Equity shares a time for caution
Nicholas Davenport
During the last account on the Stock Exchange equity shares, according to the FT ' Thirty ' Index, scored an advance of 27 points — the best effort since last summer — and a further 6 points this week. Can this be the end of the bear market? Are equity shares to be carried away by the optimism of Mr Peter Walker, our Minister for Trade and Industry and our commercial traveller to Peking? No, on the whole I advise caution. An over-sold market was due for a technical recovery and it got it, first when peace came to the gas works and promised some temporary relief from industrial strife, secondly, when the White Paper for Phase 2 brought some concessions to the members of the CBI.
Mr Campbell Adamson, the director-general of the CBI, is to be congratulated on the force of the arguments he put to the Prime Minister at No 10. " Industry,' he said, "could be brought to a grinding halt if the Government failed to appreciate the need for profits to finance investment." The new White Paper departs from the rigid profit control of the Green Paper which laid it down that prices must be reduced not only when companies have enjoyed a fall in raw material prices but also when they have cut their own costs through increased turnover. The latter provision has been scrapped. Companies are enjoined to reduced prices "whenever possible." And the former provision that companies must not pass on more than 50 per cent of their higher costs through pay increases has been Watered down. Companies whose labour costs form more than 50 per cent of total costs can pass on more than 50 per cent according to a new formula. This will help many engineering, building and other labour intensive industries and justified the recovery in the industrial share markets. My impression is that companies will now be able to advance prices on increased costs whenever it is necessary for the finance of new investment.
My advice of caution in the equity share markets rests upon monetary considerations. First, there is the yawning reverse yield, gap. The average dividend yield is 3i per cent and the yield on War Loan 10.2 per cent — a gap of 6.7 per cent. The average earnings yield is 7.1 per cent — a gap of 3.1 per cent. Now Mr Barber said in his budget speech that a " sustained effort" must be made to sell ,gilt-edged stock to the nonbank public in view of the huge borrowing requirement and this surely implied that he would keep interest rates high enough to entice buyers to come into his market. For example, he has offered a new Treasury 3 per cent 1979 at 75 which will give a tax free profit of 33i per cent in six years, which is equivalent to a profit of 48 per cent on an equity share subject to 30 per cent tax. And let us not forget Transport 3 per cent 1978-88 at 52i which will almost double your money in fifteen years. That is equivalent to a rise of 130 per cent on an equity share. Who could be certain of such an equity profit in fifteen years in these anticapitalist days?
In the second place, Mr Barber has avowed his intention to bring down the growth in the money supply and learned papers are being written in the City to give statistical support to the idea that movements in money supply and equity shares go together. To trace an exact correlation between the two is in my opinion pretentious poppy-cock. The bear market got into its swing in the second half of 1972 when the money supply was growing at the tremendous rate of over 25 per cent per annum. If Mr Barber remains under the illusion that he can bring down the rate of increase in money supply by continually raising the rate of interest he will knock the bottom out of the gilt-edged market. So that line of action is ruled out. What he may be forced to do in the end is to restore quantity and quality control over bank advances — and that, indeed, will be bad for equity share prices. It was the first call for restraint over bank advances for properties and shares which set the bear market in action.
All these are good reasons for staying out or getting out of British equity shares if they seem overvalued on a priceearnings ratio of more than 12. (I take 12 as a datum line because in past bear markets the average price earnings ratio has generally fallen to that level.) There has already been a big movement out of British equities into those of Europe and the US. I notice in the balance of payment returns that there was a sharp increase in outward portfolio investment in 1972 — the total being £700 million compared with about £100 million each in 1970 and 1971. (Most of this outward investment was of course financed by foreign currency borrowing.) Perhaps the disappointing behaviour of Wall Street has prompted some of this flight money to return home, for there has been a sharp drop in the effective investment dollar premium from 37 per cent to 13 per cent, but, if so, it has probably been attracted into certificates of deposits (where until the budget there was a tax avoi dance loophole) or into seven day money in the street where rates of I1 per cent have lately been secured. To get out of shares and into money has become fashionable on both sides of the Atlantic — as Jim Slater told a shocked public here not so long ago. When money rates decline, and the gilt-edged market booms it will be time enough to get back into shares.
It has also become fashionable for the more speculative to buy bars of gold and here again a word of caution is advisable. The first flight from the dollar this year saw the price of gold soaring temporarily to $95 per ounce on the free market. (The official monetary price is now $42 an ounce.) It then relapsed to $84 and has recovered to $89. Mr Charles Stahl, of the Economic News Agency, whose evidence before the Senate banking committee I have already quoted, has made two interesting suggestions: first, that American citizens should be allowed to buy and own gold, secondly, that the two-tier system of gold should now be abolished. The first would certainly stop the flight of a lot of private capital from the US. The second suggestion, coming from the man who actually suggested the two-tier system before it was officially adopted, should be very seriously considered by the Jeremy Morse committee on monetary reform. The present arrangement gives an unfair advantage to the gold producers — South Africa and Russia — whose central banks alone can sell their gold at the high tier price instead of at the low monetary price of $42. At the recent Paris meeting between the Americans and the other monetary powers which decided the floating no mention was made of gold but the rumour got around that the central banks would eventually be allowed to effect settlement in gold at the free market price instead of ignoring gold completely.
This should be a warning to speculators who prefer gold to shares. Any change in the system — by legalising gold trading for American citizens or central banks — could cause a sharp temporary fall in the market price of gold.
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