The Trend of Investment Values
by GEORGE H. PUTNAM
IF the break in stock prices in October 1929 did nothing else, it at least brought a measure of relief to the world’s credit, structure. Under the stimulus of a nation-wide speculative frenzy, brokers loans and stock prices in this country had mounted to unheard-of levels. We had not only diverted a large portion of our own credit, supplies into speculative channels, but we had drawn heavily on the liquid capital of foreign countries, depriving them of gold they needed for reserve purposes and threatening to dislocate their currencies. As for the effects upon our own structure, the high level to which interest rates had been forced by our speculative orgy was beginning to slow up business activity in a serious manner. If for no other reason than for the correction of our own credit situation, a fall in stock prices was necessary.
From the point of view of the bondholder, one of the best, things about the October break in stock prices and the reduction in brokers’ loans which followed was the fillip that the release of stock-market credit gave to the value of bonds. Bond prices rose, and they have been rising fairly steadily ever since. ‘Back to bonds’ has become the investment guide to an increasing number of security buyers. It would indeed be surprising if those who had lost faith as well as money in stock-market operations did not feel a distinct urge to look to the bond market alone as the place where their investment requirements should be satisfied.
In terms of past cycles in security values, bond prices have been running true to form. And it seems probable that bonds will continue to rise for a time if the traditional practice of the Federal Reserve banks is maintained. In times past it has been the policy of the Reserve banks, during periods of business recession, to do all they could to make credit plentiful in order to aid and stimulate business recovery; and cheap money invariably stimulates bond buying.
WHEN it comes to appraising the immediate trend of the prices of investment stocks, the situation is not so clear. About the only empirical knowledge we have in this connection is that a rise in bond prices, such as has occurred over the past three months, presages a rise in the prices of investment stocks. But on this point experience does not tell all that could be desired. It does not tell, for example, how much time must elapse before the trend of stocks will follow the trend of bonds. In some cycles the interval has been exceedingly short, while in others it has been long drawn out. The break in stock prices last October. for example, came only after eighteen months of falling bond prices.
It is possible, however, to point to certain factors which suggest — and that is all they do — that the recovery in the prices of investment stocks will be slower than has usually been the case. For one thing, it is obvious that stock buyers have had a severe shock. They have discovered that common stocks are not superior to bonds as long-term investments at any price; that what may have been a good principle to follow as between stocks and bonds at one stage of the market is not invariably good. It should take time to rebuild the courage of disillusioned stock buyers. In the near future they will doubtless give more consideration to yields and values and less to problematical profits.
Another factor which should not be lost sight of is the overburdened condition of the stock market itself. During 1929 the public was in a stock-buying mood essentially. Bonds were not wanted. Business corporations were quick to see that they must accommodate their plans for new financing to the requirements of the moment. Generally speaking, they found it more profitable to raise funds through the sale of stock than through the sale of bonds. Even some of the investment houses which had always held aloof from the business of underwriting stocks were obliged to fall in line and give their clients what was wanted. When the big break came, the market, was filled with quantities of undigested stocks of various descriptions which were — and in all probability are still — a threat to early and sustained stock-market recovery.
A third factor which is having an influence upon the investment market as a whole is the fear that we shall lose vast quantities of gold and that credit supplies will be curtailed accordingly. It is well known that we have already lost gold. During the last two months of 1929, the net loss of monetary gold through exportation and earmarking amounted to more than $110,000,000, and during the early part of January gold was still being exported in substantial quantities.
WHILE the loss of gold is always a proper matter for the investor’s concern, it would seem that in the present instance the importance of this factor has been somewhat exaggerated. The fact is that we are sending gold abroad because our interest rates have fallen. We are only returning to foreign countries some of the liquid capital we borrowed during our stock-buying orgy. The capital market of the world is striving to restore itself to a state of equilibrium from which we should derive profit rather than loss. Whatever disturbance we may suffer in the process of getting into adjustment with the rest of the world should be temporary only.
For the longer period, it is a fact of fundamental significance to investors that we are a creditor country, more likely to receive gold than to lose it. We may export gold at intervals as we have done on a number of occasions since attaining the position of world creditor; but when account is taken of the large volume of payments that must come to us from foreign countries every year in settlement of interest claims, our main problem appears to be one of preventing gold accretions rather than gold losses. Our world-creditor position, together with the credit elasticity afforded by the Federal Reserve System, is one of the strongest protective features, from a credit point of view, that investors could have.
Finally, whatever the general trend of invest - meat values may be, there is no reason to suppose that the prices of investment stocks and bonds will return for any length of time to their pre-war relationship, in which investment stocks were expected to yield substantially more than bonds. On the contrary, it seems very probable that sound investment stocks will continue to give a relatively small yield. This view finds its chief support in the strong financial position American corporations now occupy and in the power of growth which inheres in well-selected investment stocks in a richly endowed country.