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A U G U S T 1968

THIS

ISSUE

A n Economic Evaluation
o f the Stock M a rk e t . .

Recent M o n e ta ry
D evelopm ents . . . .

FEDERAL

RESERVE

BANK

CLEVELAND

Additional copies of the E C O N O M IC

R E V IE W m ay

be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P.O. Box 6 3 8 7 , Cleveland,
O h io 4 4 1 0 1 . Permission is granted to reproduce any
material in this publication.

A U G U ST 1 9 6 8

AN ECONOMIC EVALUATION
OF THE STOCK MARKET

For many years, stock market behavior has
been popularly used as a barom eter of the
general well-being of the economy. As a re
sult, many people implicitly accept the b e
havior of the stock market as a dependable
economic indicator, without understanding
why and without attempting to judge the
quality of the m arket's perform ance in this
role. The purpose of this article is two-fold:
(1) to discuss the stock market as an eco
nomic indicator and (2) to discuss technical
aspects of the stock market that bear on its
role as an economic indicator.
I

STOCK PRICES AN D BUSINESS ACTIVITY

including economic significance in relation to
business cycles, statistical adequacy, smooth
ness, currency, conformity to historical busi
ness cycles, and consistency of timing during
cycles. "A separate scoring plan is set up for
each criterion, under which a perfect indi
cator would earn 100 points. The six scores
are averaged to obtain a composite score.” 1
Stock market prices, represented by Stan
dard & Poor's Index,2 come out as the highest
rated NBER indicator, with an av erage com
posite score of 81 out of 100 points. Stock
prices score high for several reasons: data
are available frequently and quickly, with
virtually no time la g after the actual transac
tions; cycles in stock prices tend to lead general
business cycles (by about four months); the

The National Bureau of Economic Research
has demonstrated that the assumption on the
part of the Am erican public has some basis
in fact. The NBER, which is responsible for

data series is relatively smooth; and stock
prices reflect many important aspects of eco
nomic activity.

much of the basic statistical work on business
cycle analysis, has rated the perform ance of a
large number of economic series that reflect
the course of business and financial activity

1 Moore, Geoffrey H. and Julius Shiskin, Indicators of
Business Expansions and Contractions, (New York: Na-

in the United States. The series are m easured
over a long time period against six criteria,

lional Bureau of Economic Research, 1967), p. 10.
2 Standard & Poor's Index of Ihe prices of 500 common
stocks, 1941-1943 = 10.

E C O N O M IC R EV IEW

The relationship of stock prices to business
activity is reasonably straightforward. In Chart
1, the index of in d u s t r ia l p r o d u c tio n is
used because cyclical movements in that
series tend to coincide with generally reco g
nized business cycles, that is, it is a coincident
indicator of economic conditions. C hanges in
c a p i t a l s p e n d in g are used to represent a
laggin g indicator of economic activity, as can
be seen in the economic recovery that began
in 1961. As Chart 1 shows, the Standard &
Poor's Index does tend to lead movements in
productive activity, as represented by changes
in industrial production. Thus, it is not sur
prising that stock prices anticipate changes
in capital spending by an even longer period
of time. For exam ple, the stock market began
to rise in October 1960, precedin g an in
crease in industrial production by five months
and a recovery in capital spending by about
nine months. In an NBER study of business
cycle turning points, the Standard <& Poor's
Index led 33 turns (by a median of four
months), roughly coincided with 14 turns,
and lagged only five times.3
C hanges in stock prices also tend to reflect
market anticipations about corporate profits.
In turn, a m easure relating a f t e r - t a x p r o fits
to c o r p o r a te in c o m e originating in all in
dustries frequently leads or anticipates busi
ness activity. As shown in Chart 1, there is a
rough coincidence in the movements of stock
market prices and corporate profit margins,
particularly at interim peaks, for exam ple,
early 1962 and 1966. Based on these com
parisons, it seem s valid to accept the stock

3 Moore and Shiskin, op. cit., p. 39.

Digitized for
4 FRASER

market as a leading indicator of business
activity. However, the chain of causation may
run both ways. Stock market developments
can influence business attitudes, liquidity,
and spending decisions, just as business
activity can be mirrored in the stock market.

FACTORS AFFECTING
THE STOCK MARKET
Examination of the recent perform ance of
the stock market raises some question about
its usefulness as an economic indicator. In
order to evaluate stock market prices as an
economic indicator, five indexes of stock
market prices and their behavior since 1960
are shown in Chart 2. The indexes include:
the Dow Tones A verage, the National Q uota
tion Bureau Index, Standard & Poor's Index,
the New York Stock Exchange Index, and the

A U G U ST 1 9 6 8

squeeze on corporate profits, and diminishing
concern about inflation. All three factors tend
to depress stock prices, other things being
equal. The brief market dip in 1965 was also
blamed on overpricing, as well as public
reaction to the in creases in military strength
in Vietnam. The drop in stock market prices
in 1966 corresponded to a change in expecta
tions about business conditions and the nowfamous credit squeeze. The Vietnam situation
is generally held to have cau sed the break in
prices in early 1968. It is, therefore, apparent
that at least three additional influences should
be considered in reviewing the recent b e
havior of stock market p rices—the money and
credit situation, the extent of inflation, and
investor psychology. It should be recognized
that there is some question if these factors
can be isolated to avoid misinterpreting their
effects as a warning of a change in business
activity.
IN D E X E S of S T O C K PR IC E S
In d e x

le v e l

llll

Am erican Stock Exchange Index.4 The series
are quite different b ecause they are calcu
lated from different base periods and base
prices and reflect the price behavior of dif
ferent types of stocks. Despite these differences
in construction and coverage, the indexes
tend to move together. Each index shown in
Chart 2 rose at the end of 1960, dipped
noticeably in 1962, showed a brief adjust
ment in 1965, declined sharply in 1966, and
showed another brief adjustment in 1968.
These declines are important. If stock prices
are accepted as a reliable business indicator,
the recent record would su ggest that there
w ere five b u sin e ss re c e ssio n s in the last
eight and one-half years. In this period, how
ever, there was only one recession recog
nized by the NBER— 1960-1961 (shaded area
in Chart 2). Thus, the false signals in stock
prices in 1962, 1965, 1966, and 1968 must
be explained in order to evaluate the useful
ness of stock prices as an economic indicator.
Apparently, developments other than bu si
ness cycles can seriously affect stock market
prices. Often, these developments are exog
enous an d/or noneconomic. Some of the
reasons given for stock market weakness in
recent years can be used as exam ples. Many
observers believe that in 1962 the market
was in a technically weak position because
of high price-earnings ratios, a concurrent

