The most fantastic year MONEY
NICHOLAS DAVENPORT
This has been the most fantastic year in the whole history of the Stock Exchange. It began with the professional investment world con-, vinced that equity shares must fall—with com- pany profits—before the onslaught of the worst `stop' in all `stop-go' cycles (I refer to the savage deflationary measures of July 1966). The Financial Times index of industrial shares had just made in January a 'technical' recovery of 123 per cent above the 284 low' of 11 Novem- ber 1966. Many life fund managers had made up their minds that they would re-enter the equity market when the index had fallen to around 250, but they never saw even 284 again. After dipping from over 320 to under 310, the index rose persistently and aggressively till it touched 420 by the middle of November. At the present level of 397 the average dividend yield has fallen to 4.6 per cent and the earnings yield to 5.5 per cent, bringing the reverse yield gap to per cent now that long-dated govern- ment stocks are yielding 7-1- per cent. Yet in- dustrial production has been stagnant, invest- ment in manufacturing and private housing has been declining and company profits have at best been flattening out after their 20 per cent fall in the past eighteen months. And to make matters worse, corporation tax had been raised from 40 per cent to 421 per cent on the de- valuation of the £ from $2.80 to $2.40. How is this extraordinary performance to be ex- plained, let alone justified?
It seems to me that the cult of the equity has undergone a profound change. It had originally developed as an investment cult when the automatic growth of earnings and equity share prices had been guaranteed first by the shortages of the postwar period and then by the euphoria of the full-employment policy. When the inflationary effects of the full-em- ployment policy had caused the Tory govern- ments to adopt a 'stop-go-stop' technique and when the Labour government had been per- suaded that it must either enforce a strict control of wages, prices and dividends or en- gineer a sufficient float of unemployment to enable employers to bargain more successfully with their workers and hold wages in check, the professional investor ceased to regard the equity share as an automatic index of economic growth; he came to look on it as something to be traded in, that is, bought when the com- pany management seemed likely to beat the economic index and sold when it didn't. This may explain why the life fund managers allowed the percentage of their funds invested in equities to fall from 22 per cent to near 20 per cent. But the life fund managers are only part—and the more sluggish part—of the professional investment world.
The managers who deal with the unit trusts and the public generally were the first to see that the Labour ministers were likely to make a hash of it, that as Labour was generally ignorant of monetary management and in- capable of holding the confidence of the busi- ness people at home or abroad—continually pushing up government expenditures and con- tinually encroaching on the private sector— they would it 11. . be forced into devalua- tion of the £. The cult of the equity then became not an investment cult but a political cult. It became the chase after shares which would provide some hedge against devaluation, that is, against the failure of the Labour gov- ernment administration to run the economy successfully. It was an escape out of money (which Labour seemed bound to depreciate) into real values, in other words, into the equities of well-managed companies which would sur- vive and beat political mismanagement.
The first choice of the escapists was into companies operating overseas, especially into the metal gold groups whose managements had the highest reputation for financial ex- pertise. Anglo-American, Charter Consolidated, Selection Trust, Consolidated Goldfields, Rio Tinto Zinc were the obvious leaders. Their shares have given their holders the satisfaction of rising by from 50 per cent to 160 per cent.
Rio Tinto Zinc has vast interests in Aus- tralia. The discovery of the rich nickel deposits in Western Australia and of oil and gas in the Bass Strait has revolutionised the economic prospects of that continent. The escapist rush from sterling into Australian dollars has been the big investment feature of 1967. Broken Hill Proprietary, the leading industrial combine of Australia and the discoverer of oil and gas in commercial quantities, has become the market leader, the bluest of the 'blue chips.' Its shares rose by 214 per cent from a low of 49s 9d to 156s before settling down at 145s on a yield basis of 1.2 per cent. But this rise is even tiny compared with that in Western Mining, which is developing the new nickel deposits, and in Hampton Gold Areas, which leased to it some of its old concession. Western Mining has jumped by 468 per cent from 51s to 290s (now 275s) and Hampton Gold Areas from 4c1 to 84s—by 25,000 per cent!
In spite of their gloomy domestic prospects British industrial shares also benefited from the rush out of cash into real values. The market leader, ICI, which has just given such a disap- pointing estimate of its gain from devaluation, appreciated at one time by 50 per cent but, like others, has come back from its 'high' since devaluation. As a whole industrial shares appreciated by 36 per cent—the capital goods group by 33 per cent, the consumer durables (after Mr Callaghan's misguided reflation through hire-purchase relaxation) by 60 per cent and consumer goods by 33 per cent. The financial group had fewer outstanding gains but secured an increase in value of 25 per cent, ranging from 6 per cent in discount houses to 30 per cent in banks. Property shares were slow starters but managed to mark up 25 per cent.
To what extent these fantastic rises have been due to the reluctance of holders to take their profits and assume their liabilities to capi- tal gains tax, I do not know, but taxation has probably been an important factor in the pre- devaluation boom. Short-term gains of up to twelve months go to increase income tax and surtax; after twelve months the tax is 30 per cent. This is disagreeable enough to make in- vestors want to go on holding, especially if they see the possibility of a further devaluation of the £ under the present administration.
Another technical factor which accentuated the 1967 rise in equity prices was the growing shortage of stock on jobbers' books. Takeovers took away nearly £200 million of stock, the steel nationalisation wiped out £350 million while the supply of shares through new equity issues went down to around £60 million. As in the in- vestment dollar pool, which has seen a rise of 33-} per cent in the dollar premium since de- valuation, a diminishing supply of stock is driv- ing equity prices to amazing levels.
The effect on government bonds and unit trusts of this persistent rush out of money will be considered next week.
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