Looking 400 in the face MONEY
NICHOLAS DAVENPORT
My heart goes out to John Bull as he builds up his £5,000 portfolio in a high-priced market which is likely, he fears, to crack (though `not seriously') in the next two or three months. All so typical of his breed! If I can come to his aid I will, though I have told him that it is so much easier to invest £5 million than £5,000. Writing over a month .ago—on 8 September—I ventured to say that brokers were wrong who wanted to sell the whole mar- ket. I gave reasons why portfolio managers would refuse to sell good industrial shares in spite of the fact that leading brokers judge them to be over-priced. Now was the time, I said, to weed out the really bad and add cautiously to the really good. The Financial Times index was then 375. It rose to close on 400 and is now back to 386, yielding only 4.9 per cent on dividends and 6 per cent on earnings against a yield on War Loan of 6.95 per cent. In the conventional old days this would be regarded as a preposter- ous and dangerous situation. But these are new and unconventional times. History does not re- peat itself.
By new and unconventional times I mean that we have an unpopular Government in a budgetary trap desperately trying to reflate the economy—and partially succeeding—on the base of a weak balance of payments. Any substantial worsening of the balance of pay- ments, any final closing of the trap," would mean that sterling could not hold its $2.80 exchange rate. What portfolio manager in his senses would dream of selling equity shares on the eve of such a possible denoue- ment?
I am not suggesting that every leading firm of brokers still considers the market over-priced. There has been some hedging of opinions since 8 September. The minority view has been strongly expressed in the last weekly policy letter of brokers Simon and Coates, who write : 'There now seems little doubt that we are at the begin- ning of a major expansionary phase in the economy. Unless the external position forces a complete reversal of present government poli- cies the rate of expansion is likely to be well above 3 per cent between mid-1967 and mid- 1968.' They think 5 per cent most probable, Now I have noticed that this particular firm is often more favourably disposed towards the Government than most Stock Exchange brokers and on this occasion their analysis follows closely on the bullish monthly assessment of the economy recently published by the Treasury. They make four points. First, the pipeline of goods is relatively empty in many industries and disposable incomes are once again rising after a long squeeze. Second, the domestic appliance and motor manufacturers have seen an appreciable rise in sales after the relaxation of the hire-purchase terms. After two years of low sales, they say, there is 'an enormous pent- up demand' for consumer durables. (Mr Wilson talks of a motor boom in 1968.) Third, the building industry is in the middle of 'a major upswing.' (The Ministry of Housing claims that there is a record number of houses now under construction, but its figures are suspect.) Fourth, heavy engineering may still be in diffi- culties, with new orders still declining and stee.1 operating at only 75 per cent of capacity, but many firms have .been putting their house in order and manufacturing generally has in- creased its productivity by 3+ per cent between the second quarter of 1966 and the second quar- ter of 1967. The impact on manufacturing pro- fits, they add, when output increases can be very sharp.
This forceful minority view is sure to have some influence on the doubting Thomases. And support for it came from no less an authority than the board of the great to, which is confi- dent that the worst has been seen and that 1968 profits will climb back to the 1965 rate. Other important companies, as Custos weekly reports, are already turning in or forecasting better re- sults. But here a caveat must be put in. The recovery in the economy which has been so loudly trumpeted by Prime Minister and Chan- cellor could be short-lived; it could be held up this winter by industrial unrest and by dearer money and finally stopped by an increase in taxation next April. In several important in- dustries the workers are in revolt against their official union leaders. Unofficial strikes in the docks have already upset exports and worse could happen. If on top of this the Bank rate is put up and the already dear cost of industrial borrowing goes up to 10 per cent or more, how can industrial investment revive? Mr Callaghan would then be powerless to reflate consumer demand any further, for the balance of pay- ments by that time would be -more heavily in deficit. And the rise in government and social expenditure, which is already alarming our foreign creditors, would compel him by next April to raise taxation.
But would a postponement of the recovery put to flight the determined long-term investor? It would certainly dislodge the short-term speculator, who had hoped to ride the band wagon of the Callaghan reflation, but the long- term institutional investor buys equities for the potential increase in income which they offer. Where else can he secure a higher income apart from properties? I am aware that some institu- tional managers, having failed to get into the equity market when it was cheap, have invested much more heavily in properties, but as a result property yields have already fallen to under 6+ per cent. If the equity market ran into a sub- stantial bout of selling I feel sure that the life 'fund managers, who had allowed their equity portfolios to fall below their normal 20 per cent (at cost) of total funds, would be quick to replenish their holdings at the lower offered prices. Of course, if interest rates go on rising these managers might find that their actuarial surpluses would be adequately enlarged by in- vestment only in fixed interest securities. So we must watch very closely the current rise io American money rates. Dearer and dearer money always has brought, and always will bring, any boom in the equity share market to a stop.
A final word about the technical shortage of shares. The drying up of equity share issues for taxation reasons, the constant takeover of one company's equity by another which has_ the same market effect of increasing demand and reducing supply—witness the effect of the great steel takeover by the Government—all this has created market conditions which foster the secu- lar upward trend in equity share prices. But I have never known a technical short position prevent a substantial market correction - when the underlying economic or financial conditions are suddenly changed. But there is always one exception to a rule—in this case the threat of currency devaluation. It is, therefore, sterling which could come to the rescue of John Bull— in more ways than one.
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