Overpricec
market,
Vietnam

General
weakness

♦♦

Cred t
squee ze

♦

V etnam

♦

DC W JO h ES A V I RA G E

—

•

N ATIO N A L Q UOTAT O N
Bl JR E A U IN D E X

S TA N t5ARD 8 P O O R 'S IND IX

”
N E W YO RK
EXCH A N G E

TOCK
NDEX
-

4 Dow Jones A verage is a composite price av erag e for
65 stocks listed on the New York Stock Exchange. National
Quotation Bureau Index represents price av erag e s for
35 quality over-the-counter industrial stocks. New York
Stock Exchange Index includes all stocks listed on the
exchange, published with a b ase of 12/31/65 = 50. The
American Stock Exchange Index includes all stocks

RATIC

L a s t e ntry:

:•

SC ALE

AM ER C A N S TOCK
EXCH/ VN G E 1

M O N THLY
-----

J u n e '6 8

So u rc e s o f d a ta :

A m e r ic a n S t o c k E x c h a n g e ; D o w J o n e s C o r p o r a t i o n ; N a t i o n a l
Q u o t a t io n B u r e a u ; N e w Y o r k S t o c k E x c h a n g e ; S t a n d a r d
& P o o r 's C o r p o r a t io n

listed on the exchange, expressed in dollars.

E C O N O M IC REVIEW

th eo rists
give varying recognition to the impact of
money and credit on the stock market. Some
observers completely disregard the role of
money in stock market analysis, while others,
often represented by a school of economic
thought known as the quantity theorists, hold
that stock prices react to monetary changes
after a fairly long time lag. Often the time
lag is so long that "su ch leads may . . . raise
the question whether the series [are] posi
tively or inversely related" and make inter
pretation difficult.5 A comparison of percent
changes in the narrowly defined money su p
ply, expressed at annual rates and as a threemonth moving average, with Standard &
Poor's Index, changed to a 1957-1959 base,
shows that there is a rough coincidence
between the rate of growth in the money
supply and stock market prices. This coin
cidence was particularly apparent in 1966,
when there was a sharp restriction in the
expansion of money and credit.
Money

a n d Credit. M onetary

However, a comparison of peaks and
troughs in the 1960-1968 period reveals
discrepancies in the relationship between the
growth rate of the money supply and the
movement of stock market prices. That is, at
times changes in the money supply lead stock
prices by one or two months, and at other
times, stock prices seem to lead chan ges in
the money supply. Although it cannot be
stated positively that money supply growth
constitutes a reliable tool for forecasting stock

market prices,6 the credit squeeze in 1966
apparently had a depressing effect on the
market.
Inflation. Many investors believe that stock
market investment represents a hedge against
increases in the general price level (inflation).
A comparison of the Standard & Poor's Index
with m easures of other prices reveals some
similarity between the rise in the stock market
and the cost of living (consumer price index)
in recent years; however, the comparison
may be superficial. Although stock prices
have increased as rapidly as prices of con
sumer goods and services in general, the
influence of inflation seem s to have had little
relevance to the sharp drops in the stock
market in 1962 and 1966. The recent climb
in the stock market can be explained more
clearly when earnings are included in the
analysis. Stock prices usually reflect the
earning power behind stocks, that is, as earn
ings have risen, so have market values. This
can be demonstrated by using the value of
cash dividends paid by m anufacturing cor
porations on all types of stocks (including
preferred stocks) as a proxy for earnings and
com paring dividends with the Standard &
Poor's Index (see Chart 3).
P s y c h o l o g y . It is g e n e r a lly r e c o g n iz e d

that investor psychology, affected by certain
international and domestic developments, can
play an important role in price swings in the
stock market. Unfortunately, there is no ac c u
rate m easure of market or investor psychology.

6 Linear regression an alysis using changes in the money

5 Moore and Shiskin, op. cit., p. 19 (footnole).

Digitized for
6 FRASER

supply a s an independent variable and slock prices a s
Ihe dependent variable produced a correlation (R- a d
justed) of 0.4699 and a Durbin W atson ratio of 0.2532.

A U G U ST 1 9 6 8
C h a r t 3.

S T O C K P R IC E S a n d C A S H D IV ID E N D S

RECENT EXPERIENCE AS A N
ECONOMIC INDICATOR

IN D E X 1957-59=100

200

180

140

S C A SH D IV ID E N D S PA ID
ANNUALLY

1960
L a s t e n try :

June

S o u r c e s o f d a ta :

68 ; 1967
S t a n d a r d & P o o r s C o r p o r a tio n ; F e d e ra l T r a d e
C o m m is s i o n ; S e c u r it ie s a n d E x c h a n g e C o m m is s i o n

On the other hand, there are statistical series
that attempt to m easure consumer attitudes,
including consumers' evaluations of the state
of the economy, their income anticipations,
and buying plans. Chart 4 com pares one of
the series—the index of consumer sentiment
prepared by the Survey Research Center of
the University of M ichigan—with the Stan
dard & Poor's Index. There is a surprising
correlation between the two indexes, for re a
sons that are not entirely clear. It may be
significant that the M ichigan index began to
turn down in the fourth quarter of 1965,
shortly before stock prices began to erode.
However, there have been false signals that
would preclude the exclusive use of the con

To summarize this discussion, it is interest
ing to focus on the behavior of the stock
market from the time of the British devalu a
tion in November 1967 through June 1968.
During these few months, there were at least
four major international financial crises, three
military offensives that either worsened an
existing war or threatened a new one, serious
riots and an important election in France, two
assassinations and a com plicated presidential
cam paign in the United States, and a Con
gressional struggle in approving a program
of fiscal restraint. Some of the earlier inter
national events apparently influenced the
decline in the stock market that b egan in
January 1968. The market turned down about
the time there was a serious run on the
Canadian dollar and was pushed down further
in the last week of January by unfavorable
Chart 4.

sumer index to forecast the stock market.
For example, consumer attitudes deteriorated
early in 1963 with little apparent effect on
the stock market. More recently, the level of
the consumer sentiment index was far below
the 1964-1965 level, at the sam e time that
stock prices were setting new records.

