Normality round the corner? MONEY
NICHOLAS DAVENPORT
Proposition One: if peace talks over Vietnam really begin, expect a pause in the bull market. The aggressive buying of equity shares will stop; the flight from money into so-called 'real alues' will_die down; the rush into gold out of paper dollars and pounds will end, and life in the investment world will once again become normal. We shall all breathe a sigh of relief.
Proposition Two: if peace talks over Viet- nam break down, if the war expenditures esca- late, if the racial rioting in the American cities spreads like a prairie fire, then expect the rush out of dollars into gold to be resumed and the (wildly dangerous) bull markets in equity shares to flare up. We shall again feel nervous about our life savings and neurotically begin to curse Mr Roy Jenkins for having attacked them.
Such is the white and such is the black side to the investment picture. Is there a grey shade between the two? Very likely. I suggest that grey will mean a gentle fall in our equity share prices. One firm of brokers concludes an invest- ment commentary with the words: 'Experience shows that where there is lack of reason to buy there is nearly always a good reason to sell.' It seems to me that there is some lack of reason to buy. The bull market in equity shares which began in November 1966 is entering its seven- teenth month. The Financial Times index has risen forty points since the budget and fifty-six points since January. At 436 it is over 50 per cent above its 1966 low. The main market aver- ages have been moving to higher levels at a rate of about 30 per cent per annum. This is much too hot a pace to last. The economy at current prices has been rising at under 5 per cent per annum and if the anticipated export boom does not get into its stride very soon the savage deflation of Mr Jenkins's budget will begin to tell on the home trade. Industrial profits will rise but not sensationally like the market.
Moreover, the technical condition of the equity markets is changing: it no longer under- writes a further advance. In the first place the shortage of supply brought abouLby the absence of new issues and the spate of company mergers is becoming less. The dearness of current loan stock borrowing-8 per cent and upwards— and the suspected over-valuation of equities is bringing out the rights issues of ordinary shares. There has recently been one for Plessey as large as £27 million. In the second place, the demand for equities created by the flight from money and by the marketing of equity-linked life poli- cies by the unit trust managements has been damped down by President Johnson, the central bankers at the Stockholm conference and Mr Roy Jenkins acting, by mere chance, all together. (The ending of the single premium policies endorse4 under the Married Women's Property Act may have a distinctly adverse effect upon unit trust sales). Finally, the raising of cash to pay Mr Jenkins's special investment levy—estimated to raise £70 million this year and £100 million in a full year—will bring in a new type of seller into the equity share mar- kets. One broker puts the potential reduction in demand from these two sources at upwards of £150 million. This is quite sufficient to change the technical condition of the equity markets from one of squeeze to one of ease.
How quickly conditions in an equity market can reverse themselves has been revealed in the storm-tossed market in gold shares. While the rush into gold bullion was going on there was an acute market shortage of gold shares and jobbers used to mark up the prices of the `heavies' by lOs to 20s at a time, quoting lOs as their normal dealing margin. Now they are marking them down by lOs to 20s at a time. Thus, oFsrr, a favourite share of American speculators, who could not buy gold bullion, rose by leaps and bounds to 192s 6d. It is now quoted at 140s. Union Corporation, pushed up to 185s in a frenzy of buying, is now I 35s.
Now there is no doubt that the gold specu- lators overplayed their hand. There was no backing at all at the Stockholm conference for the French call for a new monetary system based entirely on gold. There was a general satisfac- tion with the two-tier system of gold prices and the central bankers who belonged to the old gold pool have made it known that they would not buy gold on the free market even if the price fell below $35. So speculators in gold bullion were faced for the first time with a loss. This was really all to the good for the gold share market which can forget its speculators and return to its old investment status. The talk of demonetisation of gold was always dangerous nonsense. The world outside the highbrow circles of American academics is not yet pre- pared to give up gold and accept the paper of the reserve currencies. The agreement to issue the SDRS of the IMF is proof only that the world is not willing to rely entirely on gold and be caught up in a gold shortage. But the rough shake-out in the gold share market is a timely warning to all investors in equity shares.not to allow speculators to push up prices unreason- ably high.
Some British industrial equities may have special situations and extra-special manage- ments to justify their high market prices today but surely not the average. The Financial Times industrial index gives an average yield of 4.2 per cent on dividends and just 5.2 per cent on earnings, while War Loan gives a return of 7.2 per cent and the industrial debenture over 7- per cent. Who would want to sell a gilt-edged stock to buy an industrial equity on that yield differential? The gilt-edged market is really overdue for a rise. It has been subjected to the highest Bank rate in Europe, and after the strongest dose of deflation ever impood by any government before, it can now surely..r..--
look forward to a little cheaper money. Bank rate has come down from 8 per cent to 71 per cent and should be down to 7 per cent in the next few weeks. The threat of higher interest rates in America has been removed for the time being by Mr Johnson's peace offensive and by the likelihobd that the 10 per cent surcharge on direct taxation will now be passed by Congress.
At the same time the gilt-edged market can count on a much firmer technical base. Mr Jenkins has cut his borrowing requirement to £358 million net. He has, therefore, no need to go to the market for new money; he can expect to meet his borrowing requirements out of the normal, flow of public savings into Savings Cer- tificates and bonds, into Post Office and Savings Bank deposits. With the supply of new gilt-edged stocks conspicuous by its absence the demand for the old from the life offices and pension funds will grow as their professional managers shy away from over-priced equities. So I expect to see a return to more normal investment habits — a preference for bonds when they look cheap and a suspicion of some when they look dear.wa, We have lately had a wildly unbalanced time in the security markets. We have still got one in Wall Street, and the investment dollar premium has risen to 36 per cent—equivalent to over 50 per cent at theold rate of exchange.
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