Investing Under Labour
THE STOCK EXCHANGE
By NICHOLAS DAVENPORT
IN theory, investing under a Labour govern- ; ment should have been as easy as clockwork. When a Tory government practised 'stop-go-stop' it was very difficult for the investor to time himself into the market before the `go' or out of it before the 'stop.' Economic timing was never the Treasury's strong point either. Under Labour, which proclaimed that it would abolish `stop-go- stop,' all the investor had to do—in theory— was to choose a good long-term equity investment and sit on it. Labour could claim, first, that its new corporation tax, by discoUraging distribu- tion and encouraging 'plough-back' of earnings, would steadily enhance the intrinsic value of a company's equity, provided it was well managed; secondly, that its 'modernisation' policy—helped by the 'little Neddies'—would improve industrial efficiency; thirdly, that its capital gains tax, by dissuading holders from selling good equities, would tend to buttress the secular upward trend of equity share prices. Moreover, by penalising tax-wise the 'rights' issues of new equity shares, Labour could also claim that it was creating a supply shortage of shares in the market which could actually make for scarcity prices. It did— for a time.
Alas! Nothing worked out according to the long-term plan, especially the National Plan. In- vesting under Labour became the most difficult exercise the professional investor has ever under- taken. When Mr Wilson assumed power in the autumn of 1964, the Financial Times index of industrial shares was at a peak of 378 (October 1). When the first sterling crisis broke, the first deflationary measures had been taken. The mar- ket tumbled to 323 by the middle of December. Thereafter a recovery set in—spurred by the great rescue operation for sterling—and the index touched nearly 359 by May 3. But dawn it came again when the most anti-capitalist budget of all time was introduced by Mr Callaghan. This Finance Act not only revolutionised company taxation, but penalised the investor in overseas companies, in investment trusts, in 'close' com- panies, in dollar securities, in insurance com- panies with American business, and it mulcted him of 30 per cent or more of his capital gains if he chose to cash in or switch. And it made the proper management of a dollar portfolio virtually impossible, for, by driving the indus- trialist into the investment dollar pool, Mr Callaghan pushed up the dollar premium to over 20 per cent and then exacted 25 per cent of it if the portfolio manager sold or switched. Indeed, switching became too costly—to the great detriment of our overseas investment port- folios. Switching also became too costly for the institutional managers of gilt-edged portfolios— to the great detriment of the market in govern- ment bonds. With the retreat of the life assurance companies, the wonderfully free market in British government stocks, which had been the envy of the capitalist world, was virtually destroyed.
But to return to equity shares. The post- budget slump carried the Financial Times index down to 314 (July 29). After the second crisis in sterling—in the summer of 1965—had been overcome and further stiff deflationary measures cutting down public expenditures had been pro- mulgated, the market in equity shares began a long and lively recovery which pushed the Financial Times index up to 374 (June 16, 1966). Everyone was astonished at this performance. It was regarded almost as an expression of frivolous, swinging, carefree England. But it was in reality a sign of growing disbelief in the eco- nomic policies of the Labour government. For it was obvious that the incomes policy had had no restraining effect upon the trade unions. Ex- cessive wage claims had been pressed and won and every investor had become convinced that a wage-cost inflation had come to stay. Although equity shares were not a perfect inflation hedge, they were regarded as a better holding than cash, which merely depreciated In purchasing power the longer you held it. Further, the rush of small savings into the unit trusts—at the rate of £120 million a year in the first six months of 1966 against £65 million in 1965—was creating a dangerous demand-supply situation in the share market. Good equities, it was being said, could go through the roof of the Stock Ex- change. But they didn't. The boom suddenly broke last week with the onslaught of a fresh crisis for the £ As I write, the index has tumbled from 374 to 332.
Now the equity share boom had been• asking for a knock some time before the new sterling crisis broke. There had developed a 'reverse yield' gap not only on a dividend basis, but on an earnings basis. The earnings yield on the more widely based Financial Times-Actuaries index had fallen to 6.9 per cent, while the yield on War Loan had risen to over 7 per cent. Here was a red light for the investor. A reverse yield gap on dividends of over 1+ per cent could be tolerated if earnings were likely to increase, but it was obvious that profit margins had been squeezed by the wage-cost inflation and that earnings were likely to fall. An autumn money squeeze coming from the incidence of the selec- tive employment tax was also bound to bring many dividends down, especially as they had been artificially increased in the 1965-66 period to avoid the incidence of the corporation tax. The market suddenly realised that the conditions favouring a prolonged equity share boom no longer existed.
The current setback( to equities, which will probably bring the index down to test the low levels of the 1965 slump (314)—unless a devalua- tion of sterling is in the meantime forced upon us—will certainly not destroy the faith of the pro- fessional investor in the equity share as a long- term holding. He is not allowed to forget the statistical exercise carried out yearly by a lead- ing Stock Exchange firm on the results of an investment of £1 million in the Financial Times index of ordinary shares and in Old Consols with the gross income reinvested at the end of each year. Since 1919 the equity fund on this calcu- lation had grown to f90 million by the end of 1965 and the 2+ per cent Consols fund to EA+ million. Disregarding income, the capital incre- ment of the equity fund had been from £1 million to £8.6 million, while that of the Old Consols had fallen from £1 million to £650,000. The equity income had grown from £65,000 a year to £496,000, while the Old Consols income had remained static at £42,000 (the yield on Old Consols in 1919 being 4+ per cent). But the short- terms risks of investment in equity shares can be considerable and it is questionable whether the small investor, who has lately been running after the unit trusts, has realised how heavily his fund can be hit by short-term movements on the Stock Exchange. The drying-up of new in- vestment in the unit trusts will accentuate the sharpness of the slump.
Although the long-term outlook for invest- ment in equity shares may remain as glittering as ever—provided always that Britain is not entering upon a long-term industrial decline, as
some foreigners appear to think—the profes- sional investor may now be coming to the con- clusion that investing under Labour does not pay—either in equities or in `gilts'—and should best be avoided. Labour, of course, believes sin- cerely in the modernisation of Britain and in the improvement of our industrial performance, but it does not seem to know yet how to run a mixed economy or, at any rate, how to ensure the profitability of the private sector. For the time being, the professional investor has become thoroughly `browned off.'
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