The new gamble
Nicholas Davenport
The first of the two crises I postulated last week when discussing the market prospect has come nPon us. It was, I said, the threat of something like civil war if the miners strike — except that instead of civil war we are now to have election war. No doubt some of the election meetings will be as near to civil war as we are likely to get. This sort of crisis I thought would push the FT 'thirty' index clown below 300 — and perhaps to 2,50. It did push the index down on February 4 to 294 but it has recovered since because the Market believes that Mr Heath Will win the election with an increased majority. Certainly his firm and confident broadcast to the nation must have increased his chances. His peroration about the reds who want to bring down not °I.11Y this government but any iovernment based on parliamentary democracy was votecatching. If it is true that Mr li\4eGahey, the Scottish miners' ,eL'acler, told the Prime Minister in • the Cabinet room that he had not eLonle to negotiate but to smash k" him and his government and break Phase 3, then this fact ,T,snotild be broadcast to the nation. Lille City's confident view, as I have heard it loudly expressed, is that a simple choice put before the electorate — Do you wish to be governed by fair and decent Heath With all his faults, or by cornrnunist trade unionists with all their brutality to the weak and contempt for Parliament? — Would result in an overwhelming vote for the Prime Minister. If the City view is correct, if it tUkrits up trumps on February 28, t 'en the market in equity shares sents now a wonderful opportunity for a quick profit. There has recently been some very heavy S,elling which has brought the top down 45 per cent from its :fp. This has been the steepest fall rl'i any bear market since the than the It was steeper t "an the fall in the Wilson bear Market of 1969-71 which was 41 hfler cent. The 'thirty' index has "sever actually been below 300 have never been so cheap before Inte 1964-5. In fact equity shares c the basis of price-earnings ra L°sThe usual swing is from twenty t;eaty times earnings at the top tr,'" ten times earnings at the bot-111. Today the average is 91 times
• earnings — after 50 per cent corporation tax — which is a lower average than at any time since the late nineteen-fifties. And the average dividend yield is around 6 per cent.
Now the curious feature about their low valuations is that many important companies whose price-earnings ratios should normally stand above the average are now standing below it. For example, London Brick at 35 is selling on an estimated priceearnings ratio of 4.3. Of course, its profits are expected to be halved by the housing slump but it is not a company which is ever likely to go bust. In a similar industry — plaster boards — we find BPB at 70 selling at an estimated price earnings ratio of 5.9 with a dividend yield of 10 per cent. The great Trafalgar House, which left the FT property-building group when it took over Cunard, has fallen by nearly 70 per cent from its top to a little over 50 at which it yields 6.7 per cent with an estimated price-earnings ratio of 5.9 If you regard these companies as peculiar to a particularly depressed section of home industry you will find a leader in the non-depressed consumer trades — the Burton Group — yielding 61 per cent at 96 on a price-earnings ratio of 8. And a company like Reed International with 50 per cent of its profits coming from overseas yields 6.4 per cent at 206 with a price earnings ratio of only 7. All these major company valuations suggest that we have an over-sold market.
If equity shares are over-sold the same can be said with greater force about government bonds where the fall has been around 30 per cent. Now there is a special reason Why a Coriservative election victory should bring about a recovery in the gilt-edged market which should be longer-lived than the recovery in equity shares. First, the market would have greater confidence in Mr Barber's handling of public finance than Mr Healey's. Mr Barber is much more likely to hold the growth of personal consumption below the growth of the national product, if any, than Mr Healey, for a Wilson 'softie' government would surely give in to the miners and any other strong-arm union and allow personal consumption to rise. Mr Barber has said that the £1200 million cuts he has ordered in public expenditure, not to mention the restrictions he has imposed on hire purchase finance for consumer durables, is equivalent to doubling the rate of VAT from 10 per cent to 20 per cent. Having regard to the quadrupling of the price of oil, which is equivalent to a tax increase of between £1500 and £2000 million Mr Barber hopes to present a fairly strong budget in April, which virtually abolishes any borrowing requirement, and so pave the way for the further borrowings abroad he will have to undertake to meet the estimated £3000 million deficit on the balance of payments for 1974.
In the second place, the giltedged market can reasonably look forward to a fall in the rate of interest. President Nixon has just said that he expects Euro-dollar and other international interest rates to fall as Arab countries invest on the world's capital markets the huge surplus funds they will be earning from soaring oil prices. His estimate is that if current crude oil prices are maintained the oil exporting countries will raise their foreign revenues from $27,000 million to $95,000 million of which the Arabs will account for $36,000 million or 53 per cent. They can spend or invest only a small fraction of this vast total and as some of their funds will spill into the Euro-dollar market rates could come down quite sharply from the present level of 15 per cent for twelve months. American rates should also follow suit. Mr Nixon's economic advisers predict a gloomy year with virtually little growth. So American prime rates should fall from their present 91 per cent.
As for our domestic rates in the UK, as the authorities have never instituted a two-tier system, foreign money should be attracted into our gilt-edged market as international rates fall, and then our institutions will follow. We must rid ourselves of the notion that the gilt-edged market must always offer yields to offset the domestic rate of inflation (which is now over 10 per cent). Most of the insurance companies have money obligations; it is only the "with profits" policies which are concerned with offering returns to beat the inflation. These are presently offered in the "long" end where Treasury 71 per cent 2012/2015 at 584 offers a running yield of 13.4 per cent and 13.4 per cent to gross redemptions. For a short-term rise on the election result I suggest Treasury 3 per cent 1979 at 664 to yield 11 per cent to gross redemption to 51 years of Exchequer 5 per cent 1976-78 at 77g to yield 111 per cent to gross redemption in 41 years. Tax-free capital profits of 33 points and nearly 23 points respectively are very attractive.
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