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A review by the Federal Reserve B a n k of Chicago Contents Consumer spending—will it give depth and breadth to the recovery? 4 Shift from saving to spending? 8 The stock market in 1961 10 The Trend of Business 2-4 Federal Reserve Ba nk o f Chicago OF 2 ^3usiness activity was moving upward at a brisk pace in early summer, after adjustment for the usual effects of vacations and hot weather. In the second quarter total spend ing on goods and services was at an annual rate of 515 billion dollars— 14 billion higher than in the first quarter and 9 billion above the previous record in the second quarter of 1960. Government officials had indicated in June that total spending might reach 530 billion dollars by the fourth quarter. This level could be attained even with some slow ing of the recent rate of rise in activity. In June industrial production had regained the pre-recession level of a year earlier. Total employment rose sharply and reached a record 68.7 million. Nonfarm employment passed the 62 million mark, 1.5 million more than at the start of the year after allowance for seasonal forces. Consumer buying was increasing slowly but steadily. The rise in activity in recent months has been broadly based, with gains reported in virtually all types of manufacturing as well as in construction and service industries. Largely because of the recent fast pace of the recovery, it is likely that any further increase during the summer will be slower. A few industries, such as steel and farm equipment, have experienced declines re cently. In the former case the movement is seasonal and new orders suggest an early revival. But farm equipment sales have been affected by the acreage reductions under Government programs, drought in the BUSINESS northern Plains and some price weakness in farm commodities. Rising Government outlays are playing an important role in the increase in total spend ing in 1961. During the current calendar year total Government payments to the public are expected to rise about 10 billion above the 95 billion dollars of last year. Various new programs, particularly in the defense area, may lift this total still higher. E m p loym e n t up sh a rp ly In the second quarter nonfarm wage and salary employment rose 900,000 or almost 2 per cent on a seasonally adjusted basis. About half of this increase was accounted for by production workers in manufacturing, concentrated in primary metals, motor ve hicles and fabricated metal products. Em ployment also has risen substantially in con tract construction and in state, local and Federal government. Unemployment rose seasonally by 800,000 in June and remained at 6.8 per cent of the labor force as large numbers of young people sought employment. However, there was a significant decline of 200,000 in the number of adult men unemployed. In June, 16 major labor market areas were reclassified as having an improved employ ment situation; ten of these were in the Midwest. Chicago, Grand Rapids, Kalama zoo, Lansing, Kenosha and Racine are no longer considered “substantial labor surplus” areas. Unemployment in these centers has B u sin e ss C o n d itio n s, A u g u st 1961 dropped below 6 per cent. Some betterment was also noted in Battle Creek, Flint, Sag inaw and Detroit although unemployment in these centers continued to exceed 6 per cent. The improvement in Midwest cities stems mainly from increased production of steel, cars and trucks and machinery. In the nation, 88 of 150 classified centers had more than 6 per cent unemployment— down from 101 in April. For the Seventh District, 11 of 23 centers were in the sub stantial labor surplus class in June, con trasted with 19 of 23 in April. By this stand ard, in two months the District has moved from a position of having relatively more Production increased in ail major industry groups in recent months per cent increase, february 1961 to june 1961 1 0 television f t radio m otor vehicles 8 p a rts iron 8 steel building materials to ta l industrial production furniture 8 fix tu re s textiles 8 apparel petroleum products food processing business equipment printing 8 publishing I I 20 unemployment than the nation to compara tively less. Accompanying the improvement in em ployment, personal income rose to 417 bil lion dollars, annual rate, in June—about 3 per cent above the level a year earlier. This was the fourth month of rising personal income. The bulk of the increase has been in wage and salary payments. C on stru ctio n in stro n g rise Total construction activity was at an an nual rate of 56.5 billion dollars in June, the highest in almost two years. Most of the recent gains are traceable to highways and residential construction. Until late in the second quarter residential building had been the weakest large segment of construction. Now there is evidence of improve 30 ment in this sector. The annual ~~r rate of new private housing starts approached 1.4 million in June, 7 per cent above the year-ago level. Rising construction during 1961 had been anticipated early in the year on the basis of the sizable volume of contract awards. The Department of Commerce now estimates that total construction during 1961 will be up 4 per cent from 1960 and housing starts will be up 3 per cent. These forecasts indicate a further rise in building activity in the second half. The first