E C O N O M IC REVIEW

news from Vietnam and Korea. An early
recovery in stock prices in the second half of
February was cut short by a run on the United
States dollar that eventually resulted in the
two-tiered gold market. From January 12 to
March 5, the Standard & Poor's Index d e
clined by 9 percent. This loss, however, was
not large when com pared with other recent
market breaks; for example, in 1966, the
sam e index dropped by 22 percent over a
period of eight months. A subsequent re
covery in stock prices occurred in March and
April 1968, due in part to an over-sold market
position. President Johnson's withdrawal from
the presidential cam paign, the decrease in
bombing activity in North Vietnam, and the
United States offer to begin negotiations to
end the war in Vietnam are also widely attri
buted as major factors that influenced the
April recovery in the stock market.
Interestingly, the stock market decline in
January and February 1968 occurred during
a period of sharp expansion in money and
credit, which does not provide much support
for the money supply-stock market theory of
relationship, at least on a concurrent basis.
In addition, early in 1968, price inflation was
accelerating dangerously, which seem s to
indicate that the use of the stock market as
an inflation hedge can be subsum ed by other
factors. Instead, developments in the latest
period seem to be an exam ple of the tem
porary but overpowering impact of investor
psychology.
A comparison of stock prices with an index
of bond prices (for example, the average
market price of an assum ed 3 percent, 20year U. S. Treasury bond, converted to an
index basis) further illustrates the recent
Digitized for
8 FRASER

market situation (see Chart 5). Theoretically,
when interest rates rise, both stock and bond
prices tend to fall. Conversely, when interest
rates decline, asset values rise, and stock
and bond prices increase. In the early months
shown on the chart, bond and stock prices
conformed to theory and moved together.
Bond prices, however, rem ained noticeably
strong in January and February 1968, while
the stock market declined by 8 percent. Al
though the subsequent drop was relatively
severe (amounting to more than 6 percent),
bond prices did not turn down significantly
until the run on the United States dollar oc
curred early in March. In late April, bond
prices did not share in the ebullience of the
stock market, due largely to market concern
over Congressional delay in approving the
income tax surcharge.
II

DEMAND FOR STOCKS
During the 1960-1967 period, dem and for
corporate stocks increased substantially. The
demand for corporate stocks can be defined
as gross purchases of both new and existing
shares. Because complete data are not avail
able for gross purchases, net acquisitions by
selected groups are used to serve as a proxy
for total dem and.7 The difference between
net acquisitions and new shares represents
an increase (or decrease) in the price of ex
isting shares. Throughout most of the 1960~ Nel acquisitions of corporaie stock are by: households,
insurance companies (life, property, and casualty), pri
vate noninsured pension funds, open-end investment com
panies, state and local trust funds, mutual savin gs banks,
fraternal organizations, and foreigners. Net acquisitions
of corporaie stock are gross purchases of both new and
existing sh ares less gross sales.

A U G U ST 1 9 6 8
C h a r* 5.

increased institutional activity can be attrib
uted to legal changes that fostered more liberal
attitudes toward equities. As a result, many
retirement plans, trusts, and endowments b e

B illio n s o f d o lla r s

5EMAN

\ N

)

\
NE W SUP

' LY

DEN iAND L ESS N E' v

su pp

/ —

op en -en d in vestm en t c o m p an ie s (m utual
funds), and insurance com panies (life, prop
erty, and casualty) amounted to $ 47.8 billion,
com pared with $8.7 billion in 1960. In part,

C u rre n t V a lu e

The increased role of institutions was one
of the most important factors affecting the
dem and for stocks during the 1960-1967
period. For example, in 1967, the combined
value of gross purchases and sales of common
stocks by private noninsured pension funds,

C h a r t 6.

D E M A N D for and N E W SUPPLY of C O R P O R A T E S T O C K S

1960

'66

z
c

1967 period, the dem and for corporate stocks
increased at a faster pace than the new su p
ply of corporate stocks. As shown in Chart 6,
in I960, the n ew supply was slightly greater
than the dem and for corporate stocks. In the
1961-1967 period, demand exceeded the new
supply, and the prices of existing shares in
creased.

number of large life insurance com panies
organized and began to sell mutual funds, and
others are expected to enter the field shortly.
Open-end investment com panies and pri
vate noninsured pension funds are the two
most important institutional investor groups
in terms of the dollar volume of transactions.
As shown in Chart 7, during 1960-1964, net
purchases by pension funds av eraged $2.2
billion annually. Pension funds accum ulated
stocks at a much faster pace in the 1965-1967
period, with net purchases averagin g $3.9
billion annually. In 1967, pension funds
bought $10 billion and sold $5 billion worth
of stocks. The $5 billion in net acquisitions in
1967 were more than double the net acq u isi
tions in any year in the 1960-1964 period.
During 1960-1964, open-end investment com
panies had net purchases averagin g $0.9
billion annually. In 1967, open-end invest
ment com panies bought $ 14.9 billion and

ALLY

’68

l a s t e ntry: 196 7
S o u rc e s o f d a ta :

S e c u r it ie s a n d E x c h a n g e C o m m is s io n
a n d B o a r d o f G o v e r n o r s o f the F e d e r a l R e s e r v e

