Smiling faces
Nicholas Davenport It is clear that I must have another bet with my colleague, Skinflint. I am prepared to bet him £5 (in depreciating paper) that if the referendum vote goes against the Common Market the bull market on the Stock Exchange will collapse. Stockbrokers to a man support our membership of the EEC and, incidentally, are doing a good business in buying and selling Continental stocks.
The build-up of the bull market to its present raging affair — the FT 30 index is now, after only a month, about 80 per cent above its low Point of 146 on January 6 — must be Puzzling to anyone who does not move and work in the City, as I do, but as I tried to explain last week there were good technical reasons for a recovery and the only mystery is why it happened at the particular moment when Mr Healey was introducing in the House of Commons in his Finance Bill such savage measures for the confiscation of private capital as had not been seen since the sixteenth and seventeenth centuries. I think I have now solved the mystery.
First, let me explain in more detail the technical causes of the turn-around. There had never before been an equity share market Which had been oversold. At the turn of the year shares of some great companies, which were never likely to go bust, were being offered at prices equivalent to a few years Purchase of their earnings. Their Market prices were about 75 per cent below the tops they had reachedin the previous boom of 971-2. I have made an analysis of the bear markets which have occurred in the last twenty years and the fall in the worst of them Wasonly411/2percent.Thenormal exPectation of a bear market fall is around 30 per cent to 331/3 per cent, as you will see from this table: Why Was it that in this last bear market the fall in the index was as great as 73 per cent? Why was it so abnorma0
The reason is that the City fathers, the leaders of the great savings and investment institutions, really believed that the capitalist system was breaking down and likely to be demolished. They had seen a militant communist trade union bring down a Conservative government and they had seen in the socialist manifesto of the new Labour government the communist writing on their capitalist wall. They were scared stiff. They stopped buying equities. In 1972 they had bought £700 million worth of equity shares and in the last half of 1974 they had probably bought none. They had put most of the £2,000 million a year which they collect in premiums on life and pension funds into bonds and "on the street" in seven-day money. Perhaps more than £1,000 million was waiting "on the street" for a signal.. So the opportunity for the life and pension funds to produce a dramatic rise in market values had never been greater.
The first signal came when Mr Healey showed in his budget that he was prepared to come to the rescue of companies in cash trouble by relieving them of tax on the inflation profits of their stock-intrade. This was interpreted to mean that he was really in favour of preserving the private enterprise system. The next came when the limitation on dividends was raised from 5 to 121/2 per cent. Another came when Mr Crosland announced the unfreezing of commercial rents. As it had been argued and emphasised in the press that the whole banking system had been put in jeopardy by the freezing of the property market in which their main collateral for loans was Invested this was taken to mean that the Government was not .unwilling, but ready to preserve the capitalist system.
Then came the Prime Minister's significant speech in which he warned the unions not to expect the government to bale out companies which had become insolvent through strikes. In other words public money was not going to be used to finance militancy. Here was a national government speaking. And it was saying that it was not really trying to engineer the takeover of private enterprise. All these I have put forward in this column as points for recovery in market confidence. Apart from these factual signals there were also some enlightened guesses
about the change in government attitudes to private capital. It is believed that there will be a relief of the vicious taxation of oil companies operating in the North Sea. It is even mooted that the Prime Minister and Foreign Secretary are preparing to advise the country to stay in the EEC. To cap it all, the chairman of the Stock Exchange reported on the radio that when the CBI leaders had gone to see Mr Healey they had actually returned with "smiling faces." Clearly they had got the Chancellor's "yes" to their proposals. So the City became convinced that the private enterprise system was not going to collapse — that there was to be no "communist takeover" after all. On that reassuring thought they decided that they had better jump into the market — with that £1,000 million off the street.
This explains the violence of the upswing in market prices. At the top of the bull market the equity shares of British companies had been valued at about £55,000 million. By March 1974 the value had fallen to £33,000 million. By the end of 1974 it had dropped to £17,000 million. No less than £38,000 million had been wiped off the value of private holdings of British equity shares — to the great distress of the life and pension funds and to the great damage of private wealth.
To pour £1,000 million into a market only valued in all at £17,000 million was like a bomb exploding. The jobbers were caught short of stock. Sundry market speculators had gone bears and these animals were unmercifully slaughtered. Their frantic buying came on top of the genuine investment buying of the institutions. So it was not surprising that many over-sold shares rose 50 per cent in the first two weeks of the boom. The index as I write has recovered 100 points but it has perhaps another 100 points to go — if it is not shaken by an anti-EEC vote — for at 350 it will merely have reached about a third off its previous high of 543. In other words, the abnormal slump would have been corrected and the market would have gone back to a normal decline at 350. But I am not yet prepared to bet with Skinflint about whether the next bull market will then start. That depends upon world events.
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