The Stock Exchange freeze
Nicholas Davenport
The business prospect for stock-jobbers and brokers in the enlarged trading floor of the new Stock Exchange which the Queen opened last week is pretty grim. Turnover has already fallen like a stone and the uncertainty which must accompany a ninety-day freeze is hardly likely to see any improvement. But Wall Street can still come to the rescue and turn the market upwards. The standstill on dividends is unimportant. Dividend increases postponed are merely ploughed back. (Incidentally investment trusts and companies which are part of groups are exempted from the freeze while companies which have recently increased their equity capital through cash subscriptions can increase dividends pro rata.) The only companies which might be hit by a dividend freeze are those engaged in a take-over battle where an increase in dividend might tip the scales. Some people even expected a freeze on take-overs and mergers, especially as Mr Peter Walker (late of Slater Walker) is the new Minister for Trade and Industry. However, in a rousing speech to the annual conference of the Institute of Directors on November 9 Mr Walker did say that "monopolies, mergers, restrictive practices and fair trading legislation will be reformed within months. So will insurance law." There is nothing like a poacher turned gamekeeper to be quick on the gun.
As for company profits I cannot see how any analyst can say at this stage that the freeze is good for profits in general. Everything depends on the sort of package which follows the freeze. If it is to be the Heath formula of a wage extra of £2.60 a week with price rises limited to 5 per cent and growth maintained at 5 per cent, company profits should increase by around 10 per cent in 1973. If the wage ceiling were raised to £3.40, as the TUC demands, then company profits would increase by only 5 per cent. If, however, the freeze is successful and the excess rise of wages over prices is cut down, then economic growth might be reduced to 4 per cent (unless more tax cuts are given). This again would slow down the rise in company profits. The cautious investor should therefore confine himself to the booming retail trades which are on the right side of this lop-sided boom. But even here he must be careful, for if the Government goes ahead with a 10 per cent VAT in April and allows EEC entry to push up our price level, there could be a fall in consumer spending in certain goods from next April.
I see that one firm of brokers, whose charts are always meaningful, thinks that an average rise of 20 per cent in pre-tax profits between now and mid-1973 is probable. If this were so it would pull the average price-earnings ratio down below 14. But such a wonderful profit rise will, I suggest, be confined to those companies which can effect a big reduction in unit costs through improved productivity or to those with a big export trade in goods whose profit margins are widened by the effective devaluation of the £. The productivity rise is the important factor. In the Economist of November 4 there was a chart on the " stop-go " cycles which brought out the astonishing rise of near 10 per cent in productivity since the 1971 sharp drop in employment. Nothing improves company profits so fast as when the managements find that they can step up output on half the old labour force.
This should bring home a point which so many investors forget. Equity shares, as we all know, are imperfect hedges against inflation but inflation is far better for company profits than deflation. As The Spectator pointed out in a leader, employment in the highly unionised industries has declined heavily. If firms are compelled by the monopoly power unions to pay higher wages than they can afford, they will cut down on labour. The strong arm tactics of the monopoly power unions are therefore doing a disservice to the working class as a whole. The moderates understand this very well, and Mr Heath must not come to the defence of the monopoly power unions by pumping out more money to prevent the unemployment they are causing from rising further. Let the employment consequences of grabbing too much cake be learned by one and all.
How much the pump-priming has added already to the inflation it is difficult to measure. The charts show that price rises generally follow wage rises after an interval of nine months but government pump-priming finances them both. The huge increase in the money supply is the reflection, not the cause, of the resulting monetary inflation. The Government must now consider how to bring their monetary inflation under stricter control.
The calling for special deposits of £220 million from the joint stock banks is a very feeble attempt. It is equivalent to only a fortnight's growth of bank liabilities and is no more than a neutralisation of the expected increase in money supply when some of the government securities held bY the banks become in fullness of time "reserve assets" (i.e. twelve months maturity). The big mistake of the Government was to restore freedom to the banks to lend as much as they liked to whom they liked provided they maintained the required ratios. So the rate of increase in money supply rose from £1,586 million per annum in 1970 to £2,366 million per annum in 1971 and to £2,560 per annum in the first half of 1972. This increase went to finance not only the inflationary rise in wages but the inflationary boost in houses and land and securities traded on the Stock Exchange. At the same time the borrowing requirement of the Government rose from a mere £13 million in 1970-71 to £515 million in 1971-72 and now to an estimated £3,356 million in 1972-73. Not only has taxation been reduced bY £3,000 million but ministers have authoritY to pour out millions to the development areas and to other worthy causes so designated by Mr Chataway under the Industry Att. It is time to call a halt to this government largesse. There are statistical signs that the rate of increase in money supply is slowing down but the Government has not yet confessed to auY change of monetary policy. It clings to its 5 per cent growth. One would have thought that bank advances would ha'e been made subject to the freeze but it is not so.
The immediate Government problem is to finance the £3,000 million deficit without pushing up the Treasury bill issue allY further. If only it had not mismanaged the gilt-edged market it could have asked the savings institutions to take up a long' dated stock, which it would be their duty to do. One novel idea put forward is the Issue of a "national equity bond" whose coupon would go up with the growth of the economy but this smacks of the "index bond" which has never been popular in well-ordered financial systems. The Government should long ago have issued a public unit trust, as I urged ill these columns many years ago. This woulo have doubled the national savings in a 5 per cent growth period. So wait and see it is. Let us not forget the object of the Heathian exercise. It is t° win the support of moderate trade unionism to a growth with restraint pojicY before the militants bring the Whole system crashing down.
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