Sy ste m

cam e stock market oriented. Moreover, a

E C O N O M IC R E V IE W
C h art 7

N E T T R A N S A C T IO N S in C O R P O R A T E S T O C K S
B illio n s o f d o lla r s
2 -

O PEN -EN D IN VESTM EN T C O M PA N IES

AN N U ALLY

-10 -------------------------------------------------1960
'62
’64
'66
68
L ost

entry: 1967

S o u r c e o f d a ta : Se c u r itie s a n d E x c h a n g e C o m m is sio n

sold $13.3 billion worth of stocks, resulting
in net acquisitions of $1.6 billion. Although
the dollar volume of stocks traded by mutual
funds was greater than that traded by pension
funds, the former's net acquisitions were
smaller (see Chart 7).
Individuals, on the other hand, sold stocks
on balance during the 1960-1967 period.
Available data suggest that large trusts and
estates account for the bulk of sales. Individ
uals dispose of stocks for several reasons,
such as payment of taxes, taking advantage
of rising stock prices, reinvestment of funds
in tax-free issues, and diversification of port
folios.8 Nevertheless, the New York Stock
Exchange reports that there were 20.1 million
individual shareowners in 1965, com pared
with 6.5 million in 1952, suggesting greater
public participation in the stock market. Nine
teen sixty-seven was the tenth consecutive
8 See Institutional Shareownership, A Research Reporl
by Ihe New York Stock Exchange, 1964.

Digitized for
TO FRASER

year that individuals were net sellers of stocks.
In 1967, individuals sold $8.8 billion of com
mon and preferred stocks and purchased $4.6
billion of investment company shares and
$4.8 billion of corporate bonds and notes.
In addition to strong dem and for stocks and
increased institutional activity, a change in
investment attitudes influenced share prices
during the 1960-1967 period. This change in
attitude is exemplified by the wider accept
ance, particularly by mutual funds, of invest
ment in performance stocks—those with high
growth rates in terms of market price and
potential earnings. The number of perform
ance funds formed recently has increased and
some traditionally conservative mutual funds
have become more performance oriented.
The turnover rate is a frequently used
measure of trading activity in stocks and re
flects the recent em phasis on performance.
As shown in Chart 8, the turnover rate9 of
mutual fund portfolios began to increase
markedly in 1966, and by 1967, reached
39 percent, up sharply from an average of
16 percent in the 1960-1965 period. The
turnover rate on the New York Stock Ex
change also increased appreciably after 1965,
due largely to the influence of the mutual
funds. In 1967, the turnover rate on the New
York Stock Exchange was 22 percent, com
pared with the 1960-1965 av erage of 14
percent. During the period under review, the
9 Turnover rates for financial institutions are computed
by the Securities and Exchange Commission a s the lesser
of quarterly purchases or sale s divided by the av erage
of the market value of stockholdings at the beginning and
end of the period. Turnover rates for the New York Stock
Exchange are b ased on the dollar volume for the period
and the av erage market value.

A U G U ST 1 9 6 8

S T O C K M A R K E T T U R N O V E R and V O L U M E

O PEN -EN D INVESTM ENT C O M PA N IES

STOCK EX C H A N G E
OTHER FIN A N C IA L INSTITUTIONS
M illio n s o f sh a
16

l o s t e ntry.

_____I_____ I_____ I_____ I____

196 7

S o u r c e s o f d a ta :

In v e stm e n t C o m p a n y Institute; N e w Y o rk S t o c k E x c h a n g e ;
S e c u r it ie s a n d E x c h a n g e C o m m is sio n ; B o a r d o f G o v e r n o r s
o f the F e d e r a l R e s e rv e Sy ste m

turnover rate for other financial institutions10
averaged 9 .8 percent, substantially lower
than the rate for mutual funds and for the
New York Stock Exchange. The turnover rate
for other financial institutions in 1967 was
10.4 percent, up from the low of 7.6 percent
in 1964, but unchanged from the 1960 rate.
The average daily volume of stocks traded
on the New York Stock Exchange is another
m easure of market activity. As shown in the
lower panel of Chart 8, volume has been a c
celerating since 1964. In fact, the 10 million
share average daily volume in 1967 was
triple the volume in 1960. Furthermore, the
average daily volume in lune 1968 amounted
to 15.1 million shares, substantially above
the 1967 average.
During the period under review, stock mar
ket credit, which is the amount borrowed to
10 Olher financial institutions include: private noninsured
pension funds and life, properly, and casualty insurance
companies.

finance stock transactions with New York
Stock Exchange firms, also increased. In
Decem ber 1966, customers' net debit bal
an ces amounted to $5.3 billion, or an increase
of 65 percent over December I 9 6 0 .11 By
yearend 1967, customers' net debit balances
had risen further and amounted to $7.8 bil
lion, which was 47 percent greater than a
year earlier. As a general matter, the in
creases in stock market credit, turnover rates,
and average daily volume reflect stronger
dem ands for equities during the 1960-1967
period.

RECENT PERFORMANCE
OF SELECTED INDEXES
It is reasonable to conclude that, in recent
experience, strong dem ands for equities, in
creased emphasis on performance, and other
factors, such as growth of corporate earnings,
benefited some groups of stocks more than
others. To examine this point in greater detail,
the analysis focuses on developments since
lanuary 1966, when the Standard & Poor's
Index reached an interim peak (see top panel
of Chart 9). The lanuary 1966 peak ended a
rise in the stock market that began in 1962,
and in the months following the peak, a sub
stantial "correction" occurred. The market
did not turn around until late 1966, and a
marked recovery in stock prices took place
during most of 1967. A fairly sizable adjust
ment occurred early in 1968, and the market
did not turn upward until April.
The lower panel of Chart 9 shows how
various segm ents of the stock market, m ea
sured by four stock market indexes and aver11 Net debit b alances used exclude b alances secured by
U. S. Government securities.

E C O N O M IC R EV IEW
C hort 9 _____________________________________

Industrials. In the second quarter of 1968,
the New York Stock Exchange Index was 15
percent higher than the level of the first
quarter of 1966.

