Outlook for the United States Economy and Securities Markets for 1964/The Outlook for the Canadian Stock Market

MR. LANGLEY:

Frederick A. Stahl started his career in the investment field with a member firm of the New York Stock Exchange, in 1926, after graduation from the famous Wharton School of the University of Pennsylvania, as a Bachelor of Science in Economics. Soon he moved to Standard Statistics Company, the predecessor of Standard & Poor's Corporation, and has progressed through all the facets of economics, security analysis, and investment counselling, while in time advancing through the offices of Treasurer, Vice-President and Executive Vice-President until his appointment as President in 1958. Under his leadership, one of the world's foremost investment advisory and statistical research firms has prospered in a most impressive manner.

A. Hamilton Bolton on the other hand spent a somewhat longer apprenticeship before joining his present company, spending six years with Wood, Gundy in both re search and sales before interrupting his business career for six years wartime service in the Canadian Army. Already possessing a B.A. from McGill and an M.B.A. from Harvard, Mr. Bolton decided to form his own firm of investment consultants on his return from the war, and in 1946, in conjunction with Maurice Tremblay, the firm of Bolton, Tremblay was born. This outstanding team has also prospered and has gained an international reputation in their field.

We are honoured that two such eminent authorities should have accepted our invitation to join together in peering into the mists of the coming year, and to start off our presentation I will call on Mr. Frederick A. Stahl to present his assessment of the U.S. picture. Mr. Stahl.

MR. STAHL:

I have been asked to outline, in a period of fifteen to twenty minutes, the prospects for the United States economy and the security markets for 1964. This is a subject on which one could talk for hours, but I will attempt to summarize my projections within the prescribed time.

As to general business, the prospects seem quite clear. As to the securities market, the outlook is much less clear, mainly because, in addition to business trends, one must allow for such external influences as international factors, the emotionalism of investors and, particularly relative to stocks, the ever-present effort of the stock market to perform a forecasting function.

For 1964, the American economy will enjoy the best business year ever recorded by a substantial margin, as measured by the major indicators. The momentum of the sharp recovery experienced in 1963, after the relative dullness of 1962, would have carried through the first half of 1964 without the benefit of a tax cut. Now that a tax cut in the area of $10 to $11 billion is reasonably assured, one justifiably can forecast an extension of the recovery through the second half of the year as well.

In terms of specifics, and I regard the following projections to be highly conservative, I would look for an average Gross National Product of at least $615 billion in 1964, as against $584 billion in 1963. Thus, we will be breaking through the $600 billion barrier by a resounding margin. What is equally important, the trend should continue upward quarter by quarter, so that by the fourth quarter of 1964, the GNP should be somewhat better than $625 billion vs. the $598 billion recorded for the fourth quarter of 1963.

Personal and Disposable incomes should record similar increases. Personal income should average $486 billion, with the fourth quarter at $495 billion, compared with $463 billion for all of 1963. Disposable income should average around $425 billion, with the fourth quarter at more than $432 billion vs. $402 billion average of 1963. An important contributor to the betterment in business will be a rise in capital spending, always one of the major forces in the economic outlook. McGraw-Hill Publishing, in their preliminary forecast for 1964, have indicated that American industry will spend $40.7 billion in 1964, or 4 per cent more than in 1963, for new plants and equipment. Our studies indicate that this figure is conservative and that final figures could work out more closely to a 6 per cent gain, with particular emphasis on a set-up in such expenditures during the second half. Passage of the tax bill early in the year, as now promised, would be an important factor in the decisions of corporations for capital spending.

Government expenditures, even allowing for some moderation in the budget to be presented shortly by President Johnson, should average in the aggregate not less than $130 billion, including state and municipal, vs. $125 billion for 1963, but with the fourth quarter figure reaching $132 billion.

Private construction, while lagging behind other factors, should run moderately in excess of $50 billion compared with $46 billion average for 1963. Since this figure already had achieved the $49 billion total by the fourth quarter of 1963, the overall benefit, as against present volumes, will be fairly modest.

