MONEY AND THE CITY
Investment policy for 1973
Nicholas Davenport
A warning signal that the short-term bear market in equity shares may be resumed after the year-end holidays was flashed by the National Westminster Bank last Saturday. It gave notice that it is calling in overdrafts which are being used to finance personal investments on the Stock Exchange. All the clearing banks have been cutting down on personal and property loans since they received an advice to do so from the Bank of England last August. Now that a second call for special deposits at the Bank has been made — making a total reduction in bank resources now of around £650 million — the joint stock banks are under a restrictive force majeure. The National Westminster has actually instructed its branch managers not to renew borrowing arrangements as they expire except for six months to allow the customer to square his account. Then finis.
This cut in bank lending for Stock Exchange investment comes at the awkward time when more 'paper' has been issued than ever before in one year. According to the Midland Bank the total of new capital issues in 1972 was £1,096 million again'st £928 million in 1971. There was a small reduction in the issues of loan stock but the issues of equity shares increased more than sixfold, being 65 per ccnt of the total new capital raised. There was a flood of new investment trust issues and this market is still suffering from severe indigestion.
A continual rise in money rates is bound to knock any equity market in the end. Since it abolished Bank rate the Bank of England has been quietly putting up its minimum lending rate until it has now reached the outrageous level of 9 per cent. When freedom was restored to the banks over a year ago I think I was the only financial writer to describe it as a retrograde step. Money was poured out to the private borrower for speculation in property and on the Stock Exchanges regardless of the inflationary and antisocial consequencees. At long last the Bank of England has recognised that it was a frightful blunder. Hence the call for special deposits. But it has come so late that interest rates have been forced up to a level which makes industrial borrowing in the open market too expensive as a fixed charge, especially at a time when prices are frozen and profit margins are likely to be squeezed in Phase 2 of the Government's statutory control of prices and incomes.
As for the gilt-edged market it is amazing that it has stood up so well against a wrong-headed monetary policy. The actuaries of the life and annuity funds have been finding yields of 9i per cent on long-dated stocks attractive enough for their purposes, so that the Bank has been able to sell about £300 million of gilt-edged stock to the non-banking public since April. But wieh Bank rate at 9 per cent it will not be able to sell any more until these yields have topped 10 per cent. At the moment of writing they are near this very point. At 251 the undated Treasury 23 per cent — shades of Hugh Dalton! — is yielding 9.96 per cent! The patriotic mugs Who subscribed at 100 in January 1947, if they are still alive, must be feeling bitter.
But we taxpayers who are still alive and feebly kicking should also .be feeling pretty sore. The Bank, faced with the task of financing the Government's 'borrowing requirement,' which has mounted to £2,933 million for the financial year according to the Bank's latest Bulletin, will be trying to tempt the public to buy another high coupon medium-to-long stock and so add to the already grievous burden of the national debt service. So far the Bank has been lucky, the outflow from sterling having financed the 'borrowing requirement' to the tune of £1,000 million. Perhaps it is waiting to see how much more will flow out when the foreign banks discover that we have run into a deficit on our current trading account. Curiously this suggests that the gilt-edged market may be getting near its bottom. If the Government succeeds in reducing the rate of inflation to a more acceptable level in Phase 2 of its statutory prices and incomes policy the institutional holders of govcrnment stock will find yields of around 10 per cent very acceptable. Besides, who will want to sell a government stock on this basis to buy equity shares w'nen they may be plunged in a short-term bear mirket?
It may seem strange to see equity shares falling when the profits of the two thousand companies included in the Financial Times survey rose 17 per cent last year — the quarterly rises were 153 per cent in the first, 193 per cent in the second, 14 per cent in the third and 16.6 per cent in the fourth, while the dividend income was 93 per cent higher. But we must pay more regard to profit margins. Will they be maintained' in Phase 2? It all depends on what sort of bargain emerges from the talks between Government, TUC and CBI which are due to start immediately so that a White Paper on the proposed legislation may be issued soon after the House resumes on January 22. If the TUC takes a tough line and secures major concessions this could, reduce not only profit margins but the rate of profits growth.
Lord Watkinson, the chairman of Cadbury-Schweppes, has urged the Government to relax its control of food prices during Phase 2 of the freeze. Being anxious about his profit margins he has said that manufacturers should be allowed to pass on to consumers all increases in raw material costs. During the present freeze prices of raw materials and imported goods can be raised without official permission but in view of the strong objections being raised by the TUC, Lord Watkinson is clearly afraid that this will not be allowed to continue. "The British food and drink industry," he said, "finds itself ground very hard between the upper millstone of rising world prices and the lower millstone of increasing consumer resistance in the High Street." This applies to many more industries than food and drink.
How is all this to be translated into investment policy? The stalwart who believes that Mr Heath will emerge firm and victorious from the coming con frontation with the trade unions over Phase 2 of his anti-inflation policy will no doubt hold on to his carefully selected list of equities, believing in growth and, the European common market, but the more craven-hearted, to whom I incline, will be cutting down their equity commitments in the UK, cashing in most of the remaining profits and seeking better chances in the US and ' internationals' like oil shares. This short-term bear market could last quite a time. •
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