S T O C K M A R K E T IN D E X E S
IN D EX 1941-43=10

100

- ...... STAND ARD & 3O O R S INDEX

80
60
40

MON THLY -

INDEX IQ
180 h

'64

1960

66=100
AM ERICAN STOCK
EXCHAN G E INDEX

160

140

120

_ NATIONAL QUOTATION
BUREAU INDEX

,-y

NEW YORK STOCK
EXCHANGE

100
80

La st entry: Ju n e '6 8 ; 2 Q '6 8
S o u r c e s o f d a ta : B o rro n s; N a t io n a l Q u o ta t io n B u re a u ; W a ll Street J o u rn a l,
F e d e ra l R e s e rv e B a n k o f C le v e la n d

ages, have performed since the first quarter
of 1966.12 Since the first quarter of 1966, the
Dow Jones Industrial A verage13 (representing
“ blue chip" securities) has remained below
the level reached in that quarter. In fact, in
the second quarter of 1968, the Dow Jones
Industrial A verage was still 4 percent below
the level of the first quarter of 1966. With the
recent emphasis on glamour issues, the lack
luster performance of blue chip securities

Unseasoned and somewhat speculativetype securities are frequently associated with
the American Stock Exchange. During the
period under review, the Am erican Stock
Exchange Index outperformed the seasoned
issues on the New York Stock Exchange by
a wide margin. In the second quarter of 1968,
the American Stock Exchange Index was 83
percent higher than its level in the first
quarter of 1966, 87 percentage points higher
than the Dow Jones Industrials, and 69 per
centage points higher than the New York
Stock Exchange Index. The National Q uo
tation Bureau Index closely matched the per
formance of the American Stock Exchange
Index in 1967, but was 19 percentage points
lower than the latter in the second quarter of
1968. In summary, the data suggest that in
the past few years investors and speculators
favored unseasoned growth stocks to the wellseasoned blue chips, that is, em phasis was
on performance.

should not be surprising. The New York Stock
Exchange Index moved in the same general
contour, but outperformed the Dow lones

1-The various indexes and av erages were converted
into an index using the first guarier of 1966 a s the b ase
period. Indexes are b ased on the closing prices and in
dexes for the first day of the month. D ata are for the last
month of the guarter.
Dow Jones Industrial A verage is a weighted price
av erag e for 30 industrial stocks listed on the New York
Stock Exchange.

Although the New York Stock Exchange
Index did not perform as well as the other in
dexes, there are some glamour issues listed
on the New York Stock Exchange. As shown
in Chart 10, a selected group of industrial
stocks on the New York Stock Exchange out
performed the Standard & Poor's Index dur
ing the period under review. These industrial
groups are com pared with the Standard &
Poor's Index at interim highs in September
1966 and April 1968, and at interim lows in

AU G U ST 1 9 6 8

O ctober 1966 and March 1968.14
Stocks in the electronics, cosmetics, motion
pictures, and office and business equipment
industries did substantially better than the
Standard & Poor's Index at the 1966 low, the
1967 high, and the 1968 low. In the period
shown, motion picture stocks showed the
largest gain and exceeded the Standard &
Poor's Index by 120 percentage points in
April 1968. Of the four industrial groups,
electronics had the smallest increase, exceed
ing the Standard & Poor's Index by 53 per
centage points in April 1968. Obviously, not
all groups of stocks showed such outstanding
performance. For example, railroads did not
perform as well as the Standard & Poor's
Index (see Chart 10).
Chart 10 also shows five industrial gro u p s—
tires and rubber goods, industrial machinery,
steel, automobiles, and chem icals—that rep
resent some of the major industries located in
the Fourth Federal Reserve District. Only tires
and rubber goods consistently outperformed
the Standard & Poor's Index, exceedin g that
index, on average, by about 13 percentage
points. Industrial machinery outpaced the
Index in Septem ber 1967, but lagge d in the
other selected periods. The three rem aining
group s—steel, automobiles, and chem icals—
did not perform nearly as well as the Standard
& Poor's Index. In April 1968, the Index ex
ceeded those three groups by an average of
20 percentage points.
From the foregoing, it is clear that no single
stock market average, index, or group of

14 January 1966 is the b ase period for the industry in
dexes; April 1968 is the latest month for which industry
d ata are available.

E C O N O M IC R E V IEW

securities accurately reflects the widely di
vergent trends in the stock market, and that
it is m isleading to say that the stock market
p e r se is moving up or down. Nevertheless,
many stock market observers continue to
judge the stock m arket's perform ance by the
level of some individual average or index.

TECHNICAL FACTORS
IN THE STOCK MARKET

S T O C K M A R K E T T E C H N IC A L IN D IC A T O R S
IN D EX 1941-43=10

100

ST AN D AR D & P O O R 'S
INDEX

90
80
1966
Percent
MUTUAL FU NDS C A iH RATIO

- /h

;

10-yr. Avg.
~

........ J.....

MONTHLY"

direction and extent of stock price movements.
As discussed earlier, investor psychology,
which is perhaps the single most important
technical factor affecting stock market per
formance in the short term, cannot be m ea
sured precisely. Indirectly, however, investor
psychology can be observed in short-term
chan ges in the level of stock prices.
Four widely used stock market technical
indicators are shown in Chart 11. The mutual
funds cash ratio, which relates liquid assets
to total (net) assets, gives some indication of
the ability of mutual funds to invest in the
stock market, with a high cash ratio consid
ered bullish. As shown in the chart, the tenyear average cash ratio amounts to 5.8 per
cent. In O ctober 1966, the ratio peaked at
9.7 percent, which coincided with the low
point in the Standard & Poor's Index and the
beginning of the bull market that lasted
throughout most of 1967. As the Standard &
Poor's Index advan ced in 1967, the mutual
funds cash ratio declined, reaching a low of
5.2 percent in September. In early 1968,
mutual funds again increased their liquidity,
while the Index declined. In March 1968, the
cash ratio peaked at 9.3 percent, which co
14

120
100
80

ju y in g V

Time

Many observers rely on te c h n ic a l in d ic a to r s of the stock market to help forecast the

Percent
140

SH O RT '
IN T E RE ST R A T IO

16
30-yr. Avg.

