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WorldCon puts the markets on a knife-edge

The news that US telecoms giant WorldCom fraudulently overstated profits by $3.8bn has sent shockwaves thr-ough an industry just beginning to come to terms with the Enron scandal.

Although another financial debacle was far from unexpected, it is the scale of the misreporting that has sent markets rocking rather than the fact that WorldCom is the second major global firm to admit fraud in a matter of months.

Not only are the improvements that have been made in terms of earnings&#39 growth since Enron now under threat but the investor confidence which was already paper-thin also risks falling so low that one more scandal could send markets into freefall.

Chelsea Financial Services managing director Darius McDermott says: “The markets cannot stand much more bad news and WorldCom has only served to further reduce investor confidence. Everyone will now have to reassess their portfolios and clients will simply be less likely to invest.I just hope there has not been too much long-term damage.”

While McDermott fears the worst may not yet be over, he remains, as do many IFAs, confident that the FTSE can haul itself above the 5,000 threshold by the turn of the year, as long as there are no more scandals.

But if there were ever any doubts that corrupt directors and shoddy US accountancy standards existed beyond the corridors of Enron, then WorldCom has dispelled them. The question now is whether such corporate implosions could happen in the UK – an eventuality that Wise Speke director Jane MacAlister says does not bear thinking about.

She says: “The WorldCom scandal is certainly worrying but it would be far worse if it were to happen here. UK accountancy standards are widely regarded as being more stringent than in the US and for that to be shown not to be the case would make me wonder about how the reports of other companies have been compiled.”

Despite her fears, MacAlistair believes it is “extremely unlikely” that another WorldCom could happen in the UK because, for the time being at least, there is no reason to doubt existing procedures.

But not everyone is of the view that company geography is of much relevance. Hargreaves Lansdown senior analyst Meera Patel believes the impact of any major corporate meltdown will be felt equally from one end of the world to the other.

She says: “It really does not interest me that WorldCom is in the US because the telecom sector, which was hard-pressed anyway, will be damaged everywhere. Any funds, whether they be equity or bond, that hold stocks in telecoms or technology will suffer. WorldCom could have been in Timbuktu for all it matters.”

However, Patel does subscribe to the theory that a similar disaster is unlikely to happen in the UK. She believes that a fundamental difference between the two countries is in the amount of pressure that chief executives are under to deliver earnings&#39 growth.

In the US, she says, CEOs are viewed according to their ability to conjure growth so when they fail to deliver, the temptation to cook the books is greater than in the UK, where heads of companies are often judged on other criteria.

Nevertheless, there is no doubt that any recovery in the UK has taken a severe blow from WorldCom. Gartmore believes there had recently been a positive macro-economic outlook – it points to upbeat manufacturing data and sustained housing market growth – that had yet to translate through to most companies&#39 profits. WorldCom, says Gartmore, will act as a handbrake on these firms&#39 attempts make the breakthrough by knocking back large swathes of the market.

A further problem, as far as Gartmore is concerned, is that catastrophes such as Enron and WorldCom mask the shafts of light that have begun to penetrate the gloom.

Senior investment manager Brian Gallagher points out that only 20 per cent of the 350 leading UK companies had a share price lower last week than on September 21, 2001, when the market bottomed out.

He says: “The market has been led by aggressive moves downwards by the technology companies such as Vodafone but it is not all bad news. It is just that scandals like Enron only serve to overshadow the positives that are there.”

Certainly, it is the fund managers, rather than IFAs, that have the most bullish attitude towards the US problems.

Britannic Asset Manage-ment admits the latest crisis will further fuel negative mar-ket sentiment towards companies with high debt or, as with WorldCom, those that have grown rapidly through acquisition but says there could yet be a silver lining for the industry.

Investment manager Alison Sinclair says: “On the positive side, it could be the final market capitulation. The high valuations seen during the bull market could now fully unwind and it could put the focus on value names that have strong balance sheets and business models that can drive the market forward.”

Despite their optimism, there is little doubt that fund managers have been shaken by the sheer scale of the WorldCom fraud and are highly concerned that investor confidence has been knocked back at the worst possible time. That there will be another scandal is not in question – most fund managers and IFAs agree it is almost inevitable. What does remain to be seen is whether another calamity would prompt investors to take their money and run. The industry fears it knows the answer.

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