Investment in inventory, which at times has importantly penalized the economy, should continue to gain at approximately the same pace of 1963, namely at the rate of $5 billion. The Federal Reserve Board Industrial Production Index, a relatively inflexible measuring stick, should record an average figure of roughly 131 vs. 125 in 1963, but with the quarters not varying too greatly throughout the year. It is quite clear that unless boom proportions develop, the most favourable comparisons will be during the initial half, since they will be made with relatively lower volumes for the first half of 1963.

Of extreme importance, as to the direct effect on the stock market, are the projections for corporate profits and dividends. I expect that corporate profits, both before and after taxes, will achieve new all-time highs by a substantial margin in 1964. The first stage of the corporate tax reduction will alone add 4 per cent to earnings. Specifically, I would look for pre-tax profits in the area of $54 billion vs. $51 billion in 1963 and for after-tax profits in the area of $29.5 billion vs. $26.7 billion for 1963, a gain of 10.5 per cent.

Perhaps of even greater importance are the projections for cash flow, namely profits plus depreciation and amortization, since this factor largely determines the availability of funds for capital spending and dividend distributions. Corporate profits after taxes, looking back over the past eight years, have not shown a basic trend, since the 1962 profits of $24.6 billion were only slightly above the 1956 total of $23.5 billion, followed by a final breakout to $26.6 billion in 1963. In contrast, the cash flow figure showed a much more pronounced and more significant growth. In 1956, for example, the cash flow figures were $41 billion and rose in easy stages to a figure of $52.9 billion in 1962 and, then, recorded a more dramatic advance to $57.6 billion in 1963. This reflected, in part, the liberalization of chargeoffs enacted by the Kennedy administration.

It is pertinent to note the relationship of dividend distributions to cash flow, rather than to reported earnings. In the period of the past eight years, dividends, as a percentage payout of profits after taxes, varied all the way from 51 to 70 per cent. Yet, dividends as related to cash flow at no time were below 30 per cent and no higher than 33 per cent, and averaged out to 31 per cent during this eight-year span. Converting our 1964 projections to cash flow and dividends, I would look for an available cash flow of $61 billion vs. $57.6 billion in 1963 and a total of dividends in the area of $19 billion vs. $17.8 billion in 1963, an increase of about 7 per cent.

Other basis fundamentals having a bearing on profits are the price structure, wages and productivity. Wholesale and retail prices should continue the advance of recent years, perhaps at around 11/2 per cent, while wages will rise on average about 21/2 per cent, although the automobile negotiations late this year might break this pattern for future years. Since productivity is gaining at around 31/2 per cent, this argues strongly for maintenance of profit margins to support the projections submitted above.

Turning to the money factors and their relation to the bond market, one has to allow for the ever-present influence of the balance of payments situation, as well as the normal demand factors as related to the availability of funds. While the threat of the balance Of payments seems to have lessened somewhat, this situation has by no means been corrected. There should, however, be some reduction in the balance of payments deficit for 1964, since the prospective passage of the interest equalization tax will be effective for a full 12 months' period; while, in addition, many industrial nations outside the United States are proving accommodating by increasing their prices and wages at a much more rapid rate than has held true in recent years for the United States. Specifically, such industrial nations as France, Italy and Japan, to name a few, are inflating their price and wage structures at a rate Of 6 to 8 per cent. I would estimate that the adverse balance of payments could drop to about $2.5 billion in 1964 vs. $3.5 billion estimated for 1963. However, this relative betterment by no means argues in favor of loosening the credit strings. As the year progresses and the demand for funds on the part of corporations, the Federal and Municipal governments, and for financing the public sector of housing and consumer durables, I would look for an increase in interest rates in the longer term maturities by at least 25 basis points and, conceivably, by 50 basis points should a boom psychology develop following passage of the tax bill. I do not anticipate the latter to eventuate unless the consuming public steps up expenditures faster than expected. It is quite likely, for example, that consumer savings will expand in 1964 to a level as high as $33 billion, or 7.8 per cent of disposable income, which would compare with approximately $29 billion, or 7.3 per cent, indicated for 1963. Even so, there should be at least moderate pressures for a rise in interest rates and a corresponding downward readjustment in bond prices.