QUARTERLY"

L a st entry: J u n e ’6 8 ; M a y '6 8 ; IQ '6 8
S o u r c e s o f d a ta : 8 a rro n s ; In v e stm e n t C o m p a n y In stitute; S t a n d a r d & P o o r ’s
C o r p o r a t io n ; F e d e ra l R e s e rv e B a n k o f C le v e la n d

incided with the low point in the Standard &
Poor's Index. In May, the cash ratio declined
somewhat while the Index advanced.
The short interest ratio relates the total
number of shares sold short on the New York
Stock Exchange to the av erage stock volume
for about a 30-day period (for example, Feb
ruary 15 to March 15). The logic behind this
technical indicator is that speculators and
others sell stocks "sh ort" at high prices in
anticipation of buying them back at lower
prices.15 When stock prices rise, those who
sold short attempt to maximize profits (or
minimize losses) by buying stock—or cover
ing short positions—at the lowest possible
prices, which in turn forces stock prices
15 A short sale is ihe sale of a securily lhal the seller
does not own, or a sale affected by the delivery of a bor
rowed security. At some time, the short seller must buy
the slock or deliver his own stock to cover ihe short
position.

A U G U ST 1 9 6 8

higher. A short interest ratio above 150 per
cent is considered bullish and below 100
percent is considered bearish. As shown in
Chart 11, as the Standard & Poor's Index d e
clined in 1966, the short interest ratio b e
cam e more bullish. The 209-percent peak in
the short interest ratio in November 1966
virtually coincided with the O ctober low in
the Standard & Poor's Index. Then, as the
Index advanced, the short interest ratio d e
clined to a low of 127 percent in February
1967. After February 1967, the ratio in
creased irregularly, reaching a high of 217
percent in March 1968, which was also the
low in the Standard & Poor's Index in the first
half of this year. The short interest ratio d e
clined sharply for the next two months while
the Index advanced.
The odd-lot ratio, which relates odd-lot
sales to odd-lot purchases, is a third technical
indicator. Some stock market technicians
believe that the small investors do the right
things, but at the wrong times. A vailable
data do not completely support that position.
When the Standard & Poor's Index declined
in 1966, the odd-lotters bought, and when
the Index advanced, the odd-lotters sold. It
can be argued, however, that odd-lotters sold
too early in 1967. On balance, odd-lotters
bought in early 1968 and sold heavily in the
April-Iune period while the Standard & Poor's
Index advanced.
Another technical indicator—the

price

earnings ratio—shows how some investors

cigarette stocks.16 A side from the possibility
that one stock group may have been over
valued and the other undervalued, these
ratios imply that investors expected prices of
office and business stocks to grow at a sub
stantially higher rate than cigarette stocks.
More importantly, price earnings ratios m ea
sure risk, with high price earnings ratios
suggesting high risks. In the first quarter of
1968, the average price earnings ratio of
16.2 was appreciably higher than a 30-year
average of 13.2 and the 1966 low of 13.9,
but was also well below the record 23 times
earnings reached in 1933 and more recently
in 1962.

CONCLUDING COMMENTS
If the stock market is to be used as an indi
cator of general economic activity, it should
be used with caution, as some fluctuations in
stock prices have little to do with real pro
ductive activity. In addition, certain struc
tural changes within the market in recent
years limit the m arket's value as an indicator.
It is likely that a number of basic develop
ments will help to shape the course of share
prices in the period ahead. O ver and above
the performance of the economy, it is highly
likely that institutional dem ands for equities
will continue to increase at a faster pace than
the new supply of equities, which, by defi
nition, should result in a higher level of stock
prices. Also, there is little evidence to support

appraise the growth potential of individual
stocks. In the first quarter of 1968, for ex
ample, investors paid an av erage of 52 times
earnings for office and business equipment
stocks and less than 12 times earnings for

10 The price earnings ratios are the high price earnings
ratios of the Standard & Poor's industry stocks for first
quarter 1968.

E C O N O M IC R EV IEW

a view that the recent em phasis on perform
ance is a short-term fad. In fact, the perform
ance concept appears to be gaining wider
acceptance, implying that an increasing
number of investors and speculators will focus
attention on a small but select group of glam
our stocks. Increased volatility and high price

Digitized for
16FRASER

earnings ratios in selected groups of stocks
may be the consequence. W hether these two
aspects, among others, will strengthen or
weaken the ability of the stock market to
serve as a barometer of economic activity
will be determined by business and economic
analysts of the future.

A U G U ST 1 9 6 8

RECENT MONETARY DEVELOPMENTS

Against the background of the recently
implemented program of fiscal restraint, it
may be useful to review recent monetary
developments, as reflected in the behavior of
a number of key monetary and financial sta
tistics during the period from May 1966
through June 1968.

OVERVIEW
G enerally speaking, the period under re
view includes four ph ases of monetary policy:
a period of restraint, May-November 1966; a
period of expansion, December 1966-A pril
1967; a period of accommodation, MayNovember 1967; and a period of restraint,
beginning in Decem ber 1967. In view of an
excessive rate of economic expansion, a
major purpose of monetary policy during the
first period was to restrict the growth of re
serve availability. Policy in that period was
marked by the introduction of a proviso clause
in the directive of the Federal O pen Market

to moderate substantially.” 1 By November
1966, however, evidence of moderating ten
dencies in the private economy led to a shift
in monetary policy, which was implemented
initially by achieving easier conditions in the
money market. During the first few months of
1967, in response to an easier monetary
policy, the major reserve variables expanded
substantially. W hen the economy b egan to
show signs of strengthening, the highly ex
pansionary policy was transformed in May
1967 into an accom m odative monetary policy,
which was implemented under a directive to
maintain "prevailing conditions in the money
market.'' In early D ecem ber 1967, following
the British devaluation and the em ergence of
clear evidence that the United States economy
was overheating and had becom e inflation
ary, the Federal Reserve System again moved
towards restraint in order to "foster financial

Committee in May 1966, under which open
market operations were design ed to bring
about a greater restriction in reserve avail

1 For a brief description of the proviso clause, see Fifty
Third Annual Report of the Board of Governors of the
Federal Reserve System, covering operations for the

ability "if growth in required reserves failed

year 1966, pp. 219-220.

