22 JULY 1972, Page 29


The market touch

Nicholas Davenport

Now is a good time to take another look at the bull market in equities and the beat market in gilt-edged. The week started well for equities. After its heady 80 per cent rise since March 1971 the FT index of thirty industrial shares only came back by about 12 per cent and this was on a small volume of trading which does not make it a significant move. A real break in a bull market is always accompanie4 by a huge volume of selling. The fact that a big £13 million equity issue like Mothercare can be over-subscribed 10i times indicates that money is still chasing after paper. One may begin to get worried when new issues flop and paper is seen chasing after money or when shares are so over-valued on the basis of the price-earnings ratio that buyers begin to get shy. Neither of these technical tests is yet showing a red light, although, I must confess, there are many other things to worry about.

To take the last technical point first. The average price-earnings ratio of the Actuaries' industrial index is now 18.2, having come down from over 20. If the market level did not change for twelve months, then the price-earnings ratio would fall to 15i because company profits should increase by over 15 per cent over the same period. This is due to the continuing rise in the productivity of labour. Between April 1971 and April 1972 employment in manufacturing industry fell by 5.1 per cent but output rose by 2.1 per cent. The underlying rate of productivity growth has been around 7 per cent. On the basis of these figures the market in industrial share is thus technically undervalued.

But ' technically ' must be emphasised, for the bull market is very conscious of the fact that there is a sword of Damocles hanging over its head. Everyone knows that there is a minority of militant shop stewards who can hold up the entire industrial machine if they choose to call a national strike. Companies cannot therefore rely on the continuance of the growth in productivity or on the maintenance of their profit margins. So the market is really trading on a political knife-edge. The reason why it has gone better as I write is because the TUC has actually condescended to meet the CBI and the Government through NEDC and discuss how to curb the wage-cost inflation. The militants, of course, would not allow the TUC to make any contact at all with a Tory government. It is ironic but true that the health of the bull market now depends on the goodwill of the trade unions. If they deign to discuss with the Government how best to get the CBI members to hold their 5 per cent price restraint — and so reduce the profit margins of the companies engaged in manufacture — this would be regarded as a bull point.

The second technical point which is still showing green is the money supply. The average increase over the past three months was just under 2 per cent per month, though there was a much smaller increase in May. Bank lending to the private sector was the dominant factor. In the three months ending May 17 bank advances to UK residents rose by £1,374 million — nearly twice the growth in the previous quarter. The financial sector took most — up £585 million — followed by ' persons ' — up £354 million. Manufacturing industry was only up £34 million. While the .manufacturing and investment sectors remain sluggish this huge increase in the money supply spills over into the market in securities and houses and land. The chartists will show you a beautiful correlation between money supply and the movements in equity share prices. The Chancellor has indicated in various speeches that the money supply will remain large and easy during 1972 and will not be allowed to interfere with the potential growth of the economy. As Mr Patrick Jenkins, Chief Secretary to the Treasury, told a Conservative summer school last week, to tighten up the money supply would be to choke back the growth of the economy. However, there is increasing criticism that a 20 per cent per annum increase in the money supply is socially dangerous — witness the public discontent over the sky-rocketing of house and land prices and the fact that the rich always get richer during an inflation. The floating of the £ and the exodus of ' hot ' money might well be seized upon by the Treasury as an opportunity to slow down the growth of the money supply. This in itself would not upset the Stock Exchange but the lengthening queue for new issues must be watched very carefully.

This brings me to the gilt-edged market, which is pretty sick. It was just saved from complete disaster on June 28 when the Bank of England stopped the joint stock banks selling their ' shorts' after the withdrawal of nearly £1,000 million of ' hot ' money from London. (It charged them only 6-1per cent for the accommodation). The market rate on the high coupon shorts had already risen at that time to allow gross redemption yields of 8.9 per cent and if the joint stock banks had been forced to sell the short-term rate of interest would have gone through the roof. The intervention of the Bank did surely indicate that the Government was not willing to endanger its economic policy of expansion by allowing such a rise in interest rates as would upset the business world and frighten off industrial investment. Then why does it not admit that the new monetary policy which it introduced last year was wrong and unfitted to the present crisis in our capitalist system?

This new policy, which. forbids the Government broker to support the market, allowing it to find its own level on the mistaken theory that credit will be rationed through abnormal interest rates, is responsible for the present sad disarray of the gilt-edged, market. Prices have fallen faster than at any time in recent history. The FT index of twenty year stocks dropped from its January high to 91 to below 75 in June before recovering to 78. No wonder _a firm of jobbers have given up. trading in Government stocks after only fourteen weeks of trial while another has left after twelve years of business. There are only three main jobbers left for a market which has an average turnover of over £100 million a day. The market just cannot work unless the Government broker is allowed to give it a little support when it needs it and becomes, as he used to be, the buyer of last resort.

At the moment of writing you can obtain a yield of 9.3 per cent on a 'long' stock like Treasury 7i per cent 2012/5 or 9.4 per cent on ' Dalton's.' The argument that these are not high enough to compensate for the running rate of inflation, which may be over 71 per cent, is a nonsense argument. No one buys Government stocks to compensate for inflation. The gilt-edged market is part of the money mechanism of a capitalist system and' is designed to be second to cash for liquidity purposes. The life offices and the pension funds enter into money contracts, not in real terms, and would jump at profitable yields of over 9 per cent if they felt as sured that the Government broker was ready to keep the market stable or on a rising trend. It was, in fact, on a rising trend until the Government changed its time-honoured policy and swamped the market with two enormous ' tap ' issues of £500 million. Let the Government broker put on his top hat and perform his old job — and, remove the fear from the business world of a further rise in interest rates.