest UK companies. The median is the PE ratio of the company bang in the middle if you were to rank the companies from lowest PE to highest. What the chart shows is that since 1985 there has been a sharp fall in share prices more-or-less every time that the median PE ratio has risen above 18 鈥� and the median is currently 18.85

However, one chart doesn鈥檛 make a market rout. There are other ways of analysing British shares that don鈥檛 show them to be quite so expensive. For example, the PE ratios of the biggest British companies, those worth 拢50bn or more, is disproportionately low 鈥� largely because they are regarded as still a bit too bulky to face takeover bids from private equity firms. So the average PE ratio of British listed companies is under 14, which is not desperately expensive by historical standards. So don鈥檛 panic, but鈥�

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