Equities up on cloud nine MONEY
NICHOLAS DAVENPORT
Since the Basle agreement the announcement of the monthly trade figures no longer makes the Stock Exchange anxious about another devalua- tion of sterling. This week the figures were surprisingly good, the visible trade deficit for August coming down from £81 to f30 million. Equity shares as well as government bonds went up on the result. This was odd, for equity shares look extrordinarily high. The Financial Times index has climbed through the magic 500 to reach 518 and the average yield on dividends is now 3.6 per cent and the average yield on earnings 4.4 per cent. To strike these averages we have some of the popular leaders on a price/earnings ratio of 50 or more, for example, GEC, Tesco and Slater Walker. The last business is capitalised in the market at £100 million! Even supposing the next brilliant report will bring some of these price/earnings ratios down' to 25, who can afford to buy an equity on an earnings yield basis of 4 per cent if there is the slightest doubt about the con- tinuity of the profits boom? Is the market taking leave of its senses?
The import figures—only slightly down from £665 to £652 million—should come as a warn- ing. If the import bill does not turn, more sharply downwards over the next few months the Government will really be forced to take some direct action—either by quota licensing or by prior deposit of cash on import orders. Such an upset to normal trade could be the signal for profit-taking in equities and a shifting of institutional funds into the gilt-edged market. There has already been a hint that the managers of pension funds are aching to shift. In the second, quarter of the year they cut down on their purchases of equities, hoping no doubt that bank rate would' soon be reduced and the gilt-edged market restored to favour. So it will —and must—in due course. The managers of the conventional life funds are also waiting— and indeed longing—to shift more funds into the gilt-edged market. The yields offered at current prices are attractively high-7f per cent on some 'longs' and 74 per cent on the undated against only 2 to 24 per cent on most leading equities. As the proportion of their total in- vested in equities rises, so the overall yield on these life funds declines. And the actuaries thereupon get into trouble over the bonus estimates on their 'with-profit' policies. I am sure that it is this prospect which has per- suaded the great Prudential to offer a simple unit trust to their canvassed policy-holders.
The equity share boom has also persuaded the less conventionally managed life funds to offer a different type of `profit' policy. The London and Manchester, which is now a leader in equity investment, has produced a new ter- minal bonus scheme designed to give the policy- holder his share of the investment profit on the maturity of his policy. In other words, he will get a lump sum of capital appreciation in addition to the guaranteed value of his policy. The date from which investment profit will be measured is the beginning of 1958 and the calculation is made on the basis of a moving two-year average. This is all very well for a successful going concern which, because of its annual cash inflow of new money, has no need to liquidate large chunks of its equity portfolio but it does seem to assume a perpetual equity .share boom. Is this a reasonable assumption to make?
It may be reasonable to assume under present political conditions in the western democracies that a creeping inflation can never be avoided and that equity shares, although very imperfect hedges against inflation, will therefore have an Inflationary' secular upward trend. But the investor must realise that equity earnings in -in inflation can only rise in real terms if profit- 'ability increases and surplus earnings are as profitably reinvested. If he will recalculate his -dividends and Capital appreciation in real terms be will Vtid that very few equity investments outside the us have, in fact, offset the past depreciation in the value of money.
It may also be reasonable to assume that as the western democracies give priority to growth in their economic policies, unless, like the UK, they run into balance of payments trouble and have to 'stifle growth for a time—equity shares, if chosen wisely, are bound to reflect the national growth both in earnings and assets. This" may be true but as profitability varies front industry to industry and from company to company-according to board room skill it will need continuous, active and intelligent man- agement of the portfolio if the equity shares selected for investment are to reflect and better the national economic growth.
Now both these postulates—perpetual creep- ing inflation: and growth—can be nullified as far as the equity share market is concerned by two horrible and not unlikely events. First, the Government can tax the inflation out by putting a special dividend and capital tax on equity shareholders. There is already a limitation of dividend increases to 34 per cent. Second, the workers can demand and secure by strike action a large share of the profit from growth. There were ominous grumblings from some delegates at the recent Trades Union Congress that the workers had seen nothing of the wonderful company profits accruing from devaluation.
Recently a well known firm of brokers organ- ised an investment symposium in Switzerland and produced a brief report which contained statements unbelievably silly. Such as: 'This is a world united by the revolution of rising expec- tations and by the philosophy of More.' Read 'split' for 'united' and the statement becomes intelligible. Again : 'It seems to us we must now look on the demand for equities as an insatiable, continuing and justified human and social search for a larger slice of the ever-growing
pie. Hence the enormous development of the t. security industry in the us and the explosive growth of unit trusts and other forms of equity investment in this country and elsewhere.' Have the authors never heard of the class war, of the continuing clash between capital and labour over the cutting of the cake? It seems to me that there is only one way in which this clash can be resolved without violence: give the workers a share in equity growth through a public unit trust—that is, if you can get them to believe in the equity of an equity share.
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