MONEY AND THE CITY
Black Monday
Nicholas Davenport
Writing on investment policy for 1973 in this column on January 6 I came to the conclusion Cnat those stalwarts Who believed that Mr Heath would emerge victorious from the coming confrontation with the trade unions over Phase 2 would no doubt hang on to their carefully selected list of equities but the more craven hearted, to whom I inclined, would be cutting down their equity commitments in the UK, cashing in their remaining profits and seeking better chances in the US and ' inter nationals ' dike oil shares. Having now read through the White Paper on Phase 2 I consider this advice well timed and none too strongly phrased. Since it was written £4,000 million has been wiped off share values.
I added •that "this short-term bear market could last quite a time." It began actually on May 20 after the FT ' thirty ' index had touched 543. It dipped below 480 by the end of June, recovered to 538 by August and dropped to 461 on September 28. The show of confidence in Mr Heath's squeeze pushed it up to 516 but when the Phase 2 details were published down it came 23 points and, after a short recovery, tumbled 18 points on 'Black Monday.' As I write it is still falling, but a technical recovery is due. We have not yet seen the full and final confrontation between this Government and the trade union movement and in the meantime board-room directors are going to be increasingly displeased with the proposed limitation of profits in the Phase 2 Bill and, what is more, to fear that worse is to come with Phase 3. It would not therefore surprise me to see the FT ' thirty ' index come down below 450 before Mr Barber introduces his budget on March 6. A resistance level is in. dictated on the charts around What has upset the business world is not so much that Mr Heath has gone socialist as the fearful complication of the orders establishing the Price Commission and the Pay Board and the fact that the Bill gives the Government power to regulate prices, pay, dividends and rents for as ions as a three-year period. Incidentally, to allow time for VAT on April 1 to settle itself down the present price freeze will continue until the end of April although the stand-still on pay ends on March 31 if the new Bill is enacted. The Economist speaks for the market when it describes the order as " impossibly complicated."
For example, manufacturers are not permitted to increase their prices except to the extent that they have to meet unavoidable increases in import and other costs but prices must be reduced to allow the benefits of increased productivity and other cost reductions to be passed on. Pay increases which do not comply with the Code will not be an allowable cost. To reinforce these rules net profit margins on sales in the home market will not be allowed to exceed the average level in the best two of the previous five years. Gross percentage margins of distributors will also be held to the same provision but this is not clearly defined. All large firms will be asked to submit detailed reports to the Price Commission and get its approval before any price is raised. Small firms will be subject to spot checks. There is no doubt that the whole apparatus of control will be a business nightmare.
Of course, the incidence of this complicated system of control will fall unevenly and sometimes unfairly on different groups of companies. The least affected will be the chemical and textile industries, for com panies here will at present be operating at lower profit margins than those permitted under the new rules. Engineering companies for the most part will also come off fairly well. Many of them saw their favourable profit margins of 1967-69 decline in 1970-71, so that the current recovery in trade should enable them to increase their profits as they select the best base margins allowable. However, some who achieved, their highest margins in 1972 may be adversely affected, such as Acrow and Dunford-Elliott. The same trouble applies to some companies in the electrical industry such as GEC, Granada and Thorn. Perhaps the worst hit will be the brewery companies which have steadily increased their profit margins in the last year or two. One broker I consulted put the probable decline in profits at 10 per cent for Allied Brewers and about 74 per cent for Bass Charrington and Scottish and Newcastle.
Clearly, when the market is getting near its bottom, investors will be inelined to pick up the shares of companies with large overseas earnings which are outside the Government's control. I have already drawn attention to the oil companies and. I am reminded that Bowater accounts for the bulk of its profits overseas and ICI for about half.
There may also be opportunities for some companies to introduce new products into their trade which can then be ' infiltrated ' round the DTI controls in what has been described as a Vietcong manner.
On the whole I prefer the oil companies as the best way out of the White Paper. They have already asked the DTI for price increases due to the lower value of sterling and the higher costs of crude oil from the Middle East where the Arab states have increased taxation and demanded participation in the local companies. The bulk of the earnings of Shell, BP, Burmatt and Ultramar must be derived from overseas.
Coming back •to the economy as a whole, the picture is not as black as Monday suggested. Certainly 1973 industrial profits may be lower than those of 1972 but the offset of overseas earnings must be taken into account. And the turnover of the retail trade should still be rising, if at a slower pace. The GJvernment's norm for wage rises — £1 per week plus 4 per cent of the pay bill for the group, exclusive of overtime — should raise wage earnings by 7 per cent to 8 per cent and other factors — militancy and concessions — should bring the total rise in wage incomes to around 10 per cent as compared with 1972. As the rise in prices should be contained to between 7 per cent and 8 per cent, there is a difference of between 2 per cent and 3 per cent which will allow for the rise in consumer expenditures. Further, if the public becomes convinced that Mr Heath's controls are really bringing down the rate of inflation and making prices more stable, then there will be less saving and more spending. At present saving has risen to the unusually high level of 10 per cent of net disposable income.
The institutional investor is always prepared to come into the market to take advantage of a "special situation " but I cannot see the professional managers becoming buyers of equity s'hares at large until they see whether Mr Heath is winning his battle against inflation. The first beneficiary is, after all, the gilt-edged market where yields of near 10 per cent can be obtained.
The panicky selling of Black Monday' is said to have come from the private investor, who still accounts for 45 per cent of total shareholdings, but we must before long expect net withdrawals from the unit trusts. 1972 was a bumper year for the unit trusts, with net sales of £241 million, and at December 31 their total assets were valued at £2,647 million, an increase of £656 million over the twelve months. Life and pension funds have more than double that amount in equity shares but unit trust holders are now an increasingly large — and unstable — market factor.
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