The stock market provides considerably more of an enigma, because one must argue that prices have gone relatively far in forecasting the current and anticipated pros perity for 1964. However, a few yardsticks may help to clarify what would seem to be reasonable prospects for the stock market. We closed 1963 in terms of the Standard & Poor's industrial average selling at 181/z times 1963 earnings of $4.20 a share to provide a yield of 3.1 per cent on dividends distributed. This multiple of earnings has been reached and exceeded in each year since 1957. The history of past markets, however, would argue strongly that values conspicuously in excess of this level could rot be maintained for long. The public is again showing signs of entering the market after having been an apparent seller on balance during most of the advance since October, 1962. If extended into this year, this reversal of sentiment could lead not only to a broadening of demand for stocks but, possibly, to the development of speculative excesses that could not be sustained. It is my conviction that the balance of forces, operating in our markets, dictates the likelihood of further upside progress for the stock market in 1964, but I would look for the pace of the advance to be much more subdued than the pronounced advance that was enjoyed during a good part of the fourth quarter of 1963.

Since earning power is the bulwark of the stock market, the advance in the fourth quarter of 1963 appears to be more soundly based than any other since the mid-fifties. In terms of Standard & Poor's 425 Industrials, I look for earnings to rise to a new peak of $4.60 a share, as against the $4.20 a share in 1963. Applying the current priceearnings ratio of 181/2 times earnings to the 1964 expectation, one could readily project a level of 84-85 in the S & P Industrials as a fair target for the market, as against 78 currently, without the development of any feverish speculation that coloured investment attitudes in 1961. This would be equivalent to about 840 on the Dow Jones Industrials. Many analysts feel that this is a conservative evaluation, as it does not allow for the relative scarcity that has developed in prime industrials as a result of a steady institutional absorption of the better grade issues. However, since the S & P Index covers stocks that account for approximately 85 per cent of the valuation of all listed issues, this Index is more representative than an Index that is composed solely of blue chip issues.

Projecting the market on basis of yields, one would come to a somewhat similar conclusion. Common stocks are now yielding an average of 3.1 per cent on their 1963 estimated dividends of $2.40 a share. This figure should move up to a minimum of $2.60 in dividends for 1964, so that the yield at around the 84-85 level of the Index would still be approximately 3.1 per cent. Since Treasury 91-day bills now provide over 31/2 per cent, any increase in the short term Government rates could prove competitive to the stock market, thus providing a retarding influence on a rise in stock prices beyond the levels outlined.

Perhaps it is well to bear in mind the longer term trends, which are strongly favourable for ownership of equities. Back in 1961, it was fashionable to heap scorn on the con cept of the "Golden 60s". Yet, with the passage of four years, we find that GNP has increased 22 per cent, production has risen 17 per cent and stock prices, despite intervening periods of sharp declines, have mounted by 20 per cent. The long term trend, despite occasional setbacks, is unmistakable. So is the population trend, which will be marked by a 27 per cent expansion of the family-forming age group from 1965 to 1970, which carries with it a huge potential demand for housing and consumer products of all kinds. Already production in many lines has approached or even stretched the practical optimum, which suggests that capital spending will mount in successive stages over the future.

Benefits from this expansion will vary among companies and industries and the investor who chooses with discrimination and timing in buying in 1964 should be rewarded substantially in the years ahead.

As a possible guide for stock selections in 1964, I will summarize the prospects for a few of the key industries. The auto industry far and away was the major stimulant to the economy in 1963. Passenger car production reached a level of 7.6 million units and trucks and commercial vehicles close to 1.5 million units. I believe automobiles and truck demand will be well sustained, but it is difficult to forecast, at this point, a further gain in the industry's outlook which, in fact, might be anywhere from unchanged to down 5 per cent. However, the Big Three in the industry should show profits in the aggregate not much different than 1963, with the benefit of increased replacement demand for parts and a continuing sharp rise in their international operations. There might be some slight shift in business in favour of Ford at the expense of American Motors and Studebaker, while General Motors and Chrysler should maintain their relative penetration of the auto market. Motor stocks are selling at a relatively low multiple of earnings, as compared with our Index, so that price vulnerability should not be great and these stocks probably will respond to dividend policies which, if anything, should be liberalized.

The banking industry seems assured of a nice gain in profits in the year ahead as against modest gains of less than 5 per cent in 1963. Banks should benefit not only from a rising volume of loans, but also from the anticipated probable rise in interest rates. New debenture financing by banks could reach $1 billion in 1964, thus expanding their loan potential. It is well to note that quite a few of the Central City banks are still available at a price-earnings ratio of 16 to 161/2 times earnings.

