The gilt and the gloom
Nicholas Davenport
The gilt-edged market had a rush of blood to its head last week when the Bank of England returned a further £149 million of special deposits to the banking system. This, following on the previous cut from 44 to 34 per cent which had been completed on April 16, makes the special deposits call now a mere 3 per cent. There was heavy buying of shortdated bonds on the feeling that Mr Harold Lever's determination to bring down the short term rate of interest was now getting extra support from the Bank of England. But second thoughts confirmed the more reasonable view that the move was intended to avert a possible hardening of interest rates in the next few weeks when companies have to make heavy advance payments for corporation tax, when many want to extend overdrafts in order to replenish stocks and when the oil boom in Scotland is putting fresh demands on Scottish banks. Moreover American prime rates have risen to 10 per cent and it is by no means certain that US interest rates have yet reached their peak. However, we must be thankful that Mr Lever's initiative has had an initial success. The minimum lending rate (Bank rate) has been brought down from 124 to 12 per cent — it was 13 per cent at the beginning of the year — and seven day money in the 'street' has 'fallen from 16 to 12 per cent.
Here I must repeat the warning that while Mr Lever may bring our interest down to world market levels he cannot significantly lower the domestic rate of interest unless he makes two innovations. First, he must introduce a two-tier system of interest rates which allows the authorised banking depositaries to pay a higher rate on foreign money above that obtainable in the gilt-edged market or the 'street.' We have consulted an eminent merchant banker who expressed the view that this was a feasible proposition and that leakages could be avoided. Secondly, he must direct a proportion of the flow of current savings in the life and pension funds into a special Public Works Fund which could be recycled into the housing market. This fund, being a quoted stock, would influence the medium-term yields in the gilt-edged market and bring them down to a lower level.
Long-dated stocks, would, of course, still be subject to the inflation risk. Incidentally it is good to know that the building societies have now accepted the £500 million loan from the Government which will stop them raising their mortgage rates.
The recovery in the gilt-edged market seems to have given fresh confidence to equity shares, although I must confess that I see this as a non sequitur. After falling to 263 on April 1 — the lowest level for twelve years — the FT index has recovered to 300 and could even go higher while trading remains at such a low level. It is, however, ridiculous for financial scribes to be advising their readers to begin preparing for the next bull market. There is not likely to be another bull market unless and until the political situation is completely changed. You cannot have a bull market, as I have always argued, without the happy conjuncture of favourable politics and favourable economics. You are not going to get favourable politics again until Denis Healey, Wedgwood Benn and Michael Foot and their Marxist followers are no longer able to influence and direct Labour Party policies. The free enterprise private sector will not be able to function profitably while they have power to intervene in industry at will, to fix prices arbitrarily, to order 10 per cent cuts in gross profit margins, and to make 'planning agreements' (a, la Benn) with the top hundred companies.
The immediate prospect for company profits is dismal. Retail trade was down in 1973 and returns for the first quarter of 1974 were also 2 per cent down on the preceding quarter. Mrs Williams hopes to secure profit margin cuts by voluntary restraint but this is unlikely. Her edict that gross profit margins must be cut by 10 per cent will mean a drastic fall in net profits for retail companies which either cannot increase sales rapidly or have been working on high gross margins. The fact that the brilliantly managed Marks and Spencer were only able to advance their net profits by 10 per cent after a sales rise of 16 per cent in the twelve months to March 1974 is not an encouraging pointer for 1974-75.
Turning from retail trade to the engineering industry — the key to our industrial and export future — the profit prospect is even blacker. This industry bears the brunt of trade union militancy, the obstinate refusal of organised labour to co-operate in a productivity exercise. For example, as soon as the British Leyland car plant at Cowley was re-opened after the Easter holidays it was shut down again — by an unofficial strike of 150 transport drivers over lay-offs, led by a Trotskyist revolutionary. Now begins the ban on overtime imposed by Mr Scanlan's union which could have a disastrous effect upon the whole economy seeing that the industry supplies nearly half the plant and machinery we require for manufacturing and about 30 per cent of our total exports. Productivity in the British engineering industry is about the lowest in Europe, being a third less than in Germany and France.
by two experts in the Times concludes that there are signs that overseas customers are now hesitating about placing orders with British companies — despite their competitive prices — because of doubts about whether they will be able to deliver. The report ends with a depressing comment on "the seemingly inexorable slippage which leaves the industry in Britain falling further and further behind its rivals."
This 'slippage' is revealed in statistical form by two members of the Economic Directorate of the CBI writing in the latest Lloyds Bank Review on 'The Profits of British Industry'. Their final table gives the post-tax rate of return on capital employed (historic cost) of manufacturing industry. The return has slipped from 10.1 per cent in 1964 to 7.8 per cent. For all companies the return, less stock appreciation, capital consumption and taxes, but plus investment grants, has fallen from 13.6 to 9.8 per cent. The authors conclude that British manufacturing is experiencing a secular decline. No wonder, seeing that if companies had to raise money in the market at the present high rates to pay for new investment they would make a heavy loss!
If the coming 1974 fall in industrial profits — estimated at 15 per cent or more — were translated into 'real' terms by allowing for the current price inflation the investor would hardly be dreaming of the next bull market. He has not yet seen the worst of the current bear market. Yet I have no doubt that there are some wellmanaged companies which will weather the gathering storm.
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