THE FUTURE COURSE OF INVESTMENT VALUES

By A. H. GissoN

I.—THE MAIN FACTOR

• AT .a time when political conditions in several countries remain more or less unsettled, at a time when the attitude of labour to capital and future production still remains an uncertain factor, and at a time when certain leading nations have not definitely decided to return to the gold standard by the process of devaluation of existing currency units, or by the unpopular process of further increased taxation, it is not possible to make any prognostications, with any probable degree of accuracy, as to the future course of investment values. In this article, however, there will be considered certain basic influences which ultimately determine the general course of investment values, and reference will be made to other influences which tend to exert a transient effect on prices. It will be left to the reader to decide as to the probability of altered conditions in the future which should bring about a marked change in present values of securities. The article will necessarily be restricted to a discussion of the factors which determine the market values of fixed-interest bearing securities, for space will not permit of exhaustiVe analysis of the many factors that determine or influence market values of variable dividend securities. It may be said, however, that, broadly speaking, the influences that affect market values of the fixed-interest type of invest- ments tend to have a like effect on the market values of variable dividend securities, but the public demand for the latter also varies with the degree of risk as an invest- ment, the current state of the trade or industry from which profits are made to provide dividends, and the probability of political or other developments causing diminished or increased future profits. Assuming, however, that future profits are assured sufficient to pay current rates of divi- dend, as in the case of bank shares, then yield at market prices tends to fluctuate sympathetically with the yield of fixed-interest securities.

The influences or factors that determine the general course of investment values may be divided into two broad divisions, those of a more or less fundamental or primary character and those which exercise only a tran- sient or secondary effect. In the former category there are to be classed :-

(1) The cost of living, which largely determines the margin of income available for investment.

(2) The amount of now issues and application of proceeds. (3) The strength of the public desire for acquiring investments in preference to holding savings in the form of titles to bank deposits. (4) Competitive yield of Foreign and Colonial investments. (5) Taxation, its degree, incidence and application of proceeds.

Factors which exercise transient effects on the market values of investments are :-

(6) Unusual large purchases or sales of existing investments. (7) Changing trade conditions. (8) Changing political or economic conditions, at home or abroad.

(9) War conditions. (10) Changing public confidence in the stability of future conditions.

(11) Psychological influences. (12) Expansion or contraction in bank credit. (13) Changing bank discount or interest rates.

(14) Unstable exchange rates. (15) Inflow or outflow of foreign capital for investment.

COST OF LIVINO FACTOR.

(1) Economic reasoning and past experience prove that the basic factor determining market values of Gov- ernment and other first-class stocks is the cost of living. The law or relationship existing between the cost of living and investment values may be stated as follows :--- The course of the market prices of high-class fixed interest-bearing stocks is mainly indirectly determined by the cost of living, a fall in the latter being usually accom- panied or followed by a rise in the former, and conversely. As the yield of fixed interest-bearing stocks at marketT prices obviously varies inversely to such prices, the above stated relationship iro.y be alternatively expressed in the following form :- The yield of high-class fixed interest-bearing stocks at Market prices is mainly indirectly determined by the cost of living, a fall in the latter being usually accompanied. or followed by a fall in the former, and a rise in the latter by a rise in the former. . Owing to the interdependent connexion existing be- tween market values of different stocks bearing fixed rates, of interest in the gilt-edged group, it will be sufficient,, in order to prove the relationship existing between market values of high-class investments and the cost of living, simply to compare the course of the yield of Consols at market prices over a long period of years in the past with the course of commodity prices over the same period. For experience proves that if the price of Consols declines many points, other fixed interest-bearing stocks generally proportionately do likewise ; similarly, if they rise, though irregular movements of a point or two do occur at times. The yield of Consols is necessarily considered because it is the only security available for which market prices have been carefully recorded for over one hundred years.

CONSOLS AND COMMODITY PRICES.