half of 1961 showed a gain of only 1 per cent in total con struction outlays over the same period of 1960 and housing starts were 3 per cent lower. On June 30 the President seasonally adjusted signed the Housing Act of 1961 which liberalizes terms of mort Federal Reserve Ba nk o f Chicago gages underwritten by the Government. Maturities on FHA-insured mortgages can now be as long as 35 (and even 40 years in special cases), instead of 30 years. Down payment requirements have been liberalized, and the maximum mortgage for a single family home has been increased to $25,000. The bill also provides for insurance of loans for major home repair and rehabilitation of up to $10,000 in amount and with maturities as long as 20 years. Consumer spending— will it give depth and breadth to the recovery? Jrojections of consumer expenditures play a key role in nearly all business forecasts. While the initial rise or decline in activity often develops in some other sector—such as inventories, government spending or orders for new machinery and equipment—esti mates as to the probable strength and dura tion of a recovery or recession rest heavily upon prospects for purchases by consumers. Because consumer spending accounts for two-thirds or more of total demand, even small changes can outweigh relatively large shifts in other types of expenditure. M o d e s t rise in re tail sa le s 4 Since midyear it has been clear that the low in the 1960-61 recession was passed late in the winter, but consumers have been stepping up their demand for goods only mildly. In the face of the pickup in employ ment and personal income, should the slow rise in retail sales be viewed merely as a more or less characteristic lag in consumer spend ing or does it suggest that the current re covery might be short and weak? A look at the record in other recent periods of in creasing activity may help to provide an answer. Retail sales, measured on a seasonally adjusted basis, rose slowly between April and June, from 17.9 to 18.3 billion dollars— with automobiles accounting for much of the gain—but at midyear they were still running 1 to 2 per cent below the year-ago level. Sales by dealers in consumer durables, including autos, while rising in the second quarter, nevertheless were off nearly 9 per cent from their year-earlier pace. In some respects the current slow pickup in buying at retail is very similar to ex perience in the recovery phases that followed the earlier postwar recessions. In both 1954 and 1958 it was not until several months after the lows in general activity that retail sales began to show any vigor. In the reces sion of 1948-49, on the other hand, sales of durables—although not the total for all goods —were rising even as the low in general activity was reached, but this undoubtedly reflected the special impact of the backlog B u sin e ss C o n d itio n s, A u g u st 1961 of demand for autos, home furnishings and appliances that continued for several years following the end of the war. Retail sales, of course, are only a part of total consumer spending. Expenditures on services, including such a wide range of items as rent, household utilities, medical care, recreation and education, account for a high and growing proportion—about 40 per cent in 1960—of all consumer spending (see Business Conditions, November 1960). The rising trend of spending on services slowed only mildly during the 1960-61 re cession and in the second quarter of this year had advanced to a record 138 billion dollar yearly rate. Outlays for nondurable goods also were up slightly during the first six months, achieving an annual rate of 154 billion dollars in the April-June quarter. This was 1 billion dollars or so above the rate in the latter half of last year and about the same as in the second quarter of 1960. The combined gain for services and nondurables more than offset the dip in outlays on durable goods, produc ing a slight gain for total consumer spend ing—to a record 333 billion dollar rate in the second quarter of 1961. H om e p u rc h a se s continue in slump One feature of consumer behavior that ap pears to be quite different in the current business recovery than in similar earlier periods is the trend in purchases of homes. While no precise measure of total value or number of residential property transfers is available, recordings of nonfarm mortgages of less than $20,000 on both new and used houses provide a reasonably good indication. During the first four months of 1961 mort gage recordings continued at the reduced level of late last year. At comparable stages in the three earlier business recoveries, mortgage recordings were moving upward, the “cyclical” lows having been passed be fore. Nevertheless, the volume of new con struction was rising at midyear. The pace of home-buying activity reflects not only consumers’ demand for housing but also their attitude regarding the assumption of additional debt. This is true, too, of autos and other durable goods which frequently are bought on credit. Consumer instalment borrowing, which tends to move in close agreement with pur chases of durables, rose moderately during the first half of 1961, but was running con sistently lower than in the first half of last year. Month to month, the pattern of new credit extensions reflected the somewhat erratic course of purchases of hard goods. A n a ir o f h e sita n c y ? The