In the City
Back to the equity market
Nicholas Davenport
The old year has had a bad press in the City but it could have been worse. Certainly it Was disappointing that the FT index of industrial equity shares did not hold the dazzling performance of 1975 for very 1"g—the high point of 420 was reached on 4 May—but this was not the petering-out Of a bull market; it was simply the completion of recovery from the political panic of 1974 when the life and pension funds stopped buying industrial equities and let the index drop to 147.
As I have said before, a normal bull Market loses a third to a half of its rise and if the Heathian bull market, which peaked at 540, had merely lost a half it would have brought the index down to around 420. So that was where we were in the spring of 1976. The subsequent slump to 265 by the end of October is explained by the simple fact that the managers of the life and pension funds were out of the market again, partly because they had saddled themselves with too many new issues (including gilt-edged), partly because they were having second thoughts about their 'political' recovery. Their 1974 Panic had been caused by fear that the Private enterprise system was finished and !hat communist-type socialism was here to stay. Their relief followed when Mr Healey demonstrably came to the rescue of the Private enterprise system in his budgets. But their second doubtful thoughts came When Mr Callaghan and Mr Healey seemed to be losing their fight against the comMunists in the Labour Party. The last two Months' rise in the index from 265 to 354 by the Year-end was no more than a technical recovery achieved on a very small volume of hosiness—so small that many stockbrokers railed to cover their expenses.
What lessons do we draw from this
performance? First, the equity market has obviously become much more volatile now that it is now largely in the hands of the life and pension fund boards who have become so politically sensitive, if not neurotic. The ordinary private investor is out of the market—except for the few hardened gamblers. He has at last realised that the cult of the equity was a myth. Although the equity share represents real assets the market value of it has never risen enough to compensate for the depreciation of real values through inflation. So if there are any small private investors left they tend to enter the market through the medium of the unit trusts.
The second lesson is that the status of the equity share is undergoing a change for the worse. Even if the Labour Government manages to avoid a communist left takeover it has already succumbed to the leftist attack on the legal status of the equity share. The Bullock Committee is about to recommend not two-tier boards with a supervisory board half worker elected, as in Germany, but a 50 per cent participation of workers on the normal single company board. This will make efficient business management impossible. I doubt whether its recommendations will be implemented but if they were they would drive the most competent and ambitious business managers out of the country.
The third lesson is that in spite of all these political hazards money can still be made out of equity shares in a free market which, happily, the Stock Exchange Council manages to preserve. For example, you could have enjoyed a rise of over 70 per cent in Guest Keen (or 200 per cent in Mather and Platt on a takeover) although the engineering index as a whole hardly changed. While most newspaper shares were falling you could have made over 70 per cent profit out of Thomson Organisation. That was due to North Sea oil which gave a 70 per cent boost also to Tricentrol. Even a heavy share like BP was able to score nearly 40 per cent but obviously it was very difficult to find winners in 1976. Most investors had to nurse losses particularly in the depressed industry shares like building, the fall in which has now probably been overdone.
The final lesson is surely to hang on to good equity shares—in spite of the communist threat—if they have first-class managements, if they are returning good yields—the average dividend yield is 6.4 per cent and earnings yield over 13 per cent— especially if the market price represents half the net asset value and a lot of the assets are held abroad. They can't all be nationalised and even a state take-over would have to ba at a fair price and probably above the current market.
The government estimate of business prospects in 1977 is sober but not pessimistic. With improved competitiveness and restricted domestic demand they forecast a continued shift of resources into exports and import saving and a major revival in manufacturing investment.
1 must reserve the gilt-edged market for another week but what emerged from Mr Healey's statement in the Commons on his package and the IMF loan is that a revolution has occurred in monetary management —away from Friedmanism, as I have always hoped, and towards more rational banking control, as I have always urged. 'We are expressing the essential monetary targets,' said Mr Healey, 'in terms of domestic credit expansion (ocE) rather than money supply, since we agree with the IMF that this will be more appropriate than a target for M3 money supply during a period when we shall be giving top priority to putting our balance of payments right.' This incidentally should be 1977 when North Sea oil is expected to contribute about £2000 million. By 1980 it will be contributing over £5500 million.
Mr Healey put the DCE target for 1977-78 as high as £7700 million which he said, would provide sufficient room for industry's needs and allow interest rates to fall from their 'present exceptional levels' while keeping control of 'money aggregates.' In the opinion of brokers L. Messel, whose views are always worth noting, this indicates a major change in monetary policy towards relaxation which will allow a slow but steady reduction in the cost of borrowing. Bank rate has already been reduced by
per cent stages to 144 per cent, from its preposterously high level of 15 per cent, which has been killing all business enterprise. If we can now look forward to cheaper money the Stock Exchange markets will quickly respond—from gilt-edged to equities. If we could look forward to the expulsion of the Marxist-communists from the Callaghan government they would boom.
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