More Inflation Ahead?

August 18, 1958

The signs are becoming unmistakable that the recent rise in the stock market is more a reflection of the belief in further inflation (i.e., in a further shrinkage in the dollar) than a reflection of business recovery.

Certainly stock prices are not reflecting current earnings reports. The First National City Bank of New York reports that net profits after taxes of 809 corporations in the first half of this year were 30 percent under those for the corresponding period last year. The automobile industry suffered a 56 percent drop in profits; the railroads, a 61 percent drop.

No one would suspect anything about this by looking at the recent stock market. The Dow-Jones industrial average went up from 420 on Oct. 22 last year to 513 on Aug. 8. This has created some surprising relationships between prices of stocks and the earnings and dividends of the companies. Barron’s, the financial weekly, has pointed out that the stocks in the Dow-Jones industrial average, as of Aug. 1, were selling at a rate of about 17.3 [times] net earnings. This is higher than any “earnings multiplier” rate in the entire 1949–57 upswing. And The New York Times has called attention to some extraordinary examples, such as Universal Cyclops Steel selling at 100 times its current annual earnings rate and Crucible Steel at 110 times.

STOCK VS. BOND YIELDS

No less significant is the relationship recently established between the dividend yield of stocks and the interest yield of bonds. Normally the yield on common stocks, because of higher risk and uncertainty, is substantially above the yield on high-grade bonds. But as of July 30 the yield on Standard & Poor’s index of 500 common stocks was 3.87 percent, or only .13 percentage point above the 3.742 percent yield on its Al+ bond average. This is the closest the two yields have come together since July 1957, when for a short time stocks were actually yielding less than Al+ bonds. It was the first time this had happened in more than twenty years.

This situation is usually thought to be paradoxical. In fact, the near-approach of the yields on common shares and bonds is often followed either by a fall in the price of common shares or a rise in the price of bonds. But there is one situation in which the convergence or crossing of stock yields and bond yields is a logical response. This is when investors and speculators believe that still further monetary inflation is threatened. In that case stocks are valued abnormally high in relation to current earnings or dividends. Bonds, on the other hand, are valued abnormally low, because the purchasing power of the principal is expected to decline, and lenders insist on a higher interest rate as an “insurance premium” against this.

EVER-MOUNTING DEBT

If there is a fear of further depreciation of the dollar, the blame rests squarely in Washington. Congress and the Administration, between them, are responsible for the prospect of a $12 billion deficit in the current fiscal year. Even if we admit that the Federal Reserve authorities either can or should try to “stabilize the economy,” they made an extravagant overresponse to a mild recession, slashing the rediscount rate from 3½ to 1¾ percent, reducing required reserves of member banks, and engaging in massive support-buying of government securities. Whatever the immediate effects may be of the restoration of stock-margin requirements from 50 percent to 70 percent, it is unsound and ultimately futile to encourage a general inflationary flood and then try to dam off its effects in one or two directions.

And now the Treasury wants a further $8 billion boost in the national-debt ceiling to $288 billion. It is time to ask some blunt questions of Congress and the Administration. Do you ever expect the debt to be paid off? Do you ever intend even to reduce it? If so, at what rate? Under what conditions? Are the conditions likely to be realized? Do you intend to pay off either principal or interest in dollars of even present (48 cent) purchasing power, or do you mean to keep short-changing the government’s creditors by further depreciation?

President Eisenhower has expressed great concern which, however, must still be translated into policy.