mild upturn in instalment borrow ing and absence of a rise in home financing by mid-1961 indicated that households had yet to display the renewed willingness to assume additional debt obligations, while stepping up their current expenditures, which has been almost a hallmark of firm recovery in the consumer sector. Although too short a time has passed since the low of last winter to confirm any doubts that consumer buying will contribute materially to the depth and duration of the recovery, there are some factors in the current situation which could cause consumers to depart from familiar paths. Among these is the substantial number of unemployed. Although the total of persons at work reached a record in June, the rate of unemployment remained relatively high, at 6.8 per cent of the work force. In some local areas unemployment rates have been con siderably higher for extended periods. Soft ness in the job market tends to dampen the 5 Federal Reserve Ba nk o f Chicago 6 buoyancy of consum ers’ plans and expecta tions and hence the di rection and make-up of consumption spend ing. Large additions to the labor force in the years ahead and pos sible rapid progress in automation may tend to maintain unemploy ment at relatively high levels and provide ad ditional restraint on wage rate increases and consumer optimism. T e n s i o n in t he sphere of foreign rela tions is another factor which may be adding to uncertainty. Genu ine alarm, of course, might be expected to touch off a surge of buying by consumers, but the more moderate anxiety of the present a p p e a r s to h a v e prompted an inclina tion to hold back, to accumulate liquid as sets and to go slow on new debt commit ments. The compar at i ve adequacy of consumer stocks of “real” assets is believed by some observers to constitute a further deterrent to vigorous growth of consumer buying. One difficulty here, though, Consum er sp e n d in g usually has lagged in early stage of recoveries billion dollars,seasonally adjusted annual rates H om e b u yin g rose early in three prior recoveries but was not leading in current expansion billion dollars, seasonally adjusted annual rates B u sin e ss C o n d itio n s, A u g u st 1961 is that “adequacy” to some extent depends on the level of income, current and prospec tive, at the time the judgment is made. The homes, autos, home furnishings, appliances and other appurtenances of the nation’s households considered suitable when per sonal income was growing only slowly (if at all) and employment prospects were uncer tain, often are considered deficient once prospects improve. Given a further pickup in consumer income and in the job picture, it is not unlikely that many households will soon decide to replace or add to their present holdings and to utilize savings and credit to finance purchases. The growing relative importance of service outlays in consumer budgets and the evident imperviousness of this type of spending to mild fluctuations in business activity means, of course, that a reduction or slowing in the rate of climb in t o t a l consumer expenditure has its major impact on spending for goods. Retail sales, therefore, may not be an ade quate indicator of changes in consumer spending. Uncertainty as to the outlook for this sector indeed may partly reflect buoy ancy in the prospects for expenditures on travel, personal care, education, entertain ment and other services and for home pur chases—transactions included only in part among retail sales. A f a v o r a b le s e ttin g ? The picture also includes some factors which indicate that consumers may partici pate aggressively in the near future. The recent sluggishness of instalment borrowing has taken place along with a record rate of debt repayment and a very high rate of saving. The total of instalment debt owed by consumers declined somewhat in early 1961. Allowing for the typical seasonal pattern, repayments on outstanding obligations ex ceeded new borrowing by 375 million dollars during the first five months. As a result in stalment debt totaled 42.1 billion dollars at the end of May, down 1.2 billion and some what more than seasonally from the record 43.3 billion mark reached at the turn of the year. The rate of repayment on existing in stalment debt remains at a high level, slightly in excess of 13 per cent of total personal in come after taxes, but the lessening in liability outstanding probably has improved the cur rent buying “capacity” of consumers. Another factor is the high level of time deposits, savings and loan shares and similar liquid assets held by consumers. (See article beginning on page 8.) Consumers typically step up the rate at which they add to these assets when prospects are uncertain and reduce the rate of accumulation as they become more optimistic. The inclination to channel income into current expenditures, moreover, often is strengthened by the pres ence of sizable liquid balances. Over-all, then, the response of consumers to the current indications of rising business activity are more like than unlike their re sponses in similar earlier periods. While the current situation has many earmarks of its own, consumers are in a favorable position to add their very considerable weight to the side of further increases in consumption and hence production and employment. Business C o n d itio n s is p u b lis h e d m o n th ly b y th e fe d e r a l r e s er v e ba n k o f Ch i c a g o . Sub sc r ip tio n s a re a v a ila b le to th e p u b lic w ith o u t ch a rg e. F o r in fo r m a tio n c o n c e rn in g b u lk m a il in gs to b a n k s, b u sin e ss o r g a n iz a tio n s a n d e d u c a tio n a l in stitu tio n s, w rite : R e se a rc h D e p a r t m e n t, F e d e ra l R e s e r v e B a n k o f C h ic a g o , B o x 8 3 4 , C h ic a g o 9 0 , Illin o is. A r tic le s m a y b e re p r in te d p r o v id e d so u r c e is c r e d ite d . 