The market boils over MONEY

NICHOLAS DAVENPORT

Getting away from Throgmorton Street cer- tainly improves one's sense of the fundamentals.

How transient it all seems from a distance!

Each day the brokers rush in to stake their claims, the roulette table spins, the pluses and minuses fly out, the index finger moves, like the hand of God, as the waiters close the doors at half-past three, and long before the casino re- opens for another day's play the world is going to its work assured that nothing serious has happened. Nor has it—except on paper.

Rut the paper is symbolical. The casino is a mirror of our times. The gambling disguises the fact that the Stock Exchange is the open capital market where the savings of the people are find- ing their way into the capital-hungry industries.

The recent rush into equities reflected the people's distrust of money and of government bOnds and its desire to hedge against the con- stant, creeping wage-cost inflation. So intense has been this desire that the index of industrial equity prices was carried on 19 July to 492- 20 per cent above its pre-devaluation level and 73 per cent above the low level of November 1966.

This meant that investors were willing to buy an average industrial company on the basis

of-twenty-one and a half years' purchase of its

last reported earnings—thirty-five years' pur- chase for the top 'growth! companies—and that they were content to receive an average divi- dend yield of 3.8 per cent although they could have secured about 71 per cent on an undated government bond for ever. Last week, however, a majority of investors decided that this was too absurd. The industrial equity index suddenly came back by about 5 per cent and the govern- ment bond market sprang into life. What had happened to cause this change of heart and mind?

Only a little over a month ago I was writing about 'gilt-edged in the doldrums.' I wondered who would speculate in a rise in the govern- ment market before it was seen that the balance of payments deficit was being cut and the debts owing to the central banks abroad were being reduced and not enlarged. The June trade figures did allow some hope that the trading deficit was being cut. Imports had dropped to their lowest level this year and the visible trade gap had been brought down to £50 million from the near £90 million of the previous three months. It is confidently expected in Whitehall that the July returns will confirm the same favourable trend, although the import bill may be slightly higher.

But the market has not forgotten that the re- cent $2,000 million standby raised to reassure certain official holders of the sterling balances was a potential exchange of sterling debt for dollar debt. Our short-term debts abroad to central bankers add up to $3,640 million while our gold and dollar reserves are not much over 52,640 million. Sterling is certainly not so vulnerable as it was— the discount on forward sterling has nar- rowed sharply—but no one can claim that it is yet a strong currency. It has yet to meet the threat of a franc devaluation. It was the more reassuring news from America that really caused the gilt-edged market to recover its nerve. With the passage of the fearsome Tax Bill us Treasury bill rates have fallen and could fall further as the economy moves into a deflationary phase. Our own Treasury bill rate has now dropped to 7 per cent —its lowest level since the Bank rate was cut to 7+ per cent on 21 March. Is a further cut to 7 per cent within sight? Perhaps not before the July trade returns are found to confirm a declining trend in imports, but the market is surely justified in hoping that it is not so far away. A Bank rate of 7 per cent would certainly make the whole gilt-edged market look cheap with the undated stocks yielding 71 per cent, the longs 7.7 per cent to redemption and the shorts up to 7.8 per cent.

I suspect that the sharp drop in equity prices last week was initiated by some of the life and pension funds switching into the gilt-edged market as the traffic light on interest rates turned to green. The sharp appreciation in the market value of their equity portfolios has made the managers of these funds no longer interested in buying more equities for the time being. But this move was accompanied by a shake-out of speculators in the fashionable mining stocks— not only in the Australian market but in the more solid gold-finance houses, Selection Trust, R-rz and Western Mining. The boom in Aus- tralian mines was crying out for correction. The transfer offices of the mining companies had be- come three or four months behind with their registrations. It would be wise for the London Stock Exchange to ask Sydney to take a fort- night's holiday and allow brokers and transfer departments to get their books straight. But this healthy shake-out makes me feel that what we are seeking in the equity share markets is not the end of the boom but a necessary correction in an over-excited market. And I don't consider 5 per cent enough.

The unit trusts, which attract the inflation- hedgers, may be slowing down their market operations after the £118 million increase in their funds in the first six months of the year— three times as large as in the first six months of 1967—but let no one suppose that the middle- class investor has yet changed his mind about the wisdom of getting out of cash into the real values represented by good equity shares. The wage-cost inflation is still with us. I see that one firm of brokers has been arguing that the in- flationary pressures are not as severe as was feared, but another firm rightly points out that it iS the long-term trend which has frightened investors out of cash. It gives the following table as evidence:

GNP at % rise

current prices Wages and Salaries

% rise % rise GNP at 1958 prices

1964 ••• ... £29,231 m. 7.9 £17,690 m. 8.2 6.0 1965 ••• ... £31,137 m. 6.5 £18,955 in. 7.2 2.9 1966 ••• ... £32,948 m. 5.8 £20,120 in. 6.1 1.6 1967

••0

••• £34,000 m.

3.2 £20,830 m. 3.5 0.9 The pending wage claims from the engineers and the fight over the provincial busmen's claim are reminders that the wage-cost inflation has become a hardy annual. The most any govern- ment can hope to do without a revolution is to slow it down.

Just as the growth of unit trusts feeds upon the rise in equity share prices which it helps to generate itself, so the rise in wages feeds upon the inflation which it helps to generate itself. The vicious spiral can be broken from time to time by a sharp rise in productivity, but it tends to be unreliable. I see that Mr Aubrey Jones in his annual report of his Prices and Incomes Board suggests that the rise in wages might be slowed down if the workers were given post- dated cheques in the form of equity shares in return for present-day restraint. Dear Mr Jones, how do you apply this wonderful scheme to the bus drivers and other workers in the public utilities and nationalised industries? How do you give them a slice of the national cake? The only way to solve the problem of 'fair shares,' which looms larger when the Stock Exchange stages a hectic boom in equity shares, is to set up a public unit trust in which the workers can be given an interest. But don't let us do it until the present boom has had its full correction.