ECONOMICS AND THE CITY
The market prospect
Nicholas Davenport
Pirst I must correct a misprint about my illness. I have not really ,been ill but very angry. After atLending an investment meeting at an Oxford College I slipped — in entirely sober condition — fell neavily and dislocated my right Shoulder. As my friends will agree, It Was an Act of God which Prevented my writing, not illness, and even now I can only type with tnY left hand. Which makes me angrier than ever, for there is Much of practical importance to say to the investor who has been getting a lot of conflicting advice. , Whatever sage economic advice He may be getting to restore his nerves let him not forget that we are Still in a bear market. As Sir 4°hn Foster and I have lately been P(Patiating in this column, there Is a grave crisis in the property World. With the market in Property now non-existent there is
bound to be a lot of forced liquidation which will affect shares as well as real estate, particularly the shares of the fringe banks, the merchant banks and even the clearing banks. Following on the Vavasseur collapse — with losses last year of over £18 million — we now have the troubles of the Lyon Group and the Stern Group which are trying desperately to sell for cash properties which no one wants to buy. These are important companies. Lyon's gross assets are — or were — estimated at £130 million and those of Stern at £200 million. With commercial as well as domestic rents frozen by government order where can they find bids? Even the richest of the life and pension funds which invested in their properties will hardly want to add to their portfolios more property assets, even at knock-out prices. We shall hear of more company collapses, but happily the Government has now announced that the freeze on business rents will end in May 1975, after which there will be a phased relaxation of controls.
The leftists will argue that the Government should do nothing to rescue speculators who deserve the huge losses they are making. Certainly many of them deserve to lose their shirts. And most of them will. But they were not the prime movers in this rash and reprehensible property escapade. The prime movers were the Tory government who gave in 1971 freedom to the moneylenders to do what they liked with the thousands of millions the Treasury was pouring into the economy by tax reliefs and subsidies. The fringe banks, the mushroom finance houses, the slick and risky property development companies, all grew upon the lush mountain of credit which the Government created. Mr Anthony Barber as Chancellor, the Governor of the Bank, the Treasury knights and all the functionaries who helped to inflate the M3 money supply to fantastic levels — it has now slowed down to normal levels — should be hanging their heads in shame. The technical and financial ineptitude of the well-meaning but crassly stupid Tory government passes my comprehension. I can understand that Mr Healey and Mr Anthony Crosland would like to rub their predecessors' noses in the mess they left but they are now responsible for the well-being of the mixed economy they have inherited and I can assure them that it would not survive if they continued to freeze its most important assets.
So let the investor not imagine that a bear market can end while the property crisis is unresolved and while forced liquidation can fall out of the blue on anyone. Yet outside the property market the economic weather is improving and this is giving the gilt-edged market the signal to go ahead. The reason is that imported inflation has really started to decline. Some commodity prices have fallen sharply over the past few weeks. Basic materials are only 3 per cent higher this year (excluding oil) after a 26 per cent rise in the previous three months. I recently criticised the tight monetary policy of Dr Arthur Burns of the Federal Reserve but I have to admit that the longer the US authorities stick to a tight monetary stance the greater the chance that commodity prices will fall. In fact, Dr Burns may be staging a grand attack upon the speculative positions in commodities, so that the fall in commodity prices could be sensational.
Here I must add that this does not affect the basic position of gold. No central bank is going to unload its precious gold on the open market. The only accident would be an act of force majeure on the part of a bank in trouble, but the central bankers' club can be relied upon to come to the aid of a country in trouble, like Italy. Remember that the future of gold
depends not on commodity inflation but on wage-generated cost inflation which forces supine governments, bowing to trade union power, to print more and more paper.
The prospect of a decline in imported inflation, the feeling that prime rates in America have now been pushed up — around 121/2 per cent — as far as they are likely to go, and the cut in our clearing bank base rates to 12 per cent, have all brought fresh confidence to our gilt-edged market. In fact, there has been quite a boom, in which I suspect that the highly sophisticated money managers of the opulent Arab oil states have been taking a hand. For the foreigner the attraction is the fantastical high returns offered up to ten years — and the correspondingly high capital profits — in a currency which, if not already guaranteed against depreciation under the extended Basle agreement, will be one of the strongest currencies in the world when the oil from the prolific North Sea oilfields is flowing in the nineteen-eighties. For the domestic investor or speculator the gilt-edged market is obviously a 'buy' — except that at the long end, that is over ten years, the risk increases with the homegenerated wage-cost inflation, which is now being made worse by the threshold agreements. Here are some examples which are attractive to both foreigner and native over the short-term: Treasury 61/4 per cent 1977 at
87% to yield over 7 per cent and 111/2 per cent to gross redemption; Exchequer 5 per cent 1976-78 at 821/2 to yield over 6 per cent and 101/2 per cent to gross redemption; Treasury 3 per cent 1979 at 74% to yield 4 per cent and 9'4 per cent to gross redemption; and Treasury 12 per cent 1983 at 957/8 to yield 123/4 per cent and over 13 per cent to gross redemption. The Treasury 3 per cent 1979 offering a tax-free capital profit of 33 1-3 per cent in a little over five years is a dream for the surtax payer.
A boom in gilt-edged is generally taken to be the forerunner of a revival in the equity share markets but it is not necessarily the case today. There may certainly be one or two shares which have seen their worst. The first quarter report of ICI was wonderfully good and a price-earnings ratio of around 51/2 and a yield of 6.3 per cent are some protection against the risks ahead. The half-term report of Trafalgar House also confounded the pessimists and with a priceearnings ratio around 5 the shares may have seen their bottom. But there can be no return of a bull market while prices and _profit margins are under the control of a minority government which takes its orders from the trade unions. In most City circles the social compact between the Government and trade unions is regarded as a social plot to smash the capitalist system. If it breaks down, the immediate result is, of course, a 20 per cent domestic wage-cost inflation — or worse.
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