Profits go down the drain

But this is not the nineties and City traders are not opening the champagne just yet. Companies are being forced to use today’s profits to pay for the mistakes of the past. Rather than investing the money in new equipment and expansion, firms are worrying about how to pay off liabilities.

The CBI has calculated that British firms have a collective pension deficit of £160bn, as measured under FRS17 accounting rules. This is not loose change by anyone’s standards. Consulting actuaries Lane Clark & Peacock have confirmed the CBI’s worries, estimating that the giants of British industry in the FTSE-100 alone have a £55bn deficit.

As it reported a 78% increase in profits, Rolls-Royce for one said it might have to contribute up to £50m a year more to the group pension fund.

And the problem is not confined to the UK. BP has said its priority is to reduce its enormous pension deficit. It will spend £1.2bn just to plug the hole of its US pension schemes.

Diverting this profit to pay for your pension scheme could have some knock-on effects, as Merrill Lynch has pointed out. In the UK, we may see more bond and equity issues as an indirect result.

The cash to fund any upturn in mergers and acquisitions activity might have to come from junk bond issues if all the big profits are eaten up by liabilities.

In Europe, there still seems plenty of enthusiasm for corporate bonds, particularly in the high-yield market.

For many, the tide has still not turned in favour of the equity markets and away from bonds. Despite a rally in equities just after the Iraq war, the FTSE-100 is still only about 4% up since January.

Lane Clark & Peacock has claimed that the FTSE-100 index would need to climb to 6,000 by this time next year to clear the £55bn deficit.

The FTSE is currently around the 4,100 mark, so perhaps we should not be too surprised that the value of M&A activity is at its lowest for 10 years.