The building industry is subject to conflicting trends. Some phases of the industry, notably the cements and roofing equities, are still suffering from excess capacity. However, the well managed companies in this industry, such as Armstrong, Sherwin-Williams, and Johns-Manville, to name a few, should show a rising trend in earnings.

In the chemical industry, the gap between productive capacity and output is beginning to narrow. This should eliminate, if not reverse, the price erosion from which this industry suffered in recent years. As a result, we feel that an increase of 5 per cent in sales should be translated into a larger gain in profits.

The drug industry continues to provide one of the most favourable growth trends of any industrial category. It not only shows a return on invested capital about the highest achieved by any industry, but sales continue to expand at a rate approximately twice the average growth in the economy. The leading companies in this industry should record earnings gains Of 10 per cent or more.

The electrical products industries, which cover a vast area, appear destined to achieve new highs by a substantial margin. Electronic Industries Associates recently estimated that the 1963 volume was up 11 per cent from 1962. I would look for a somewhat smaller percentage increase in 1964, mainly because sales of defense industries will rise only modestly. In the commercial aspects, however, there could be some dramatic gains, notably in colour television, which could rise to a volume of 1.2 million sets in 1964 vs. 750,000 sets in 1963. The major companies benefiting from this trend should be in order--RCA, Zenith and Motorola.

The food industry continues to gain at a rate somewhat greater than the increase in population. Profits in the aggregate should be up about 6 to 8 per cent.

There are prospects for a somewhat more spectacular rise in earnings on the part of the various machinery industries, although these will vary company by company because of the wide diversity of their operations. However, companies that seem destined to enjoy sharp gains on basis of current trends would include Ingersoll-Rand, Clark Equipment, Link-Belt, Cincinnati Milling, National Acme, International Harvester and Deere.

The oils enjoyed a greater than normal increase in 1963 profits in the area of 10 per cent plus, which reflects a firm price structure during the initial nine months, the cold winter of 1963 and a continuing gain in profits in the international areas. Oil consumption domestically should rise about 2 to 3 per cent in 1964 and around 6 per cent in the Free World outside the United States. Assuming normal winter weather and a relatively satisfactory price structure, this should permit a gain in profits of not less than 5 per cent. It is a significant characteristic of the larger companies that their cash generation is now in excess of their expansion needs. Thus, the liberalization of dividends that was experienced in 1963 should be extended into 1964. On any relative basis, the oils as a group seem undervalued, as many leading companies can be selected currently at only 11 to 12 times earnings, while even the top companies like Standard Oil or New Jersey and Texaco are in the area of 15 times earnings. This disparity, as compared with average ratios, seems unjustifiably wide.

Retail trade, reflecting higher consumer spending, should record new peaks in sales and earnings that will vary widely as between segments in the industry. Overall, retail sales may be up as much as 5 per cent. Unfortunately, the food and variety chains are still suffering from excessive price competition and stamp giveaways, so that only modest increases in these divisions will be possible, except for the best managed companies. The situation is more clearly defined as related to department store and mail order divisions. Leading companies in this segment of the industry, such as Sears Roebuck, Associated Dry Goods, Federated Department Stores, Macy, Gimble and May, could readily record earnings gains of 10 per cent or more. Here, again, can be found individual issues that are selling at a moderate valuation of earnings at 15 or 16 times.

The steel industry, at long last, seems to be working out of its difficulties. Production for 1963 at the ingot level of 109 million tons was well above the 99 million tons of the preceding year. Preliminary estimates would indicate that this figure could reach or exceed 112 million tons in 1964, with production spread out fairly evenly over the four quarters. This should permit much better cost control and a widening of margins. Thus, while production may be up only around 3 per cent, it is not difficult to visualize a gain in profits of 10 to 20 per. cent for leaders in the industry.