7 Federal Reserve Ba nk o f Chicago Shift from saving to spending? S in c e March, consumer attitudes toward saving have undergone a noticeable change. The rapid rise in time deposits at commer cial banks, savings and loan shares and other personal holdings of liquid assets that began in 1960 shows signs of slowing down. Re demptions of E and H savings bonds, after being below sales in the first three months of the year, have exceeded sales beginning in April. The shift to a slower rate of growth in the acquisition of liquid savings over-all, however, is far from being “across the board” at this time. There are areas in which no changes in savings behavior are detectable. In previous periods, such shifts as have oc curred recently almost invariably have sig naled an upturn in consumer spending for durables. The m id - 1 9 6 0 sw in g to liqu idity 8 Beginning about May 1960, as business activity began to slacken, commercial banks experienced an increase in savings and other time deposits. This continued during the early months of 1961. Passbook savings in Seventh District banks rose from 7.7 to 8.3 billion dollars, or 8 per cent, in the year ending in March 1961. Another factor of increasing significance since the beginning of the year has been the sharp rise in time deposits of corporations. Some of these re sulted from the issuance of noninterest bearing certificates to a large retail firm in payment for consumer instalment paper, and some are interest-bearing negotiable time certificates that are being actively promoted for the first time by banks in a few large cities. Corporate time deposits in Seventh District banks rose from less than 100 million dollars in March 1960 to 350 million a year later and by May were 480 million. Sales of E and H bonds, which had begun to rise in the fall of 1959 following an nouncement that the rate of interest paid on them would be raised from 3V4 to 33 per A cent, showed sustained growth during the recession. Other types of personal savings such as savings and loan shares also rose. Seventh District insured savings and loan associations reported an increase of 13 per cent in share capital in the year ending last March, several percentage points more than in the previous twelve-month period. A turnabout in consumer attitudes toward liquid savings appears to have started in March. It has differed in some respects from similar shifts in other recent periods of economic recovery. For example, in the Seventh District the rate of gross inflow of funds into savings and loan shares has de clined in some cities, particularly in Chi cago. Also, the rate of withdrawals from both bank savings deposits and savings and loan shares in various Midwest areas for which such data are available rose before retail sales of consumer durables began to increase. Initial increases in withdrawals may have been occasioned by a greater-than-usual need for funds to pay income taxes in March and April. Continuation of the trend into May and June, however, suggests that more consumers again may be starting to use their financial reserves to finance purchases de ferred while the economic outlook was clouded with rising lay-offs and shortening work weeks. B u sin e ss C o n d itio n s, A u g u st 1961 While savings data for the Seventh District support the conclusion that a trend toward rising purchases— aided by the consumers’ store of liquid assets and improved capacity to assume instalment debt—may now be shaping up, this same information on a cityby-city basis points up the substantial amount of variation that exists. In areas such as the eastern Michigan cities which were harder hit by income losses stemming from wide spread and prolonged unemployment, there have been relatively small increases in sav ings deposits and shares in savings and loan associations during the recession. Principally, this is because high withdrawals by those who supplemented reduced incomes with past savings more than offset the effect of those who were able to reduce withdrawals merely by curtailing their spending. C h a n g e s in gross flows of savings per cent change from dec 1960-feb 1961 to mar-june 1961 -2 0 ____________JO _____ ' , Chicago 9 _____ +10_______T____ 4 2 0 I E and H bonds sales 1savings and loan |associations, inflow s, regular savings,inflow savings and loan associations, withdrawals banks, regular savings, debits Indianapolis In t e r - a r e a v a r ia tio n s The Chicago area shows the most con sistent response of savers to improving eco nomic conditions. As is indicated in the ac companying chart, seasonally adjusted gross flows of funds into bank savings deposits, savings and loan associations and E and H bonds all have declined from the high rates in the winter of 1960-61. Moreover, with drawals of savings deposits and savings and loan shares have risen; for the two combined, the rise from the