Accompanying this article will be found a chart, the curves of which, based on averages for each year, represent the course of the yield of Consols at market prices and the course of wholesale commodity prices since the year 1820, the curve for the latter being based on the index number winpiled by Mr. Sauerbeck for the period 1820-1912, and by the Statist (in continuation) since 1913.* Wholesale- commodity prices have necessarily to be taken as repre- sentative of the cost of living for the purposes of this . article, in the absence of an available and reliable index number based on a consumption standard. The difficul-' ties in compiling such an index number have generally been considered insurmountable. It will be observed from the chart that, generally speaking, the curve representing the course of the yield of Consols and the curve represent- ing the course of commodity prices generally either both rise together or fall together, a lead of any change in direc- tion usually being given one year in advance by commodity prices. For the few periods or years in which there was not a sympathetic movement between the curves, an ex- planation can be given for such disagreement. The rise in the yield of Consols for the years 1830 and 1831 was due to a revolution in France in 1830 and the introduction of the Reform Bill into the English Parliament in 1831, which caused considerable political disturbances, though it passed both Houses the following year. Both these im- portant factors temporarily severely depressed the price of Consols. The introduction of the Reform Bill caused many of the richer classes in this country to send their money to America and Denmark for investment. Another period of marked disagreement between the two curves was experienced during the three years, 1871-1873. This lack of sympathetic movement was due to the fact that the Franco-German War, which commenced in July, 1870, and terminated in May, 1871, induced the wealthy classes on the Continent to send their money to England for safe investment. This abnormal inflow of foreign money seeking investment prevented the price of Consols falling (and, consequently, the yield rising) with the increase in the cost of living during this period. A minor divergence between the curves is shown for the year 1880, com- modity prices rising this year instead of continuing to fall in sympathy with the gradual fall in the yield of Consols. During the previous year there was experienced the worst harvest of the century, and to this cause is to be attributed the temporary rise in commodity prices during the follow- ing year. Though the prolonged fall in the yield of Consols during the period 1875-1896 was primarily due to the rapid fall in commodity prices that took place during this period, yet some transient effect was produced by the Government making within this period very large * For figures from which the curves are plotted, see tables in article on Investment Values, Rankers' Magazine, January, 1923. For the three years, 1922, 1923 and 1924, the average price of Consols was 58i, 58 and 571, respectively, and the commodity price index number, 131,.129 and 140 respectively. purchases, on Savings Bank. ..account, of Consols and the other " Three per Cents " of the State then on the market.1 Some slight divergence between the curves is also shown for the years 1889, 1890, and 1903, 1904, 1905, following the reduction in the rate of interest on ConsolS from 3 to 24 per cent. from April 5th, 1889, and from 24 per cent.. to 2i per cent. from April 5th, 1903, -arranged for in the Conversion Scheme of 1888. , These reductions had admittedly been previously largely discounted by the market in the price of Consols, but some slight liquidation was left to be effected after 1889 and 1903, and the yield therefore continued to fall at a time when the commodity price curve would have warranted no change or a slight rise. All the causes that have been named to account for certain divergences up to this time between the courses. of the two curves were, however, transient in effect, and simply partly hid, for short periods, the full influence being exerted on the yield or price of Consols by the course of commodity, prices. • WAR EFFECTS.

After the Conversion of 1888 had been effected, the two curves of the chart show (apart from the already named slight divergences) close sympathetic fluctuations up to' 1914. In August of this year the great European War commenced, and hostilities continued until the Armistice' date, November 11th, 1918. The War was accompanied by world-wide economic disturbances which, together with unprecedented bank credit expansion, gave rise to a rapid increase in the cost of living. The chart shows that commodity prices and the yield of Consols both rose very rapidly during 1915-1919, the acceleration in the former being much greater than in the case of the latter.' In 1918, however, during April-October, there took place, a rise in the average price of Consols (and consequently a, fall in the yield), owing to• growing evidence and feeling that the War would terminate in favour of the Allies. But the effect of such sentiment on the market prices of high-, class investments proved to be only temporary during this time, the basic factor, the increasing cost of living, again' asserting itself during 1919 and 1920. During these two years the chart shows that the yield of Consols and corn-. modity prices both continued in their upward trend (taking averages for the year). In 1921, there took place. a rapid fall in commodity prices, and in this year the upward movement in the yield of Consols was checked preparatory to a reversal in direction. For the following year, 1922, both curves in the chart show a marked down- ward movement. The very different gradients of the two' curves for the period 1915-1920 clearly indicate that the extent of the rise in commodity prices during such period was not warranted by basic economic conditions of the' United Kingdom. Part of such ripe was undoubtedly due' to profiteering during exceptional- conditions and to the effect on commodity prices of transient psychological in- fluences. For the year 1923 the rate of fall in the two curves Materially slackened, preparatory to a change in direction in the following year, 1924.

GOSCIIEN CONVERSION.

