MONEY
The investment prospect
NICHOLAS DAVENPORT
As we can now see the beginning of the far-off end of the currency crisis — the yen having agreed to float — we may as well take stock of the investment prospect. The Stock Exchange has been extremely kind to the investor. It has remained consistently bullish in spite of all the terrible uncertainties. On August 25 the FT index of industrial shares touched 419 — a rise of 37 per cent from the 305 bottom of March 3. The larger FT Actuaries index of 621 shares touched 183 — a rise of 41 per cent from its March bottom of 129. At the moment the market is coming back — having been upset by the huge engineering wage claim — but it appears to remain confident not only that the sharp rise in unemployment will slow down the sharp rise in wage settlements but that the upsurge in the freed American economy will more than compensate for the present import surcharge and the 2 per cent or more up-valuation of sterling. All these are big assumptions on the optimistic side for there is a real threat to world trade from this outbreak of protectionism, but what stands out of the investment scene is that floating exchange rates have been taken universally to be good for stocks and shares.
Floating ought to be good for the giltedged market. When the economic strains are taken in the exchange rate the monetary authorities are free to bring interest rates down and help the business world forward with cheaper money. The Economist would like to see Bank rate cut from 6 per cent to 4 per cent to stop hot money coming here and keep sterling undervalued for the good of the export trade. The Treasury has, alas, done the opposite. It has retained the bottom buying rate for sterling of $2.38 and put in force a series of measures to avoid reducing Bank rate. For example, it has told the banks that they must not pay interest on any increase in the sterling accounts of non-residents; it has restricted the conversion of foreign currency deposits into sterling; it has forbidden the sale to non-residents of sterling certificates and bills (government-backed for local authority) with a maturity date earlier than October 1976; and it has stopped financial institutions and local authorities accepting further deposits from nonresidents. One might be living in the Soviet Union. There must be some perverse character in the Treasury or the Bank who is determined to stop the cheapening of money which is so essential for the reflation of the economy.
I doubt whether Mr Barber will ever be able to achieve his growth rate of between 4 per cent and 44 per cent unless he lowers Bank rate and cheapens the cost of borrowing. The high cost of finance — 10 per cent to 124 per cent — is still acting as a restraint upon capital spending. In the first quarter of the year industrial investment was, in fact, down by 11 per cent. If there is no sign of investment reviving before 1972 Mr Barber will certainly be called upon to add to his reflation in his next budget — or even in an autumn budget. So there is good reason for him not to neglect the spur of cheaper money. The gilt-edged market is still inclined to think that sooner or later Bank rate will be cut to 5 per cent one Thursday morning. The long-dated " tap " stock — Treasury 8i per cent (A) 1997 — is said to be running out and no wonder with a current yield of 9.2 per cent.
The strength of the equity shares is proof that the market still believes in Mr Heath's quiet revolution. If the unions do not respond to his reflationary programme by slowing down the rate of increase in
wage claims market confidence will no doubt collapse and a statutory freeze of wages, prices and dividends in the Nixon style will be discounted. But for the moment bullishness prevails. The market preference is for banks, financial services and stores where the labour problem is not so acute. There is a natural reluctance to jump into the capital goods side of engineering which will be the last sector reached by the reflation programme of Mr Barber — if it ever is without cheaper money. Nevertheless we have seen the start of a major bull market which has just run ahead a little too fast for its boots. As I have often said, a major bull market depends upon the simultaneous con
juncture of a favourable political and a favourable economic climate. We have only just got the latter and without cheaper money to back up the reflation it is not going to warm up quickly. But the Stock Exchange has been cute enough to see that enough has been done — through
the sacking of redundant or inefficient labour — to cause a dramatic turn-round
in company profits. In the first quarter of 1971 gross company profits rose by 10.7 per cent as compared with the bad first quarter of 1970. This gives a suggestion of what may be expected when the reflation has boosted the turnover.
Gold shares have not participated in the industrial euphoria. The market was upset by the fall in the free price of gold from over $43 to near $40 (at the moment of writing it is just under $40). Nor was it greatly cheered by the leaking of the IMF working memorandum which suggested that the Americans should agree to a modest writing up of the price of monetary gold. Since the Nixon bombshell the FT index of gold shares has fallen by nearly 17 per cent. This is not surprising seeing that the South African government has pegged the value of the rand to that of the dollar, which means that the sterling value of the dividends paid by South African gold mines will be reduced by the extent of the up-valuation of the £ against the dollar. Of course, this will be offset by the increase in the premium paid to the mines by the central bank — the premium being the excess of the 'free ' price over the monetary price of gold — which could be considerable. But it all makes for uncertainty. Gold shares can no longer be regarded as the precise currency hedge they used to be. I am not suggesting that the world is likely to drop the monetary use of gold just because the Americans see no further use for it except as a war reserve. The Europeans still value it for monetary purposes and as gold still accounts for 38 per cent of the total
reserves of the central banks it would be a foolish — and deflationist — act to get rid
of it by throwing it on the ' free ' market and causing the price to slump. The commercial demand for gold is steadily increasing and in ten years' time may even absorb most of the output of the South African mines. But for the time being the gold share market is best left to speculators. Dr Diederichs, the SA finance minister, alarmed by the rise in imports —
in July almost twice the value of exports — which have to be paid for by the sale of gold, must be having some sleepless nights while we in Britain relax.
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