December 1960-February 1961 average rate is close to 7 per cent. (Re demptions of E and H savings bonds on an area basis are not available.) Information for credit unions in the Chi cago area (not charted) shows similar changes. Cashings of credit union shares dur ing all but one month of the period from July 1960 through February 1961 were below the volume a year earlier. Beginning with March, however, they have exceeded their year-ago levels. Milwaukee Changes in the flow of savings in Chicago followed similar patterns during the 1957-58 recovery. Gross inflow into savings deposits declined about 5 per cent in the three months following the trough reached in April 1958. Sales of savings bonds fell, also by 5 per cent. Withdrawals at both banks and savings and loan associations rose somewhat. Since March, gross inflow into bank sav ings accounts and savings and loan shares in Indianapolis has increased, but withdraw 9 Federal Reserve Ba nk o f Chicago als have increased even more rapidly. The same is true for savings and loan shares in Des Moines. For each area, the net result is a slowing in the rate of growth of these liquid holdings. In Detroit, activity in savings accounts stemming from changed consumer attitudes has been obscured by flows resulting from the recent decision of a number of banks in the area to convert substantial amounts of time certificates and various types of open accounts owned by individuals to regu lar passbook savings. These transactions have been reflected in a greatly increased flow of funds into regular savings and withdrawals (not charted) from other types of time deposits. Without this, the inflow into regular savings in March through June might well have been less than in the preceding three months. The most significant difference be tween the Detroit, as well as the Milwaukee, experience compared with that of the three other areas shown in the chart, is the rela tively smaller increase in withdrawals from savings deposits and savings and loan shares. Withdrawals in Detroit, contrary to the trend in the majority of other Midwest areas, remained about at pre-recession levels during the third quarter of 1960 and then increased in the final quarter and the first two months of 1961. In Milwaukee, there was some decline in withdrawals but less than in the District as a whole. In these areas, the be havior in withdrawal activity in the spring of 1961 may be evidence that many families are still deferring hard goods buying until their holdings of liquid assets are increased further and their debts are reduced. The stock market in 1961 . . . reflects shifts in expectations as it revalues shares in American business 10 X n May the Dow-Jones index of industrial common stocks topped the 700 mark. From the recession low in the fall of 1960 this measure of the level of stock prices had advanced about 25 per cent. At 700, the industrial average was more than four times as high as in the early postwar years and 80 per cent higher than the pre-depression peak in September 1929. By a broader measure—Standard and Poor’s composite stock price index of 500 stocks—prices were more than double the 1929 peak. The economy has changed greatly in the past 32 years. Goods and services are being produced currently at a rate five times as high as in 1929. The general price level, like the stock market, has about doubled in the intervening years with physical activity in creasing about two and one-half times. Cor porate profits after taxes in 1961 will be almost triple the 1929 amount. Prior to the crash in the autumn of 1929 the level of stock prices had risen more than 50 per cent in a twelve-month period, from a point which, in turn, had been a record high. In the ensuing slide which continued ir regularly to the summer of 1932, the total value of stocks traded on the exchanges de- B u sin e ss C o n d itio n s, A u g u st 1961 Stock in d e x e s a n d a v e r a g e s There are several widely used measures of stock prices. One of the most comprehensive is Standard and Poor’s composite stock price index. It includes 500 stocks which account for about half of the total number and 90 per cent of the current market value of all common stocks listed on the New York Stock Exchange. Companies are added and deleted from time to time to keep the various groups of stocks in the index proportional with their relative import ance in the market. When such changes occur the calculation of the index is adjusted so that the series is linked and continuous. In computing the Standard and Poor’s index, prices of each issue are “weighted” by the num ber of shares outstanding, which gives the cur rent market value for that issue. This procedure largely eliminates the effects of stock splits and stock dividends on prices. Adjustments are made also to offset the effect of sales of new stock by firms included in the index and to take into account mergers, acquisitions and liquidations. The resulting values are expressed as an in dex, using the 1941-43 average values as a base set equal to 10. An index of, say, 60, would indicate a sixfold increase in the unit value of the representative list of stocks in the index, after adjustment for the changes noted above. The total value of stocks has increased more over relatively long periods than any of the stock price indexes in common use. Between the end of 1948 and the end of 1960 the