E C O N O M IC R EV IEW

conditions conducive to resistance of infla
tionary pressure and progress toward reason
able equilibrium in the country's balan ce of
paym ents."
The successive shifts in monetary policy
during the period under review involved the
use of a number of tools available to m one
tary policy, but not all at the sam e time. For
exam ple, the discount rate was changed
several times. The discount rate was lowered
in April 1967 and in creased in November
1967 and March and April 1968. Reserve
requirements on time deposits were restruc
tured and raised twice in 1966 (July and
September) and selectively lowered in March
1967; reserve requirements on dem and d e
posits were restructured and in creased in
January 1968. Maximum rates payable on
time deposits were changed several times
(July and Septem ber 1966, and April 1968)
and restructured with respect to both matu
rity and amount. Furthermore, after enabling
Congressional legislation, steps were taken
in concert with other regulatory agen cies to
coordinate levels of and chan ges in interest
rate ceilings at deposit-type financial insti
tutions. Finally, open market operations were
designed to alter the growth of nonborrowed
reserves (reserves supplied at the initiative of
the Federal Reserve System) in accordan ce
with the changes in policy objectives. It is
difficult to disentangle the effects of various

altered the growth of monetary reserves and
bank deposits and credit as the situation
warranted.

MAY-NOVEMBER 1966
The impact of the restrictive policy during
May-November 1966 shows up clearly in the
behavior of the reserve ag gregate s (see table),
the variables over which the Federal Reserve
has the most control. During this p erio d—
possibly the most restrictive monetary policy
period in recent history—all of the reserve
aggregates declined. The behavior of bank
reserves was reflected in the money supply
and bank credit. The Federal Reserve System
exercises only indirect control over these lat
ter variables, which reflect in large part the
responses of banks and the public to policy
induced variations in bank reserves.
The narrowly defined money supply d e
clined slightly during the May-November 1966
period, while the broader m easure of the
money supply plus time deposits experien ced
only modest growth. Total bank credit also
showed only moderate growth during the
period; total loans expanded fairly rapidly as
banks borrowed from the Federal Reserve
Banks and the Eurodollar market. Interest
rates on U. S. Government securities rose, re
flecting an environment of strong dem ands
for credit com bined with a restrictive mone
tary policy.

policy tools, especially in a period m arked by
complications in the international financial
system. Nevertheless, it is apparent to most
observers that, during the period under re
view, monetary policy acted flexibly and re

ing the December

sponsively, used virtually all of the general
policy instruments available, and effectively

period (see table). Expansion of nonborrowed
reserves was exceptionally rapid during

Digitized for
18FRASER

DECEMBER 1966-APRIL 1967 AND
M A Y 1967-NOVEMBER 1967
Bank reserves expanded substantially dur
1966-November

1967

A U G U ST 1 9 6 8
C h a n g e s in Selected Financial Variables
Annual Rate of Growth*
M a y 1966November 1

December 1966April 1967

M a y 1967Novem ber 1 9 6 7

December 1967June 1 968

Reserve A ggre gate s
Nonborrowed rese rve s................................... .......... — 1 .6 %

2 0 .0 %

1 0 .6 %

Total r e s e r v e s ........................................................ — 2.4

13.3

11.0

2 .1 %
5.2

Required reserves.......................................... .......... — 1.6

12.3

12.0

4.1

M oney Supply and Bank Credit
M oney s u p p l y ........................................................ — 0.1

3.7

7.6

6.5

M oney supply plus time d e p o sits..................... .......... +

2.0

11.0

10.7

5.7

Bank c r e d i t f ................................................. .......... +

3.7

12.6

12.2

6.2

L o a n s f ............................................................... + 5 . 1

8.2

7.4

In v e stm e n ts!........................................................ +

21.4

19.8

4.0

0.8

Change in Basis Points

Interest Rates (monthly averages)
U. S. Treasury three-month bills (market yield)

— 68

U. S. Government long-term b o n d s ............................ + 1 7

— 112

+ 112

+ 56

—

— 13

* Monthly ave rage of daily figures, seasonally adjusted,
f End-of-month series, all commercial banks.
Source: Board o f Governors of the Federal Reserve System

Decem ber 1966-April 1967. Although non
borrowed reserves continued to expand in
the May-November 1967 period, growth was
considerably less than in the Decem ber 1966April 1967 period. Much of the increase in
nonborrowed reserves in the earlier phase
was used to repay borrowings at the Federal
Reserve Banks, leading to a slower rate of
growth for total reserves than for nonborrowed
reserves. Borrowings increased moderately
during the second phase and were reflected
in a slightly faster rate of growth of total re

not apparent until the fall of 1967 and even
then was obscured by the effects of strikes.
A number of developments during the Decem
ber 1966-November 1967 period compli
cated the formulation of monetary policy.
These developments included a rise in in
terest rates—especially in the May-November
1967 ph ase—that threatened another round
of disintermediation, the potentially adverse
effects of changes in monetary policy on the
international financial system, a series of
large-scale Treasury financings, and an ex

serves, as com pared with nonborrowed re
serves. The rapid growth of the reserve a g g re
gates in large part reflected the concern of
the Federal Reserve over the unsatisfactory

pected program of fiscal restraint. In light of
these factors, monetary policy did not move
to restraint until shortly after the British d e
valuation in November 1967.

perform ance of the economy.
Due chiefly to a sizable inventory adjust
ment, the economy showed little real growth
in the first half of 1967. Evidence of strength
in the economy, while widely expected, was

