In the City
Budget reactions
Nicholas Davenport
Second thoughts in the gilt-edged market were extremely hostile to Mr Healey's budget. Prices fell by nearly four points at the 'long' end on heavy selling, it was rumoured, by Swiss bankers and other foreign gnomes. To make matters worse, the trade figures published on Friday were disappointing — the deficit on visible trade being £264 million in March. The volume of imports in the first quarter of the year is now 12 per cent up against a rise of only 4 per cent in the volume of exports. Imports of finished manufactures were 81 per cent higher. So the 1978 surplus due to oil will be smaller than we all expected. And sterling will be weaker.
Disappointing trade figures, however, cannot account for the extreme hostility felt in the market towards the Chancellor's budget. It was, I think, his attempt to oversell his financial virtue, his over-confident bull talk, that made the market turn against him and become suspicious of his estimates. I commented at the time that he was being too optimistic about reducing the rate of inflation. The fall in sterling produces an unfavourable trend in raw material costs and the Treasury forecast of an 8 per cent rise in retail prices in the year to mid-1979 was based on the bland assumption that the rise in average earnings in the next pay round would be half that in the current round, which is 14 per cent. No trade union leader has given any suggestion that 7 per cent would be their 'norm'. Would.they be prepared to keep Mr Callaghan in office for even 10 per cent? Would Mr Callaghan care to stay in office if the trade union movement always insists on getting a rise in pay in excess of the rise in output and productivity? Is there any future in democratic socialism if it means a perpetual in-built inflation?
Having said this, which is best discussed in the front part of this paper, I must admit that the market has not been entirely fair to Mr Healey and that the fall has been greatly overdone. I am supported in this view by Tim Congdon, the economist who writes the Messel Weekly Gilt Monitor. He agrees with Mr Healey that the debt funding problem will be roughly similar in size in 197879 as in 1977-78, that is, around £5 billion, and that institutional 'cash flow' should be stronger and more than adequate to cope with it. Indeed, it should be around £81 billion in 1978-79.
Tim Congdon puts the PSBR (public sector 1 borrowing requirement) at about 1,000 million less than Mr Healey's estimate of £8,500 million. One must not forget that if inflation moves higher, as it undoubtedly will if the trade unions do not play ball with the Chancellor's guide lines, the tax revenues benefit and the PSBR falls. Further, the same restraints on public sector spending remain — the cash limits. So I back Tim Congdon's smaller estimate of the PSBR but not his monetarist argument for another rise in the MLR (minimum lending rate). He says that it is a golden rule that MLR increases must be convincing, that is, big enough to calm speculation about future rises. Why must we play down to market speculators?
If the market listened more to what is sound mathematics, not monetarist fads, there would be a substantial rise in the giltedged market. I would expect a recovery to begin before long. Yields of 13 per cent at the very long end of the market must prove attractive for the life and pension funds and in the 1992 and 1993 stocks they can secure over 121 per cent. At the short end Exchequer 9/ per cent 1982 offers 9.6 per cent and near 101per cent to redemption, and the 1981 stocks just over 10 per cent to redemption. A monetarist Chancellor may allow the MLR to rise for a time but the country will never get out of its deep recession on dear money. The MLR-money supply equation is a technique which will have to be discarded.
As for the equity market, a fall of 19 points in the FT index — wiping off some £2,000 million for the value of quoted shares — seemed to demonstrate as much hostility to the budget as did the gilt-edged market. No equity market likes dearer money but the fall was surely overdone. After all, company taxes were unchanged, there was no further rise in employers' contributions to NSS and the taxes on capital gains were lowered. The Chancellor's promise that the stock relief plan would continue until a form of inflation accounting had been agreed should enable the companies who have been making full provision for 'deferred tax' to show higher profits. The price-earnings ratios on average are very low which points to an historically undervalued equity market. In Japan the price-earnings ratios are as high as 20 and more, but their equities discount the fact that on the factory floor the Japanese worker, unlike the British, behaves like an autonomist ant.
There were extremely useful tax concessions in the budget to the small business world — raising the profits limit for corporation tax to £50,000, raising the limit for 'retirement relief to £50,000 etc — which were entirely justified because, as Mr Healey said, small companies can provide jobs faster than the big corporations and because they have always been 'the seed bed for new techniques and new ideas'. Unfortunately this is of no practical use for investors, as the small business is not usuallY quoted on the Stock Exchange, except through a subsidiary of FCI, namely EDITH (Estate Duty Investment Trust), whose record of growth has been fantastic. The big pension funds should, of course, ha investing £10,000 or £20,000 or £40,000 in, the enterprising small business but alas' they have no organisation to enable them to do so. That may explain why the Railwar, Board pension fund invests millions in 01° masters and objets d'art, which I find shoating and an insult to our financial system, but this will be corrected, I understand, by Mr Harold Lever, the Cabinet patron saint of the small business, if Labour survives the coming autumn election. Small companies apart there are plentY°f moderate-sized companies quoted on the Stock Exchange which should appeal to the investor because of their good earnings records and the low, price-earnings ratio at which they are selling. The insurance 1:01‘. ers come to mind seeing that they are, extremely well managed and collect a lot 01 their income in foreign currencies more highly valued than sterling. Some of the pension fund managers now give orders to their brokers to offer this class of Wit! rather than that of the giants. We recently had a report from ICI, surely 0e0 the best managed of the giants, revealing that the productivity of labour in their 1311;t:, ish plants is only about half that of labour their foreign plants. What does this signitY but the British sickness — the comPlete breakdown of management control over the shop floor? The frightful Heath Robins°, rule books of the trade unions, the militants
love of downing tools over the smallest dispute and disrupting producting, must I/Y
now have demoralised Our top factory Inatill; agers. As they get paid only 30p in t,r pound after tax if their salary is nv,r £15,000 — 17p in the pound if it is £17,500 they have probably lost all incely, tive to try a little harder to solve their Inou
dening labour troubles. es
This great problem for investors aPP.li d to the giant but not to the moderate-s00 company whose managers generally get ° very well with their staff. The small CO pany probably employs no union lab° That is why small is beautiful.
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