total value of all stocks listed on the New York Stock dined by more than 80 per cent. Post mortems on the 1929 crash concluded, almost universally, that stock trading in 1929 had reflected “wild speculation.” The rise in common stock prices in that year and the subsequent collapse were commonly de scribed as “America’s South Sea Bubble”— a reference to a speculative binge in the stock Exchange, for example, increased 358 per cent while the Standard and Poor’s composite index rose 280 per cent, the Dow-Jones industrial average, 251 per cent and Moody’s 125 indus trials, 265 per cent. This faster growth in the total market value of stocks results from several factors. As noted above, the index does not re flect increases in value of stocks which result from sales of new stock by companies included in the index, and appropriately so, since it is designed to measure price changes, not total value. However, the sale of additional shares, by both the firms included in the index and other firms, increases the total value of shares as does the organization of new companies, many of which have experienced rapid growth. Stock price indexes such as the Standard and Poor’s composite are subject to certain limita tions in measuring price changes of common stocks. The lists exclude many important firms, particularly in new industries. The shares of these firms may show quite different perform ances than those included in any particular index or average even though efforts are made to keep the index “representative” of the general market. Changes in stock prices, as shown by the widely used indexes, provide a useful means of comparing the performance of individual port folios with that of larger groups of stocks or even with “the market.” The indexes are not designed, however, to measure the growth of the economy, the rise in the total value of busi ness enterprises or the increase in the equity in these firms. of the South Sea Company in London during the early 18th century. In the 1930’s Congress enacted legislation to deal with some of the abuses which had accompanied the stock speculation of the great bull market. Responsibility for deter mining margin requirements, to limit the use of credit in stock purchases, was placed with 11 Federal Reserve Ba nk o f Chicago the Federal Reserve System. The Securities and Exchange Commission was created and given a broad range of authority for regulat ing the issuance and trading of securities. With these safeguards and the disillusion ment resulting from the collapse, it was be lieved that the public would show greater discrimination in the purchase of stocks. The recent record highs in most measures of stock prices appear to have been reached without the major earmarks of speculative activity which were evident in the late 1920’s. The volume of trading, for example, has been relatively much lower than in the earlier period. After increasing substantially in early 1961, trading on all the stock exchanges (expressed as an annual rate) was about 20 per cent of the number of shares of listed stocks compared with over 100 per cent in 1928 and 1929. The amount of credit employed in stock market trading, though growing recently, has been moderate when contrasted with the 1920’s. There has been relatively little sign of manipulation and rigging of stock prices by insiders—one of the unsavory aspects of the earlier era. Nevertheless, the postwar period has witnessed four broad upswings of stock prices which have carried the market to successively higher levels. Measures which relate stock prices to earnings, dividends, the general price level or the volume of savings indicate that the market has recently been quite high if judged in terms of past relationships. Changes in tax laws and ex pectations as to economic growth and infla tion are, of course, powerful factors affect ing stock prices. The 1 9 5 5 stu d y 12 The Senate Committee on Banking and Currency in March 1955 undertook a study of the stock market following a rapid ad vance in prices which had carried the market averages up about 40 per cent during the preceding twelve months. Witnesses drawn from business, financial and academic circles were asked their views as to the possibility that the market rise had advanced stock prices to dangerously high levels. Typically, the response was that the upswing was justified by the state of the economy and the prospects for the mainte nance and growth of corporate profits. It was suggested that the market had been unrea sonably low in the early postwar period rather than too high in 1955. Confidence in the nation’s future prosperity and an expecta tion of continuing inflation were given as the major reasons for the market’s advance. A number of statistical comparisons were offered to show that stock prices were low relative to the 1929 peak, inferring that there was no reason to fear a possible collapse merely because prices had risen rapidly. Nevertheless, the majority report of the com mittee found that recent market develop ments had been characterized by “signs of increased speculative activity,” that interest was centering on capital gains rather than “earnings and other sound investment cri teria” and that in certain extreme cases speculative activity constituted “a flight from reality.” When the committee issued its report in May 1955, the Standard and Poor’s composite stock price