THE WALL STREET OPTIMISTS

By NICHOLAS DAVENPORT

4 No, the sharp drop of 31 per cent. on Wall Street at the beginning of last week cannot be explained away by the mere fact, however extraordinary, that a well-known stockbroker took advertising space in the New York Times to tell his clients to sell. They would 'not have sold if they had not been feeling already that the market Was too high. And the higher it goes the more fidgety they will Strong fhe herd instinct on Wall Street is always

and it only needs a determined lead from

it pi. oi. si4mmn ient 'bull' turned 'bear' to start another )ede of these nervous animals. , The last time a 'bull' market broke, which was 'Li July last year, the industrial shares underlying the Standard and Poor's index were giving a divi- dend yield of 4.6 per cent. (against a bond yield of 3.6 per cent.) and an earnings yield of 8.7 per cent. The market thereafter fell 20 per cent. Today, after a rise of 30 per cent., the dividend yield is 3.2 Per cent. (against a bond yield of 3.75 per cent.) and the earnings yield only 5.3 per cent. Clearly, the market is discounting a sharp and uninter- rupted recovery in dividends and earnings for the next twelve months, which few economists would dare to predict while the President is threatening t.° c it expenditures and balance the budget. Indeed, if Mr. Eisenhower secures the support of the e h xtreme Right in both the Democrat and nepublican parties in an economy drive against 101 'the spendthrifts' he hates so much, the recovery whici- „.. i America is now enjoying will not be V- onape(j but W-shaped. The 'State of the Union' message to Congress in January will point the way. such a conservative Democrat as Senator 1/Yrd as chairman of the Senate Finance Com- in ... lite! it is not at all impossible that the President willI ,, )e able to carry through some measure of ”, etlation. But until the message has appeared it is a dangerous gamble to buy at the current level On Wall all Street. All Americans love slide-rules and it is a corn- 'lion exercise among the professional managers or

fu ..

tds on Wall Street to project the earnings of the. , constituent companies of the smaller Dow J ones index and, using the price-earnings ratio, to.,,. livet :diet the level of the index three, four and Years ahead. I have seen one prediction of 750 fur 1963 against the present figure of 558. If you are a - divinely patriotic American and firmly believe in the . 4y ordained growth of the United States M ilt- , II its population due to expand more rapidly 11 the Sixties, and with its dynamic industrial

ollo

'c 'my activated by a high rate of obsolescence),

.you Will hardly pause to ask yourself at what level

if the Dow Jones index you are making your own

t11(1)velsi ment. You will just buy and think of the n tg rise. But one day reality is going to_over- lake and crush this optimism.

Sii

1 ice 1951 dividends on the shares of the Dow 4,ones

industrial index have increased by about

..5 n.-. , vcr cent., but the index of share prices has ',1'en by 125 per cent. and the pricd-earnings ratio ,rom r aboUt 8 to nearly 20. What is the justification , 'ur this rise when the earnings of the shares : aiehr led in the index have never gone appreciably mov_ , c their level at the beginning of 1951 and are A.Ay tctually below'? In other words, what is the I Xcl-lsc for share prices continually rising faster Illittn earnings? The only possible answer is creep- ,- mti. inflation or the fear of it. But the facts do P 110i support the inflation thesis. Since 1951 the index of American wholesale prices has risen by about 2 per cent. only. Until the middle of 1955 the index had actually fallen by 5 per cent. from its level at the beginning of 1951 : the rise in the last two and a half years, which has been at the rate of 3 per cent. per annum, was due mainly to the increase in farm prices-a reflection of the immoderate farm price support policy. Recently the wholesale index has stopped rising. And the great increase in productivity since the industrial sector of the economy started to recover suggests that the consumer price level will now be kept steady. The inflation bogey, which is said to have been the mainstay of the recent stock market boom, may before long disappear. What then will support the price level on Wall Street'? If the price level did resume its rise, it is pretty certain that the Federal Reserve would endeavour to exorcise inflation by making money still dearer. If that should happen, it could make the present burden of debt insupportable. The expansion of the American economy in the past ten years has been largely based on borrowing. While the Federal Government debt has remained nearly constant the increase in private debt, both short- term and long-term, has been colossal. Any further rise in the rate of interest could discourage enough borrowers on mortgage and on hire-purchase to curtail their demand for goods and so slow down the economy. Even a rise in the rate of interest sufficient to upset continuity in the creation of debt could have unpleasant 'deflationary effects.

The health of the American economy is very delicately balanced. In its September bulletin the Federal Reserve wrote 'From the end of 1948 to the end of .1957 the dollar amount of liquid assets held by consumers increased about 40 per cent. Their total financial assets increased substan- tially more-nearly 75 per cent. -largely because of higher market prices of corporate stocks [on Wall Street]. But the biggest increase of all occurred in outstanding debt : total liabilities of consumers were more than three times as large at the end of 1957 as they had been at the end of 1948.' The situation today is very different from that of 1929, but when the inflationary bubble on Wall Street bursts, as sometime it must, with or without government action-in spite of the pen- sion fund buying-the economic consequences could be serious. The recovery could become W- shaped overnight.