FTSE loses its mettle

“We are concerned about the buoyant level of investor optimism,” said Graham Secker, its head of UK strategy, who calculated that British stocks are trading on average an average of 18.5 times earnings. That premium valuation is undeserved because profit margins and return on equity are at “peak levels”, he argued.

Across the Atlantic, the Dow Jones Industrial Average lost 40 at 10844 after US trade figures came in slightly weaker than the Street had expected. The deficit widened by 1.5 per cent in December to reach $65 billion, the Commerce Department said. Economists had on average expected a deficit of $64.6 billion.

For more on US markets, click here.

Prudential led London’s top-line risers on renewed gossip that the insurer could be subject to an all-share bid from larger peer Aviva.

The genesis of story appeared to come via a presentation by Gordon Aitken, JPMorgan’s insurance analyst, which was mailed out to some of the Wall Street bank’s clients today as an “audio teach-in”.

In the presentation, Mr Aitken said the combination made some sense as the companies have little geographic or strategic overlap, with Aviva attractive for its free cashflow generation and Pru for its growth opportunities. He also argued that such a deal may not be blocked by the compeition regulator, as the government would favour creating a “European champion”.

However, JPMorgan’s presentation noted that the limited geographic overlap reduced possible cost savings. Mr Aitken therefore argued that a deal would likely dilute Aviva’s earnings on most measures.

Speculation about a merger between the insurers is not novel. The rumour last had a run-out last month, when Pru dropped JPMorgan Cazenove as its broker in favour of City heavyweight Goldman Sachs.

Pru shares were ahead 15p to 591p. Aviva added 5p to 739p.

Track Pru shares here.

On a more fundamental tack, P&O tumbled 20.75p to 516.75p after PSA International, the state-owned Singapore investment fund, said it was putting down its paddle and backing out of the auction for the ports operator. That left unchallenged DP World’s 520p bid, which the UK company’s board has already recommended.

PSA said that while P&O offered “an attractive opportunity”, its trumped offer of 470p was full and fair. “To pay more than this price would not be compatible with commercial business sense and PSA’s future success,” it said.

For more on P&O, click here.

Basic resources stocks did most to drag the FTSE lower as metals markets dived. Commodities traders on the London Metals Exchange blamed the nervy market on margin calls for some of its big institutional gamblers after their stop-loss limits were tripped.

Copper and aluminium futures traded lower by about 5 per cent each, their second such slump this week. Gold and silver were down more than 2 per cent, encouraging some dealers to talk about a correction in the market.

The contracts, once the preserve of the industry and specialist investors, have become increasingly volatile of late as hedge funds create liquidity even when there is no fundamental news to move prices. This has come as the two-year bull run for commodities generated unprecedented demand among pension, endowment and mutual investors -- an appetite some analysts believe has taken prices way above fundamental value.

Antofagasta, the Chile-based copper producer, was off 82p to £19.90. Anglo American was lower by 54p to £20.31 after in-line but unexciting results from De Beers, its minority-owned diamond miner. Rio Tinto weakened 86p to £20.31.

BHP Billiton fell 50p to 956p ahead of interim results due February 15, which will likely reveal record profits thanks to the buoyant metals prices. However, because of its oil operations, the world’s biggest miner is likely to have been hit more than peers by shortages of equipment and skilled labour.

“It is possible we could be in for a nasty surprise,” said Investec. Citigroup reckoned there was also potential for disappointment if management does not announce a share buyback or special dividend.

Xstrata resisted the selloff, down just 18p to £16.16 after a broker upgrade. Morgan Stanley moved to “overweight” from “equal-weight”, arguing that the Swiss-Australian group is the cheapest in the sector.

Track today’s trading by industry sector here.

Back the leaderboard, Compass was ahead 2.5p to 220.35p after the embattled caterer -- currently subject to three investigations about its procurement of UN contracts -- said its trading is in line with expectations.

“We are not changing our forecasts at present which after years of consistent downgrades is wonderful news indeed,” Merrill Lynch commented. “This gives us confidence that forecasts may indeed have troughed and the group can concentrate on implementing its strategy of improving returns on capital employed and driving cost efficiencies.”

Read the Compass statement here.

BAA had a rollercoaster session, rising as high as 798p on hopes airport operator could be subject to a bidding war, then sinking as low as 773.5p on concern a new set of bondholder terms could have the power to kibosh any deal.