index was 37.60 (1941-43=10). In May 1961 this index reached 67.39— a rise of almost 80 per cent in the six-year interval; a comprehensive index of prices of commodities and services had risen about 15 per cent over the same period. Corporate profits after taxes totaled 23 billion dollars in 1955. It is unlikely that this figure will be exceeded by any wide margin in 1961. B u sin e ss C o n d itio n s, A u g u st 1961 P o stw a r rise in stock prices not matched by corporate profit growth index, 1 9 4 1 -4 3 * 10 It is interesting to reconsider the data offered in early 1955 to support the view that the market was not too high. For example, the price-earnings ratio (the multiple of annual earnings at which stocks sell) for Moody’s industrial stock average was 14 at the end of 1954 compared with 17 in August of 1929. Recently this ratio has been about 19. Moody’s average common stock yields (dividends as a per cent of market price) were 4.09 per cent at the end of 1954 com pared with 3.19 per cent in 1929. In May 1961 this figure was 3.11 per cent. It was suggested in early 1955 that com mon stocks, even at their advanced prices, were a good buy relative to bonds. Yields on stocks were about one-third higher than on bonds, while in 1929 the situation was re versed. Since 1955, stock yields have de clined while those on bonds have risen, with the result that recent yields on stocks, as measured by Moody’s, have been about one third below the yields on high-grade bonds— about the same as in billion dollars 1929. Through most of the 20th century, common stocks have yielded more than bonds is sued by firms of com parable standing. The reason usually offered is that the payment of interest is contractual whereas dividends on stock are uncertain. When stocks are yielding much less than bonds in periods of prosperity, there is an indi cati on that many stock purchasers are more interested in capital appreciation than in current dividend income. This may be because they expect a substantial increase in dividends in the future or because in vestors are willing to forego current returns in order to purchase equities which they believe will go up in value. Many buyers be lieve that inflation of prices of goods and services will cause stock prices to increase. Stock prices have risen in recent years despite the fact that corporate profits after taxes have not moved up substantially during the postwar period. Profits after taxes in 1959, the peak year, were only 16 per cent higher than in 1948, while the nation’s total output of goods and services was 86 per cent higher. Common stock prices were four times as high in 1959 as in the earlier year. A b u sin e ss in d ic a to r? Stock price indexes were fairly stable at a low level in 1947 and 1948. The postwar 13 Federal Reserve Ba nk o f Chicago 14 uptrend in stock prices began in mid-1949 and has continued to the present although interrupted by declines in 1953, 1957 and 1960—years which saw the beginnings of business recessions. In each recession the market resumed its upward trend several months before business activity touched bottom, thereby enhancing the reputation of the market as a “leading indicator” that tends to presage general economic develop ments. In the early postwar years, yields on com mon stocks were high, averaging 6 and 7 per cent in 1948 and 1949. Stocks of many well-known companies could be purchased for ten times current earnings, a traditional rule of thumb indicating “good values.” However, many investors feared that postwar prosperity would be short-lived. They pre ferred to buy goods or hold liquid assets. The recessions which the nation has ex perienced have been unsettling to the stock market, but as it became apparent in each case that the decline in business activity would not be severe or long continued and that profits were holding up surprisingly well in the face of the modest declines in sales, confidence in the economy and therefore in stocks was bolstered. Acceptance of the idea that the economy is less vulnerable to declines than in the past has broadened ownership interest in common stocks both on the part of individuals and institutions. The effect of this buying pres sure upon prices has been magnified because of the relatively small volume of new stock issues. According to a New York Stock Exchange survey, more than 12 million persons owned stock in 1959 compared with 7 million in 1952. Doubtless the number has increased further in the past two years. Financial institutions have been investing more heavily in common stock in the past several years. By far the largest increase in institutional holdings has occurred in noninsured corporate pension funds. The stock held by these funds increased from 1.4 billion dollars in 1949 to 12.3 billion at the end of 1960 and undoubtedly will rise further as the funds continue to grow. In the past six years new issues of common stocks totaled 12 billion dollars. Funds raised by corporations from the sale of bonds and increases in bank loans and mortgages totaled 58 billion dollars during this period. The market value of all common stocks listed on the New York Stock Exchange, which accounts for about 80 per cent of the value of the stock of all United States corporations, was recently on the order of 350 billion dol lars compared with 200 billion six years ago. Obviously the great bulk of the increase