In the City
The equity prospect
Nicholas Davenport
At long last the stock markets responded to the more cheerful noises sounding from Westminster. The FT index of industrial shares actually went up 14 points in a week and has now climbed back to over 390. If you have a Labour prime minister saying to his left wing that it is very nice to have a socialist welfare state but someone must earn enough to pay for it—what more could Throgmorton Street want ? The economic penny has certainly dropped with Mr Callaghan who received his sound economic teaching at Nuffield College, Oxford.
The CBI may still be disgruntled but the White Paper on changes in the Price Code was, !believe, a sincere attempt on the part of the Government to make industry more prosperous. Mrs Shirley Williams acknowledged that the present return on capital of about 2.2 per cent for all industry was 'disastrous'. She claimed that the new proposals, assuming a static rate of demand in the next six months and a small upturn in the first half of 1977, would raise the return on capital from 2.2 per cent to near 3 per cent and add about £1000 million to company profits. The stockbrokers whose analysts study these things in depth have now revised their estimate of company profits growth upwards. A rise of 35 per cent this year may prove conservative.
Mrs Shirley Williams looks so reasonable and charming that one is in danger of accepting everything she says as gospel truth. When she assured the CBI that all the disincentives to higher output and investment had been swept away she was clearly exaggerating, but it is something that the proportion of new investment expenditure which can be passed on in higher prices is now to rise from 20 to 35 per cent and that shop premises join the list of qualifying expenditure. (Store shares have already responded.) The measures to help offset the effect of inflation on stocks and assets were also helpful but the new provision which should bring most comfort and heart to private enterprise is that the productivity deduction clause, which prevented companies passing on in prices more than 80 per cent of their increased labour cost, has been abolished. Anything which goes to show that socialism under Mr Callaghan is not against a productivity boost to profits falls like manna from heaven on companies in the socialist wilderness. Under Sir Harold.the City never felt sure that socialism was not out to destroy private enterprise and profit. Under Mr Callaghan the City feels that we have a Labour prime minister who believes in a mixed economy.
A large drawing in defence of sterling has now been made on the $5300 million stand
by credit from the overseas central banks. The size of the drawing has not been disclosed but it is thought to be around $2000 million. What seemed to please the City is that Mr Healey is prepared if necessary to borrow from the IMF in order to repay the central banks by the end of the year—which means submitting to the terms which the IMF might impose on the borrower. But this touch of pleasure for the anti-socialist in the City has surely been overdone. Mr Healey has already told the IMF first, that he will not allow the money supply to grow faster than the growth rate of the economy— a gesture that any politician might make, knowing that no one can say how the obligation could be honoured—and secondly, that he intends to bring down the borrowing requirement in 1977-78. In fact, according to the Lobby correspondents there is already an unholy Cabinet row about the scale and nature of the cuts in 1977-78 expenditures which Mr Healey is planning. Far from the IMF demanding more financial rectitude from the Labour government it is more likely that it will be asking Italy and other bankrupt borrowers to copy the financial and social contract policies of Great Britain.
What the drawing on the stand-by credit does do is to put brakes on the gilt-edged market. We have now reached a critical stage in the defence of sterling. The Treasury has revealed that the gold and foreign currency reserves fell by Sill million to $5312 million at the end of June in spite of the fact that they had received 8395 million by the accrual of foreign currency borrowing. In February of this year the reserves were as high as $7024 million. I do not suppose our creditors would like to see them fall below 85000 million seeing that only half of them could be mobilised in a crisis. Sterling re
mains an under-valued but still a vulnerable currency because of its large 'reserve' holders—and this makes the Chancellor eager to issue 'tap' stocks in the gilt-edged market so that foreign creditors can see that he is not running any risk of inflating the money supply. At the moment they are believing him and sterling is improving.
Does this give a better or clearer run for the equity share market ? Before me lies a chart of the FT industrial share index from 1951, when the post-war Labour government was defeated, up to the present day. It does not present a reassuring picture : in fact, it shows up the falsity of the equity cult. There have only been four full-blooded bull markets in twenty-five years. The first, from 1952 to July 1959, celebrated the release from socialism and scored an advance of 117 per cent. The second from 1958 to 1960 (Macmillan's 'never had it so good') scored a gain of 123 per cent. The third was under Labour but not due to Labour; it was due to the 1967 devaluation, to which Labour was driven after fighting against it for three years. The devaluation bull market lasted two years and two months and won an advance of 83 per cent. The fourth was under the Tories, or under what might be called Mr Heath's 'unquiet revolution', but it only lasted fifteen months and gained an advance of only 74 per cent. It might be said that four bull markets in twenty-five years is not a very strong performance for equity shares. Nor is it when you find that at the top of the last (Heathian) boom the equity share rise did not offset the fall in the value of money.
But, you will say, you are not taking into account the bull market which began in January 1975. I know that this is generally regarded as a bull market—and I may have loosely described it as such myself—but strictly speaking it has been a technical correction of an overdone bear market when the index fell in three years from 545 to 147 through sheer panic. This was when the old boys' brigade in the City had decided that the game was up—that the new socialism was going to bring the private enterprise system to an end. It was not surprising because it really did appear that Sir Harold had surrendered to the Marxists. His successor is much more firmly based, having trade union support for a mixed and prosperous economy.
One of my investment rules is that you cannot have a bull market without a conjuncture of favourable political and economic forces. Mr Callaghan may give us the first : Mr Healey may give us the second. Historically, a bear market loses a third to a half of the previous-bull market gain. The panic of 1972-74 lost not only all the previous gain but all the gains back to the Macmillan period. If there had been no panic the fall should have stabilised at around the 400 mark. The index has dipped this year to 365 but is now consolidating itself. If it breaks out over 500 it is laying the foundation for the next bull market but wait for the party conferences to establish the favourable political conjuncture.
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