Private equity firm Star Capital Partners is eyeing the Heathrow owner for a possible £8.4 billion takeover, The Times said today. Star Capital, which last month hired Rick Haythornwaite, the former Invensys chief executive, is thought to have been working on a potential bid for BAA for several weeks. The bid preparations are at an early stage and Star Capital is yet to make an approach to BAA, it reported.

Ferrovial, Spain’s second-largest builder, admitted this week that it was considering putting together a bid for BAA, probably as part of a consortium.

Later in the day, the BAA put out a statement amending terms on its most recent sterling and eurobond debt issues to add a change-of-control agreement.

In the event of a takeover and the notes losing their investment-grade rating, the new provisions will allow debt holders to sell their notes back to BAA at the maturity rate plus accrued interest. BAA last week priced three bond issues, raising £2 billion, in order to pay down more expensive debt and fund the construction of Heathrow Terminal 5.

The initial response from traders was that, while this extra £2 billion of liability is probably not enough to derail any plans for a leveraged buyout, it adds a signifdicant extra hurdle to the buyer’s risk and return calculations.

For more on the debt agreement, click here.

Second-liner Aegis erased early gains to fall 2p at 133p after a US newspaper claimed Vincent Bollore, the French entrepreneur, is nearing a decision on whether to launch a full bid or sell his stake.

Mr Bollore, who is chairman of Paris ad agency Havas, last month raised his Aegis holding to more than 25 per cent. That followed rival agency Publicis holding preliminary talks with the UK group over a deal, which came to nothing.

While a full buyout by Mr Bollore would seem a logical move, the £1.5 billion price tag for the remaining shares could be too rich. However, dealers reckon Publicis would renew its interest in the advertising buyer if he did choose to bail out, offering some downside protection for the share price.

For detailed information on Aegis, click here.

Stanley Leisure was the top performer in the mid-caps after yesterday’s bid approach for London Clubs’ flagship Les Ambassadeurs casino -- thought to have come from Indonesian punter Putera Sampoerna -- revived speculation about a merger between the two UK gaming groups.

The union of London Clubs and Stanley Leisure has been mooted ever since Genting, the Malaysian casino operator, built significant stakes in the pair. However, any deal would be sure to attract the attention of the redulator, as a combined businesses would own almost half London’s casinos.

London Clubs was up 2.25p to 149.5p. Stanley Leisure took on 95p to 875p, with a counter-rumour doing the rounds that an industry peer such as Rank may intervene.

For more about Mr Sampoerna, click here.

Further down the market, QinetiQ was in demand on its debut day of trading, with shares in the defence research firm rising to a premium of about 5 per cent.

The stock was changing hands at around 213p on a when-issued basis, having had its controversial £1.3 billion flotation priced near the top of the range at 200p per share.

For more on Qinetiq’s IPO, click here.

BG Group -- last session’s top performer on a gain of around 10 per cent -- today gave back 7.5p at 667.5p. Forecast-beating results and raised production targets yesterday from the gas prospector convinced most sell-side brokerages that its value was fair. But not Sandford Bernstein.

“The reaction in the market yesterday was largely a result of short covering and failure to digest the detail of the updated strategy,” the US research house told clients. “The potential from exploration again appears over-hyped.”

Bernstein argued that BG had “thrown everything possible” into its forward guidance, and had “focused investors on volume growth rather than on the economics of this new growth.” It said that projects in Russia and Libya will be low profit, while Alascan exploration, even if it is successful, will not pay off before a pipeline is built in 2014 at the earliest.

“It is a good company, but this is fully reflected in its valuation,” wrote the Bernstein team in a note repeating “underperform” advice and a 590p share-price target. “While our medium-term risks may take some time to play out, the current drop in US gas prices may mean that the first quarter results may be a key risk to the stock now that expectations have been set high after a strong fourth quarter performance.”

Elsewhere on broker watch:

Merrill Lynch raised Arriva to “buy” from “sell”, citing the possibility of a leveraged buyout for the transport group over the next couple of years.

HSBC cut Centrica to “neutral” from “overweight” and made the same call on United Utilities. Both Pennon and International Power went the opposite way.

Numis raised Rolls-Royce to “buy” from “add”.

Altium cut Michael Page to “hold” from “add”.

And ING cut Smith & Nephew to “hold” from “buy”.

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