Despite weakness in the economy, the
money supply and bank credit resum ed a
more rapid rate of growth during the D ecem
ber 1966-April 1967 period. Although bank
19

E C O N O M IC R E V IEW

reserves expanded markedly, the money sup
ply only grew at an annual rate of 3.7 percent.
The money supply plus time deposits expanded
m ore rap id ly than the narrow ly defin ed
money supply as interest rates eased some
what and banks were able to attract time d e
posits (see table). The growth of bank credit
also accelerated sharply in response to the
growth of reserves, but most of the expansion
occurred in investment portfolios. Loan ex
pansion w as only moderately greater than
during the preceding period of restraint (see
table).
In the May-November 1967 period, money
supply growth accelerated rapidly. The rate
of growth of the money supply plus time d e
posits was slightly less rapid in this phase,
however, as rising interest rates again re
strained the ability of banks to compete for
time deposits. The growth of bank credit, as
well as loans and investments, rem ained at
approximately the sam e pace as in the
precedin g period. Interest rates (short- and
long-term) rose sharply, despite very rapid
growth of bank reserves, the money supply,
and bank credit.

DECEMBER 1967 - JUNE 1968
The impact of restrictive monetary policy,
initiated in Decem ber 1967, shows up most
clearly in the behavior of the reserve a g g re
gates, especially in comparison with the b e
havior during the preceding two periods of
monetary expansion (see table). For exam ple,
nonborrowed reserves slowed from an annual
rate of increase of nearly 11 percent in the
May-November 1967 period to about 2 per
cent in the D ecem ber 1967-June 1968 period;
total reserve growth also slowed markedly.

The growth of total reserves, however, was
at a rate somewhat above that of nonborrowed
reserves as a result of in creased member
bank borrowings. The slowdown in the rate
of increase in nonborrowed and total reserves
was transmitted to deposit growth at banks
and in turn was reflected in a reduced rate
of increase in required reserves.
The growth of the narrowly defined money
supply, which amounted to an annual rate of
7.6 percent in the May-November 1967 period,
slackened only moderately in the Decem ber
1967-June 1968 period to a 6.5 percent rate
of growth. While this may appear inconsistent
with the intent of policy, much of the growth
of the money supply in the latter period was
due to the draw ing down of U. S. Government
deposits during March-May 1968. U. S. G ov
ernment deposits are not counted in the pri
vate money supply, although when spent,
they increase private dem and deposits and
the money supply. The money supply plus
time deposits m easure showed more of a slowdow n d u rin g D ece m b e r 19 6 7 -Ju n e 1 968,
due to the considerably reduced growth of
time deposits.
The rate of increase of bank credit was also
reduced during the D ecem ber 1967-June
1968 period, as was the growth of the major
components of bank credit (see table). While
total loan growth slowed only moderately,
the rate of increase of investment portfolios
fell sharply, as banks attempted to accom m o
date loan dem ands in the face of reduced re
serve growth and reduced deposit inflows.
While interest rates on long-term U. S.
Government securities eased slightly on bal
ance during the December 1967-Jun e 1968
period, rates on short-term U. S. Government

A U G U ST 1 9 6 8

securities on balance continued to rise, al
though not at the sam e pace as during MayNovember 1967. The behavior of interest rates
reflects a number of influences in addition to
monetary policy. For example, such factors as
constantly shifting expectations, recurring
problems in international financial arran ge
ments and developments, changing prospects
regarding p assage of a fiscal restraint program,
a strong surge in economic activity coupled
with rapidly rising p rices—all had an im
portant influence on interest rate behavior
during the period from December 1967 to
June 1968. At the same time, the under
lying concern on the part of business firms
and financial institutions to maintain liquidity
rebuilt in 1967 — after the "credit crun ch "

of 1966 — stimulated strong dem ands for
credit and contributed to upward pressures
on interest rates.
In comparison with the period of restraint
from May to November 1966, monetary p'olicy
during December 1967-Iune 1968 does not
appear to have been nearly as restrictive—
at least according to the statistics. The growth
of reserve variables, while sharply reduced,
was still relatively high in the D ecem ber
1967-June 1968 period (in the May-November 1966 period, the reserve ag gregate s de
clined). Similarly, basic money and banking
m easures experienced greater expansion
during December 1967-Iune 1968 than in the
1966 period, with the growth of the money
supply, as previously noted, especially rapid.

"R e a p p ra isa l of the Federal Reserve Discount M echanism : Report of A System Com m ittee,"
1968. 23 pp. $0.25 a copy; 10 or more sent to one address, $0.20 each. A v a ila b le from
Publication Services, Division

of Adm inistrative Services, B oard of G o ve rn o rs of the

Federal Reserve System, W a sh in gto n , D. C. 20551.

E C O N O M IC R E V IEW

RECENTLY PUBLISHED ECONOMIC COMMENTARIES OF
THE FEDERAL RESERVE BANK OF CLEVELAND

"O n Curbing Inflation"
August 3, 1968

"Recent Business and Banking Activity in Cleveland"
August 10, 1968

"Holdings of Municipal Obligations (Fourth District)"
August 17, 1968

Economic Commentary is published w eekly and is a va ila b le without charge. Requests to be
a d d e d to the m ailing list or for additional copies of a n y issue should be sent to the Research
Departm ent, Federal Reserve Bank of C leveland, P. O . Box 638 7 , C leveland , O h io 4 4101.

A U G U ST 1 9 6 8

NEW PUBLICATION
Selected Econom ic Indicators, a monthly supplement to the biennial
Statistical Profile: S t a n d a r d M e tro p o lita n Statistical A re a s of the Fourth
Federal Reserve District, is now availab le from the Research Departm ent of
the Federal Reserve Bank of Cleveland. The publication presents data for
all S M S A s in the Fourth District on employment, unemployment, production,
distribution, construction, income, and banking. Requests to be a d d e d to
the monthly mailing list for Selected Econom ic Indicators should be sent to
the Research Department, Federal Reserve Bank of Cleveland, P. O . Box 6387,
Cleveland, O h io 44101.