In the City
The case for the bulls
Nicholas Davenport
Writing before the announcement of the new pay deal I must be guarded, but instinct tells me that the bulls who trade in the City markets are going to lift the FT equity index up to 450—it has been running this year between 382 and 420—and bring some life back also into the gilt-edged market, where trading has been extremely thin. The pessimism about the pound which the miners have stirred up is overdone because foreign holders misinterpret the oblique way in which the political animal works in this country. What appeared to be a breakdown in the LabourTUC consensus was, in fact, the actual start of a new purposeful negotiation. The miners will always ask for £100 a week but will not break the 'Social Contract'. On the assumption that the talks will end in a settlement not damaging to the battle lines against inflation the bulls in the stock markets have certain points in their favour. I will take the equity share market first.
To begin with, America is pulling out of the world recession more quickly and more thoroughly than many economists were expecting. The sales of General Motors rose by 50 per cent and those of Ford by 46 per cent in the first three months of this year. What is important for the rest of the world is that in March America ran into a deficit on its international account of over 8700 million. If this rate of spending goes on it could greatly help us on towards our objective—an export-led recovery. West Germany is already enjoying one.
The company analysts beavering in the stockbrokers' offices are now estimating a rise in our industrial company profits for 1976-77 of 25 to 30 per cent. The favourable impact on companies' cash flow of falling inflation (offset to some extent by higher import costs), together with rising productivity and turnover, should lead on to the long-delayed recovery in company investment. Stock-piling has already begun. It is something to see that the industrial editor of the Times, feeling no doubt that he must counter the doom-laden forecasts of the economics editor, reported this week that 'a fundamental change is taking place within our industry, both in work practices and in the quality rather than the quantity of investment'. There is greater co-operation, he said, between union leaders and management: there is, in fact, reason, he added, for optimism about the industrial future of Britain. It is good to have this change in journalistic sentiment, for it helps to sustain bullish feeling on the Stock Exchange, but, sentiment apart, the trade figures do show that Britain has actually been increasing its share of the world
export trade even before the recent fall in sterling made British goods so much cheaper.
Next, I come to the technical position in the market for equity shares. The increase in savings has meant that money flowing into the life and pension funds goes on increasing year by year. Last year the increase in their long-term investment funds was over £700 million and their total net investment came to £2,723 million. This year we may expect over 0,000 million. In other words, nearly £60 million will come into the offices of the life and pension funds for investment every week. The boards of directors who have to decide how these funds are to be invested between loans, mortgages, property, government stocks and company shares, are very conservative people. When they get frightened by the political trend towards the Marxist socialised state and stop investing, the markets on the Stock Exchange fall into an appalling slump, as they did at the end of 1974. When they recovered from their fright —thanks to Mr Healey—and resumed their normal practices in 1975, the FT index of industrial equities nearly trebled—rising from 146 to over 400. From an analysis I have made of the government figures for life and pension fund investment it appears that institutional buying of equity shares dropped to 6 per cent of that total investment in 1974 and recovered to 35 per cent in 1975 when Mr Healey came to the rescue of corporate taxation.
It would seem, therefore, that institutional investment in our industrial equity shares has become extremely sensitive to political trends. The fact that the new prime minister is not like his clever, unpredictable but devious predecessor but a reliable consensus man who can use commonsense with the trade union leaders and ignore the unrealities talked by the Marxists on the National Executive—all this is reassuring for the investor. In fact, if Mr Callaghan
could persuade Mr Healey to lift the restriction on dividends, institutional investment in equities could rise from 15 per cent to 20 per cent or more. The average dividend yield on the FT index is now 5.10 per cent and there are many leading industrial equities yielding well over 6 per cent. The average price-earnings ratio is now 9.8. Anything below 10 is historically cheap. Indeed, the equity share market must surely be good value at 9.8 times earnings based on one of the worst trading years since the war. The FT index is still a long way from the heights it reached more than seven years ago (521). No less than a trebling of the index would be needed to bring it back in real terms to the same high level.
A change also in the government attitude to the taxation of business managers' earnings would work wonders. Look what it has done in India. Mrs Gandhi has prohibited strikes, cut corporate taxes and replaced progressive taxes on investment income with proportional flat rates. The highest income bracket has been reduced from 974 to 66 per cent and the tax threshold raised from 89,000 to 812,000. As a result the economic growth has surged from 3 per cent in 1975 to 6 per cent in the first quarter of this year the inflation rate has declined to under 10 per cent from 30 per cent at the beginning of 1975 and the foreign exchange reserves have grown to $2,000 million. These statistics I have taken from a leader in the Wall Street Journal of 27 April which commented: It is a great tragedy that Indira Gandhi felt that she had to destroy democracy in order to institute capitalism'. It is not necessary for Mr Callaghan to destroy democratic socialism in order to bring back prosperity to a mixed economy. He has only got to give tax incentives to the business managers as well as to the workers on the shop floor.
While we may look with more confidence on the rise in equity shares there is not such a clear case for the gilt-edged market although the Economist made the best of one in its issue last week. In spite of the fact that the Bank of England put up its minimum lending rate by 14 points to 104 Per cent during its recent panic over sterling, this is the time when interest rates should be easing. The tax-gathering season is past and the banking system is caught up in a liquidity surplus. The argument that interest rates have to be raised to induce foreign holders to stay in sterling is no longer valid. The foreigner can now get a yield of over 10 Per cent on London paper against 3 per cent on German and 5 per cent on American treasury bills. The interest rate differential argument always fills me with despair seeing that it is obvious we should have recourse to a two-tier system of interest rates in London. The long-term outlook for the gilt-edged market is clouded by the borrowing requirement but could be brightened by success 10 bringing down the rate of inflation below 10 per cent. Short-term it looks good and this will reinforce an upward turn in equitY shares. So the bulls could have a good run for their money.
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