Another feature about the two curves that calls for some comment is the increasing width between them for the period 1881-1887. To explain the reason for this widening tendency it will be necessary to consider briefly the course of the price of Consols during this period. The chart shows' that during the period 1875-1896 there took place a pro- longed fall in commodity prices (with an occasional up- ward temporary tendency), which fall was mainly due to the rapid development of'the young food and raw material producing countries during the 'seventies and 'eighties of the last century. The degree of the fall was such that the price of Consols reached par by the year 1880, the highest' and lowest prices for this year being 1001 and 971. There- after the price was retarded from rising much above par, and the yield proportionally falling, in sympathy with the continuing fall in commodity prices, through fear felt by, the market of the Government exercising its standing Option to redeem Consols at par on giving twelve months' I notice to the holders. This fear later proved to be well, fOunded, for, in 1888; the Government offered holders of Consols, and of the other two Three per Cents then out- standing, in exchange for their holdings a new stock' bearing 21 per cent. interest from April 5th, 1889, until April 5th, 1903, then 2f per cent.• until April 5th, 1923, after which date the Government reserved the option to redeem the new stock at par.

Apart from the period 1881-1887, the chart also shows that no fixed difference has been maintained between the two curves for any other long period, though an approxi- mate fixed difference has occasionally continued for several years. If, however, commodity price index num- bers were accurately representative of the cost of living, there would probably be found still greater correspoirdence between the two curves, in other-words between the yield of Consols and the cost of living, except during a period of great economic disturbandes, such as was experienced during 1915-1920. Even if the yield of Consols had varied proportionately to commodity prices, the chart would not have shown an exact fixed difference between the relative fluctuating curves, for one is plotted higher than the other from the base line. As already indicated at the commence- ment of this article, apart from the basic cost of living factor, there are several minor influences that affect the course of investment values, some of which operate through their direct or indirect effects on the cost of living.

The general sympathetic movement between the two curves representing commodity prices and the yield of Consols is obviously due to the fact that the less the cost of living the greater must necessarily be any margin of income available for investment, and, conversely, the greater the cost of living the less such margin, and pro- bably the greater compulsory sale of investments in the case of some holders. The correctness of this opinion is strongly supported, by the fact that the chart discloses that changes in the direction of the curve representing the yield of Consols have usually been preceded by like changes in the direction of the curve representing commodity prices.

II.-SOME OTHER FACTORS

Mot:Gil the cost of living is undoubtedly the basic factor determining -the course of first-class investment values, yet, as already indicated, there are certain other influences which tend to bring about more or less pro- longed or transient movements in market values, and these will now be considered briefly :- (2) The amount of new issues and application of pro- ceeds. The market prices of investments naturally tend to vary with supply and demand, and, therefore, if during a period of years there is an exceptional amount of good new issues available, a depressing effect will tend to be produced on market values of existing investments. The extent of the disturbance will obviously depend on the amount of the new issues relative to the amount of existing investments. During the last Great War there was an un- precedented amount of new issues of Government secu- rities. The character of the issue has also to be taken into consideration: The long effect on market values of existing invest- ments of the issue of a Government new loan is also de- pendent on the application of the proceeds. If used to pay off a maturing loan, the effect should be nil, but if the proceeds be applied to purchase of consumable commodi- ties or services for War purposes, the immediate effect is to cause an increase in commodity prices and to depress market values of existing investments. Should the banks take up the issue and, per contra, credit the Government with the subscription price, the effect is twofold—increased demand for existing consumable commoditiei, and an increase in the total monetary purchasing power of the community, in other words, inflation. (3) The strength of the public desire for acquiring in- vestments in preference to holding savings in the form of titles to bank deposits. (4) Competitive yield of foreign and Colonial invest- ments. The influence of this factor varies with different classes of a community. Some people prefer home invest- ments, notwithstanding a lesser yield than might be derived from investments abroad of a safe character. Relative political and economic conditions at home and abroad often also influence a person in choosing a home or foreign investment. - - - • - - - (5) Taxation, its degree, incidence and application of proceeds. The effect of taxation on the market values of investments is- one of the most elusive factors to estimate. Since the Great War terminated, Income Tax has been reduced from 6s. to 4s. 6d. in the and yet, on each occa7 sion of announcement of a reduction, practically no per- manent -effect was produced; on the market values of investments. In so far as the reduction has enabled some investors to have a greater margin of income available for investment, or, in other cases, reduced the amount of . compulsory sales,- then the effect, of the reduction in taxation must have tended to raise market values of in- vestments.: On the other hand, in }navy cases the greater a person's net income, after payment of taxation, the greater will be that person's consumption of com- modities and services, or purchase of stocks for trade purposes.

INCIDENCE OF TAXATION.

