The market, the Governor and Skinflint
Nicholas Davenport
This week I have perforce to deal with Skinflint and the Governor of the Bank of England. Skinflint bet me £1 that the FT 'thirty' index would sink to 450 before it hit 550. This, as he says, was early in May when the index was 520. He thought at that time that the bull market was over and I told him it wasn't. Subsequently it went up to 543.6 on May 19, declined to 483 and recovered to over 538 in August, which proved my point. I did not collect my £1, not because Skinflint is ungenerous — I think he chose this repelling pseudonym to hide a most generous nature — but because the charts were not too clear. It was only last week that the index fell through its long-term support line and gave the signal that the bull market might be finished (as I write the index is 493). Certainly bullishness has evaporated. But this does not mean that a real bear market has yet started.
It is unusual to expect bear sales when over the next twelve months the economy should be growing at the rate of 5 per cent per annum and when company profits should be rising by at least 15 per cent to 20 per cent. The price-earnings ratio on the 500 share index is now 17.6. On a prospective price-earnings ratio of 15 or under the market cannot be considered so over-valued as to invite bear selling. When I forecast the end of the previous bull market in October 1968 the price-earnings ratios were over 20.
What I suspect is happening in the market is a repetition of what happened in the previous Tory administration. After the first great bull market which lasted from June 1952 to July 1955 and scored an advance of 117 per cent there was a long period of hesitancy up to February 1958 during which the market fell by 31 per cent. This was due to the political upsets of the time — the fatal Suez invasion, the collapse of Anthony Eden and the fear that the Tory party had shot its bolt. After the quiet convalescence uhder Harold Macmillan political confidence was then restored and with "you never had it so good" the secs \ad bull market started up and lasted Up to January 1960, scoring an advance of 122 per cent.
The present reaction may be like that of 1955-58 — a loss of political confidence due to the defeat of Mr Heath by the strong-arm tactics of the militant ' trade unions. When Mr Heath found that he could not apply the Industrial Relations Act to the dockers for a 'cooling off' the market felt, as in 1955, that the Tory party had shot its bolt. I have often repeated my old rule—a true bull market always requires a concurrence of favourable economic and political factors. We have for the time lost the favourable political factor. If this were to lead to the same sort of decline as in 1955-58—a bear market — the FT ' thirty ' index could lose a third of its rise, that is, it could fall to 464. So Skinflint would still have to hand me over that £1.
The restoration of political confidence now depends on some success being achieved in the talks between Government, the CBI and the TUC about a voluntary incomes policy and the control of inflation. The talks are said to have started well but to improve the relative position of the lower-paid without pushing' up the higherpaid and worsening the inflation is going to be extremely difficult. The adoption of the " threshold " clause in wage agreements could also be inflationary if the price restraint policy broke down. In the 30 per cent builders' settlement — 14 per cent spread over the twenty-six months — there was a " threshold " clause which stipulated that if there is an increase in the cost of living of more than 8.i per cent there would be an additional payment in October 1973. The retail price level is now 6 per cent above the average for last year. For what it is worth, the National Institute of Economic and Social Research expects to see the retail price levelabout 8 per cent higher at the end of the year, as compared with December 1971, and another 9 per cent up by the end of 1973.
As the TUC conference declared emphatically against any form of wage restraint the outlook is not very promising. The local authority manual workers have put in a claim for 43 per cent, the miners for a further 30 per cent, the electricity workers for 40 per cent and the Ford motor workers for 40 per cent. Strikes or give-aways — it will make little difference. The market will be conscious that equity shares are a very imperfect inflation hedge but perhaps better than none. The only event which might restore politicalconfidence and set the bull market running again would be some positive evidence that Mr Heath is capable as prime minister of managing this awkward nation. That would be a point of real decision.
Passing from Skinflint to the Governor of the Bank I am moved from friendly argument to one of anger and dismay. We all know that priorities at the Bank have been changed from pushing expansion to controlling inflation. The recent Bulletin ended with the sinister words: "The highest priority must be given in all aspects of policy to the reduction in the rate of inflation." This has been assumed to mean that the Bank is going to slow down the rate of increase in the money supply and to push up the rate of interest. Are we then to expect an increase in Bank rate from 6 per cent to 7 per cent and another round of increase in mortgage rates and loan rates to industry and trade? All this adds to the inflation of costs and to the inflation of wages. Businessmen can no longer come to the market to raise capital for investment in plant and labour-saving machinery because the costs of borrowing exceed the profit margins they expect.
If the Bank really wants to reduce the money supply it must find buyers for government stock which it will never do if investors feel that the market is going down instead of up. In the last quarter the banking sector reduced its holdings of giltedged stock by £550 million while other holders increased their holdings by £111 million. Now the insurance institutions and pension funds are stuffed with money. Their total net increment last year was £1,481 million and this year their net funds are accruing at the rate of about £1,700 million net. Last year they put £400 million into the gilt-edged market and this year they could well put more as yields actuarially are much more attractive.
We must not forget that the insurance institutions enter into money, not real, obligations in their life business and that if they want inflation hedges they buy equity shares and property. At the moment they are not feeling very happy about buying equity shares as inflation hedges. My information is that there is a lot of cash in institutional hands which is waiting to go into the gilt-edged market if the Governor of the Bank does not frighten it off by knocking the market with dearer money. Will the Treasury step in and prevent sudh madness? After all Mr Patrick Jenkin, the chief Secretary of the Treasury, recently said that cutting the money supply abruptly was "politically wholly unacceptable" as it would choke back the growth of the economy. I notice that Dr Arthur Burns, chairman of the Federal Reserve Board rejected the IMF idea of raising short-term interest rates by saying: "We are not going to take measures to increase unemployment." Sir Leslie O'Brien and Skinflint — please note!
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