in the value of common stock outstanding has come from higher prices for existing issues rather than from an increase in supply. C red it a n d th e stock m a rk e t During the 1929 bull market, purchasers of common stock used a large volume of credit to finance their holdings. Margin buy ing was employed extensively with brokers commonly supplying credit equal to 80 per cent of the purchase price of the stocks acquired by their customers. Since 1933 the Board of Governors of the Federal Reserve System has had the authority to regulate the amount of credit that brokers and commercial banks can extend on pur chases of listed common stocks. “Margin requirements” were as high as 100 per cent in 1946—no additional credit could be ex tended by brokers or banks for purchasing stock. Currently, the requirement is 70 per cent. Loans to stock purchasers from brokers (customers’ debit balances) and banks were B u sin e ss C o n d itio n s, A u g u st 1961 C o rp o ra te bo n d yield s have exceeded stock yields since 1 958, reversing relationship of earlier postwar years per cent 5.4 billion dollars in May 1961. Unfortun ately, comparable information is not avail able for 1929. However, at the end of 1931 these loans were over four times greater relative to the total value of stocks than now. Another measure of stock market credit is the borrowings of members of the New York Stock Exchange to finance their own and customers’ transactions. In May these loans were 3.1 billion dollars compared with 8.5 billion in September 1929. Brokers’ loans recently were less than 1 per cent of the value of stocks listed on the exchange in contrast with 10 per cent in 1929. Although customer borrowings for pur chasing stocks have not been as high relative to stock values as in the Twenties and early Thirties, credit outstanding during the post war period has tended to rise and decline with changes in stock prices and the volume of trading. The similarity of the movements has been particularly striking in periods such as 1949-50, late 1954 and early 1961 when prices were increasing rapidly. Changes in margin requirements appear to have moder ated these swings sub stantially, and when a requirement as high as 90 or 100 per cent was in effect for some period of time cus tomer credit outstand ing declined materi ally. The data on credit used to purchase com mon stocks is not com prehensive. There are many ways in which credit granted for other purposes can, in effect, help to support the demand for stocks. For example, the investor who repays a mortgage more slowly than he would if he were not in the market really is using credit to carry securities. Stock purchasers may borrow on other collateral such as life in surance policies. Moreover, unlisted secu rities are not covered by the regulation and the margin requirement does not apply to all lenders. Despite these and other gaps in the figures, it appears that credit has been a significant factor in financing the 1960-61 stock market rise but of much less relative importance than in 1929. The stock e x c h a n g e a s a m a rk e t Free markets form the very essence of the private enterprise system. Among the most important of the formal markets are the stock exchanges which provide a means of deter- 15 Federal Reserve Ba nk o f Chicago 16 mining the value of Stock m a rk e t credit ownership rights of has fluctuated with stock prices business firms and a index, 194 1 -4 3 • 10 mechanism for readily t r a n s f e r r i n g s uch rights. Everyone may have an o p i n i o n as to whether the market is “too high” or “too low.” The fact re mains, however, that posted prices are the collective judgment of many buyers and sell ers operating freely and with access to a great deal of informa tion about the firms per cent 1 00 whose s t o c k s are margin requirem ents I------- 1 I traded on the ex 75 — l_ _ . changes. SOlWhi l e c o m m o n 2 5 stocks have value be 0 —____ I____ I____ I____ I____ I____ I____ L 1 cause of the real assets 1946 1948 1950 1952 1954 1956 they represent and the earning power of the ’Loans from brokers and banks for purchasing and carrying securities. respective firms, stock prices rest heavily up on expectations of business conditions, pros records of vigorous growth for 40, 50 and 60 pective profits, possible changes in the tax times earnings. Obviously, the future will structure, Government actions and interna have to develop very favorably for these firms tional developments. These and other im if recent prices for their shares are to prove ponderables affect the individual’s assessment reasonable in retrospect. of <he value of stocks, and stock prices reflect With the benefit of hindsight, it is evident the composite of such judgments. that stock prices a decade or more ago were As pointed out earlier, a traditional “rule low. This was indicated by comparisons of thumb” for evaluation of stock prices with such measures as earnings, yields and was ten times current earnings or an average book value; today, by the same yardsticks, of earnings for several prior years. Today the market is high. However, as noted above, most common stocks sell for 18 to 20 prices are affected by many factors and at times reported current earnings and shares least some purchasers believe the conven of some firms with established or potential tional yardsticks are now obsolete.
@FedFRASER