In the City
Exciting times
Nicholas Davenport
My guess was that the bull market in equity shares would burst through its previous top — 544 in May 1972 when the Heath symphony was being played — by February 1978, but to my surprise it made the score last week when the FT index hit 549. It has dropped back sharply since then — by 33 points — on the market's disappointment with the reports of some leading companies. This surely emphasised my argument that the buoyancy of City markets has nothing to do with the revival of Britain or with industrial growth, which is non-existent, or with the workers' performance, which is strikeprone and dispirited by taxation: it merely reflects the financial blessings which we are now enjoying, namely, a rapidly falling interest rate, an oil-rising surplus on the balance of payments, a strengthening exchange rate for the pound and an improvement in the government finances (the borrowing requirement being some £500 million below the £8,700 million budgeted).
have no wish to be cynical about our prospects. Cheaper money will undoubtedly help business to revive and replenish stocks. (The Bank of England says that stock-building was well up in the first half of the year.) It will also help to boost housebuilding through cheaper mortgages and a reduction in direct taxation is undoubtedly coming, which will encourage all of us to work harder. Indeed, a new spirit is getting abroad in industry. The workers are becoming fed up with the strike-prone militant shop-stewards and Sir Galahad has drawn his sword. Victor Matthews, the new chairman of Beaverbrook Newspapers, has stood firmly against anarchy in Fleet Street. The Daily Express is being printed again in London on the Victor's terms.
If you want to understand the financial markets in the City you must follow money rates. Bank rate has fallen from 15 per cent last October to 6 per cent last week. You cannot have such a drastic fall in money rates without generating a terrific boom in the gilt-edged market. And if you have a roaring boom in government bonds it will spill over into equity shares. Cheap money is always the driving force.
, The gilt-edged boom has been stupendous. If you had bought War Loan or Gas 3 per cent 1990-95 or Treasury 5 per cent 1986-89 at the beginning of 1975 you would by now almost have doubled your capital. The rises since a October last year, when the Bank got into a panic and hoisted Bank rate up to 15 per cent, have been remarkable in spite of the fact that the Bank of England has tried to hold down the boom by issuing billions of new 'tap' stocks. In the current financial year it is calculated that the Bank has floated no less than £6,000 million. The effect of issuing these billions of government stock to the non-bank public is to pull down the growth in the money supply. The August money supply figure was an abnormally low 9i per cent growth for M3, which was well within the IMF target range of 9 per cent to 13 per cent.
The calls on the partly paid new issues amount to nearly £3,000 million over the next few months. This will be a damper on the gilt-edged boom. In fact, it has already begun to fall away but in my view buyers will move in on the fall, for the differentials between Treasury bill rate (under 6 per cent) and some 'short' yields (over 9 per cent) and between 'short' yields and 'long' yields in the high coupons (around 12i per cent) are both wide on past standards. In fact, they have not narrowed very much since the middle of July when the present phase of the bull market began. So, after the current weakness, I would expect to see the present yield differentials narrowed.
The Bank of England persists in holding down the rising trend in the sterling exchange rate. This tends to encourage capital inflows from abroad, seeing that sterling is about to be made a very strong currency through the oil bonanza in the North Sea. The Bank has therefore to keep on issuing these gilt-edged 'taps' to offset the monetary expansion which a capital inflow brings. The idea behind the Bank's exchange rate policy is, of course, to keep British export goods at competitive prices and to further employment in the manufacturing indus tries. But what makes foreign countries buy British goods is not only the competitive sterling price but the quality, the advanced design and the delivery-service per, formance. One begins to wonder whether the Bank of England, and the Government which directs its policy, are not hidebound by the old idea that to maintain employment we must foster and subsidise investment in the old manufacturing industries. That is really no longer true.
While the economy is stagnant the object of new investment in manufacturing industry is to employ less labour. Mr Jack Jones and Mr Clive Jenkins are old-fashioned union leaders who do not take time off to think about that and to devise new ways of economic growth. There was a lecture given not long ago by Professor Medlik at Surrey University on 'Britain — Workshop or Service Centre of the World'. He pointed out that in mature economies there is always a shift of manpower to the service industries. From agriculture to manufacturing and from manufacturing to services is the historical trend. In the nineteen-thirties we had about half of the working population in the service industries and today we have nearly 60 per cent. In the US over twothirds of the work force are in services. When it comes to reflating the economy I hope Mr Healey will bear in mind the need to finance those who have just been made redundant in manufacturing getting themselves re-employed in new services.
It is not generally appreciated that Britain is among the world's leaders in internationally marketed services. The range of these services is wide and the earnings from exported services, together with the earnings from British capital invested overseas, give Britain the second largest surplus, after the US, on the so-called 'invisible' account in the balance of payments. I wish the trade union leaders would wake up and think about the economic facts of life. Our industrialists have shown them the way — at any rate those who take time off (one day a week) to think like Nigel Broackes, the chairman of Trafalgar House. If you analyse the growth of Trafalgar House, which began. in property and building, you will find that it is based on the clever exploitation of services — from Cunard outwards.
But to come back to equities. After the shake-out, which was inevitable after the sharp rise, there should be a recovery sutficient to take the market into new high ground. For there are still many equity shares reasonably priced on dividend yield and price-earnings ratio.,In previous booms the price-earnings ratio averaged over 20 per cent. It is now under 10 per cent. In dividend yield it used to be under 3 per cent; it is now over 5 per cent. And there are far better managements today than in the past. It is only the trade union leadership which is behind the times. It should wake up and demand a share in the equity of the wellmanaged companies. It should stop whoring after egalitarianism and allow its members to get rich through capital ownership.
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