MONEY AND THE CITY
Back to gilt-edged
Nicholas Davenport
Skinflint and I have come to terms. The bet is off and we have been invited to lunch at The Spectator to agree the formula which settles the terms. (I wanted to call in a top trade unionist like Jack Jones skilled in drafting crafty compromise formulas but was over ruled.) We agree that the market is in a short-term bear phase which, if you Like, you can call a secondary reaction in a long-term bull market, and that this bear phase could pull the FT 'thirty' index down to Skinflint's 450. (Incidentally, if the index did fall to 450 it would probably go on down to the 420s because the charts indicate that there is an historical supporting level here rather than at 450.) It will come out of its bear phase, as I suggested, when the market sees Mr Heath governing the incomes policy.
The week started with a recovery after the panicky selling of last week because it was reported that the Government was nearer to introducing a voluntary national incomes policy than had been generally realised. I am sceptical of this but better news on the political front is not impossible and the market panic last week goes to show that the institutional investors who do not buy first class equities on such an occasion are negligent, if not mad. The panic brought the average price-earning ratio down to 16.7 which on the prospective rise in company profits is probably equivalent to well under 15 for many of the leading equities.
But I have not come to terms with the Governor of the Bank. He has just issued a formidable survey of the flow of funds in 1952-70, showing the financial surplus or deficit each year for each of the four main sectors of the economy — public, personal, company and overseas. This purported to reveal the period when the . Government used a surplus in the public sector to finance a run-down of gilt-edged holdings by the non-bank public when it ought to have been repaying Treasury bills and allowing yields in the gilt-edged market to rise. Now that the Government broker is not allowed to be the buyer of last resort the market fears that we may see a further fall in the gilt-edged market. It is considered wrong, they say, for the central bank 'to lean against the natural market movement of interest rates.' All this stems from the mistaken view that a rise in interest rates has an anti-inflationary effect, when in fact it actually increases the inflationary pressures.
The quarrel I have with the Governor of the Bank is that he should even consider allowing the gilt-edged market to drift downward when he has to finance an increasing borrowing requirement and redemptions of stock. The higher the coupon he has to offer on new stock the more we as taxpayers have to pay for the already colossal national interest bill which topped £1,725 million gross in the last Exchequer account. In January next year the Treasury has to pay off £700 million of Exchequer 6i per cent off £700 million of £500 million of Electricity and Transport 3 per cent stock. In addition the Treasury has to deal with a borrowing requirement which last April was estimated to run up to £3,000 million. Historically this is usually raised in the third and last quarters of the calendar year because the first quarter is usually in surplus from the heavy collections of tax. In the June quarter about £900 million was technically 'raised' from the Exchange Equalisation Fund via the outflow of funds which preceded the floating of the pound on June 23. This was more than sufficient to meet the estimated borrowing requirement in that quarter. So the Treasury is faced with the problem of having to raise by the end of December something over £1,500 million. This it can do either by selling Treasury bills or by selling mediumto long-dated government stock. If it sells Treasury bills it tends to push up shortterm interest rates and the money supply, for the reserve assets of the banks are thereby increased. If it sells mediumto long-dated government stock it tends to push up the long-term rate of interest and restrain industrial borrowing. Of this choice of evils the Treasury will no doubt prefer to issue mediumto long-dated stock and for this reason the Governor of the Bank ought to see that the market is kept firm.
If the non-banking public could be convinced that the gilt-edged market is more likely to rise than to fall there would be plenty of buyers for the stocks which the Treasury proposes to issue. Of medium-dated stock you can now buy Funding 6i per cent 1985/87 at 79i ex dividend to yield just over 8 per cent flat and close on 9 per cent to gross redemption. A capital gain of 20 points in fifteen years, free of tax, is not unattractive. On the longer end of the market you can obtain 9.6 per cent flat and over 9i per cent to gross redemption. The market does not have to fall much to offer you 10 per cent yields which would be irresistible to many businessmen who are not even trading on a 10 per cent profit margin.
It is the short end of the market which I ' find particularly alluring in a time of potential political crisis. Savings 3 per cent 1965/75 will be paid off at par in two years and eleven months.You can buy it at 881 to yield 3.4 per cent flat. A gain of nearly 12 points tax free in under three years — say 4 points a year — must be very attractive to a rich man. To count on a profit of nearly £12,000 tax free on an outlay of £88,220 in under three years should enable you to sleep soundly at nights.
There is another ' short ' which appears overlooked. Transport 4 per cent 1972/77 technically enters the short list when it goes ex dividend on November 13. (It can be dealt ex dividend on October 23.) This,, can be brought at 83 to give a flat yield of 4.8 per cent and a gross redemption yield of 8.1 per cent. A tax free capital gain of over 16 points in five years is surely worth having and the income yield is higher than that of 3 per cent Saving 1965/67.
The 'reverse yield' gap of 6.3 per cent between the average equity and War Loan is historically high and it is only the fear of galloping inflation which prevents the investor from rushing out of equities into the gilt-edged market. It was interesting to observe this week that the mere chance of a voluntary incomes policy being announced within the near future caused a sharp rise in government bond prices. I hope the Governor of the Bank listened carefully to the speech of M Pierre-Paul Schweitzer; the managing director of the IMF, at the opening of this year's conference. It must be observed,' he said, 'that the experience of countries that have relied solely on demand management policies in recent years has been generally unsatisfactory. This experience indicates that it is often not possible for fiscal and monetary policies by themselves to stop a strong wage-price spiral without provoking costly economic and social effects.' Now Mr Heath has been pouring out money to get the economy moving and a voluntary incomes policy accepted. It would be foolish for the Governor to try and upset this policy by making the money dearer,
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