The effect of the incidence of taxation may also be con- sidered from several angles. An alteration in the distri- bution of taxation will usually be followed by increased consumption of commodities in the case of some persons, necessary reduction in consumption in other cases, and an increased margin of income available for investment pur- pcises in other cases. The application of proceeds of taxation may also have several different effects on the cost of living, and there- fore on market prices of investments. The British Gov- ernment at present applies the proceeds of taxation to four main purposes : first, to payment of non-productive services ; second, to payment of interest to holders of its securities ; third, to payment of War pensions ; and fOurth, to payment of interest on its War debt to the American •Government, and repayment of a relatively small amount of the capital sum of this debt. The wasteful part, from a national standpoint, is the payment for non- productive services, but a large percentage of this pay- ment is necessary to ensure that other members of the community may peacefully carry on their work of a pro- ductive character. Payment of interest on Government loans is largely a transfer from one pocket to another of the same individual, or payment by one individual to another for past services rendered to the Government. Payment of War pensions is a national duty for past pro- tection afforded. The payment of interest on the American Debt, and part payment of the principal, is a direct loss to the British people, but a moral lead to other nations to honour debts created in the ,War period, and to this extent enhances British financial prestige abroad. In view of what has been said above; the influence of taxation on market values of-investments will largely' depend on its direct or indirect effects on the cost of living and on the margin of income available for investment of the saving classes: The factors which have been already considered may be classed as more or less of a basic character. Influences which tend to exercise transient .effects on market values of investments are discussed below.

(6) Unusual large 'purchases or 'sales of existing invest- ments. The temporary effect of such operations is obvious. During the past year the joint stock banks have materially reduced their holdings of Government invest- ments at a time when there has been no very great public demand for gilt-edged securities.

(7) Changing trade conditions. Though the cost of living is undoubtedly- the basic factor 'determining the course of first-class investment prices,. yet changing trade conditions accelerate a fall or rise in such prices.

(8) Changing political or economic condition; at hoem or abroad. Any great change in political conditions at home or• abroad naturally tends to have some influence do the demand for or rate of sale of- investments, owing to the effect on confidence. Moreover, lack of confidence in future conditions tends to restrict production and exten- sion of productive plant. Consequently, the flow of con- sumable commodities tends to diminish, or its rate of increase to slacken, with effect on the cost of living and the margin of income available for investment. Changing economic conditions also create a feeling of uncertainty as to the future course of trade and prices. - (9) War conditions: War not only causes an atmo- sphere of uncertainty, but gives rise to a great increase in consumption of commodities and increase in taxation, and therefore a rise in the cost of living and depression in market values of investments.

(10) Changing public confidence in the stability of future conditions. The effect on investment values is the same as explained in (8), though a temporary appre- ciation may take place in market values of Government securities through the investing public increasingly con- sidering safety and not rate of yield.

(11) Psychological influences. From time to time the Stock Exchanges of the world have experienced extensive and prolonged buying or widespread and prolonged selling of investments e'by the public, not because there was any change in the character or safety of the invest- ments, but because the public were increasingly tempted by continual appreciation in prices or increasingly lost confidence during a prolonged fall in market values.

(12) Expansion or contraction in bank credit. Many persons who held investments before the War have since been compelled to sell them in order to meet the increased cost of living and taxation, mainly due to excessive ex- pansion of bank credit and currency since 1914. An excessive expansion of bank credit not followed by a proportionate increase in consumable commodities brings about a rise in the cost of living, a, reduced demand for gilt-edged investments, but a temporary increased demand for shares of industrial concerns which benefit materially by a rise in values of stocks of commodities. And the con- verse is true whenever banks unduly curtail credit. For this reason excessive inflation may be said to bring about its own Nemesis to capital.

(13) ('hanging bank discount or interest rates. Some writers have stated that high-class investment prices arc mainly determined by the Bank of England discount rate and money market conditions generally. This statement is only half a truth. If a curve representing the Bank Rate for a long period of years be compared with one representing the yield of Consols, the two tend to fall or rise together when there arc great changes in Bank Rate averages over a period of years, but the correspondence is very rough as compared with that disclosed by a com- parison of a commodity price curve with a Consol yield curve. Moreover, as the chart accompanying this article clearly proves, a coming change in direction of the Consol yield curve is often indicated a year previously by a like change in the direction of the 'commodity price curve. The truth of the whole matter is that it is .economic con- ditions, reflecting themselves in commodity prices, that determine the margin of income available for saving, and therefore the demand for investments. Finance and the level of rates for money, generally speaking, are the reflex of economic conditions, and not vice versa.

(14) Unstable exchange rates. Fluctuating exchange rates cause uncertainty to manufacturers and traders, and therefore indirectly restrict production.. An increase in unemployment tends to an increase in the cost of living.

(15) Inflow or outflow of foreign capital for invest- ment. The influence of this factor is obvious.

III.—FUTURE ECONOMIC CONDITIONS

Ix the preceding pages it has been shown that the main factor determining the course of investment values is the cost of living, but that certain other factors tend to exert minor influences. Therefore, to answer the question, What will be the probable future course of investment values is to answer the question, What will he the pro- bable future .course of the cost of living ? As no present answer can be given to the second question, therefore none can be given to the first. At the present time there are no clear indications of any coming great change in the price level of general commodities. The future cost of living depends very largely on labour recognizing certain basic economic truths and human nature, for fulfilment of certain of the already declared intentions of labour would cause serious damage to the economic fabric of the community, .and labour would suffer along with other classes, and probably to a greater degree. Economic well- being of the masses depends very largely on maximum possible production consistent with health and an equit- able distribution among all classes of the products of industry. It must be admitted that before the War capital received more than its due share of the rewards of industry, and that a large number of workers did not receive an adequate economic wage for their labour. Certain sweated industries in pre-War years were an abomination under modern conceptions of living condi- tions.

Labour apparently looks upon capital as a great monster ever ready to suck its life's blood, and therefore one of its declared objects in the future is to disable the avaricious beast by a levy on its strength. Admittedly a capital levy is not impracticable if it took the form of payment of interest on the amount assessed as payable by different individuals, but labour forgets that a continuous capital levy has been in operation for a long number of years in the form of Income and Super Taxes. A further capital levy, therefore, in net effect, would simply mean higher Income and Super Taxes. To what degree the present rates of such taxes could be raised without having a re- strictive effect on future production is a matter of pro- bably many different estimates. But one fact is abso- lutely certain, human nature being what it is, that if there is no great future incentive to save, the rate of future production will not be great enough to maintain even the present standard of living of the working classes.

ECONOMIC EFFECT OF SAVINGS.

Saving, from an economic standpoint, means refraining from present consumption in order that posterity may have the use of improved or enlarged means of production and transit, and enjoy a reasonable degree of comfort and recreation. Therefore; an individual, by saving, confers benefits on the general community, present and future. As a general economic truth, a steady annual excess of production over • consumption cannot fail to raise the standard of living of the working classes. Restricted production and services is the real enemy of labour and not capital, and indirectly is the main cause of unemployment. The dole to the unem- ployed is, in reality, very largely paid for by commodities produced by labour, and tends to retard a fall in the cost of living. That restricted production injures most the working classes is well illustrated by the present shortage of houses for the working classes.

Sooner or later employers will be compelled to solve with Labour the great problem of payment of economic wages, and until this struggle is over there can be no restoration of sound economic conditions. In fixing rates of wages clue account has necessarily to be taken of foreign com- petition., Another fallacy of labour is its views on inherited wealth. On several occasions it has expressed its future intention of increasing death and succession duties to point of extinction of future inherited wealth. On the doctrine of equal opportunities fOr all it does not seem right that one youth should inherit, say, £100,000, and another youth of equal ability nothing at all. But it is certain that,. human nature being what it is, if pirents are deprived of the incentive to save for their -children's future welfare, general economic conditions of the country will go backward instead of forward in the future. The foregOing remarks On labonr- fallacies have been made with the view of assuring the reader of the imprac- ticability of certain of the declared future intentions of labour. Fortunately for theTuture welfare of the country, labour has among its members several leaders who have a very clear conception of the silent working of economic laws, operating through or based on human tendencies.

GOVERNMENT AND GOLD STANDARD INFLUENCES.

To what extent Government action in the future- may affect economic conditions and the cost of living it is not, of course, possible to estimate. Any Government action should preferably be directed to finding that middle point between the views of capital and labour that will satisfy both divisions, after some adjustment, and lead to greater output and more equitable distribution of the products of industry among all classes than was the case before the War. Many profit-sharing schemes in the past have ad- mittedly failed in operation through labour, though 'sharing in exceptional profits during periods of trade activity, refusing to suffer reductions in wages in times of trade depression. The solution appears to be the accu- mulation of sufficient reserve funds in times of prosperity to enable the payment of reasonable wages during times of trade depression and unemployment. -.

The imposition of tariffs on imports is certainly not the final cure for present economic evils. Though import tariffs might prove temporarily beneficial to certain trades with a large home market, yet they would be highly injurious to the general export trade of the country in future years. Tariffs in the long run invariably tend to raise home costs of production, unless compensated for by greater application of machinery to industry and other aids to production, and greater efficiency of labour.

There is no reason to think that the restoration of the Gold Standard in the case of the United Kingdom will have any great influence on investment values. except any due to sentiment, unless its future maintenance involves further curtailment of credit by banks, which action would tend to bring about a fall in commodity prices.

A. H. Grnsox.