Perhaps a kind word should be said for the cigarette industry which has suffered for some years from adverse publicity, climaxing with the Surgeon General's report to be

released shortly. As a non-smoker, I can be sympathetic to the attacks on the industry from a health standpoint. Yet, human nature is such that I would look for very little deviation in the consumption of cigarettes over any extended period of time. Future annual growth may be less than the historical pattern of about 3 per cent, but should continue to rise over a period. In the meanwhile, the leading stocks in the industry are thoroughly deflated, whereas, on statistics, as a consumer industry they should be entitled to sell at 15 times earnings or more. Instead, we find them priced at close to the 10 times level to yield in the area of 5 to 6 per cent. For investors with a little fortitude, the leading stocks provide exceptional values at going levels.

The utility industry will continue to record a steady gain in profits in keeping with consumption trends. Profits should rise 7 to 8 per cent in 1964. These stocks frequently achieve a temporary overvaluation, but patience usually corrects this factor by a growth in earnings and this area of investment should continue to be lucrative.

I trust the foregoing comments will provide some perspective as to my basic thinking as to the outlook for 1964. Permit me to say in conclusion that it has been a great privilege to have the opportunity to present this discussion to you.

MR. LANGLEY:

And now with his analysis of the Canadian scene- Mr. A. Hamilton Bolton.

MR. BOLTON:

It is a great pleasure for me to be here with you today in the company of such a distinguished economist and investment analyst as Mr. Stahl, President of Standard and Poor's Corporation, who has just finished giving you his views on the outlook for 1964 in the United States.

My task, which is now to give my own views on the outlook particularly for the Canadian stock market, falls rather neatly into place as the aftermath of what Mr. Stahl has had to tell you, because unless we are clear as to the outlook for the United States, we have no hope of being clear as to the direction of the Canadian economy and the major influences affecting the market place.

I cannot hope, however, in the fifteen minutes allotted to me to cover more than a fraction of the field, especially since I will be developing one or two themes which may well be considered controversial. There is a school of thought perhaps typified by Mr. May of the Commercial & Financial Chronicle which says that attempting to forecast the stock market is a useless exercise. In other words, any time is a good time to buy good value. Unfortunately, this begs the question since what is good value now in relation to our obviously high-priced stock market would have been very poor value in 1954, say, let alone in 1949 or 1942. Nobody yet has developed a value theory for stocks which will prevent large losses under conditions of economic contraction except, of course, if one is prepared to remain uninvested for spaces of 10 or 20 years at a time. In other words, any time is a good time to buy good value, but let us not fall into the trap of using a rubber yardstick to measure what value is.

Stocks which were available a dime a dozen 10 or 15 years ago, now cost 25 cents a dozen. But even this does not measure the increased risk in today's stock market, because the whole economy of North America is far more mature (I hate that word . . . perhaps advanced would be better) and liable to a major economic setback than it was 10 or 15 years ago. Consequently, the vulnerability ratio of the purchase of a group of stocks such as an average Canadian portfolio would have today is probably closer to 3 or 4 to 1 compared, say, to early 1954. This statement is incontestable if one takes a hard look at the size of private (and public) debt today as compared to 10 or 15 years ago in relation to the size Of the economy.

If ever there was a time, therefore, to beware of the clich6 "we don't buy the market, we buy stocks", it is certainly now when by all reasonable standards that from an historical basis stock prices are high, even though we can point to periods when they have been higher.

So we start with a statement rather than a theory that stock prices are high. They are. Does that mean necessarily that they are about to fall out of bed? Not necessarily, but it does suggest to me that some day they will fall out of bed and that this time will probably coincide with evidence of a major recession developing perhaps on a world-wide scale, which I may say, I do not find at all in evidence today. The interlock of economies, through the channel of balance of payments, today is far greater than it was 10 years ago, but there is nothing on the horizon that I can see to do what the Marshall Plan did 15 years ago to create a Free World bootstraps operation.

Mr. Stahl gave us an excellent rundown on the forces at work which should keep the U.S. economy moving forward at least through a good part of 1964. My own view is that the U.S. will enact a major tax cut in 1964 effective either the 1st of January or the 1st of July, and that this will inevitably result in increased demand in the economy by way of capital and consumer spending. I don't think it makes much difference whether the date is January 1st or July 1st, and in fact, I would prefer to see it, I think, effective July 1st since the forces of expansion are sufficient, I believe, to make it unnecessary to have a tax cut in early 1964, and its impact therefore, if enacted only at mid-year, would last longer.

Be that as it may, a tax cut has major implications for Canada and the Canadian stock market from three different directions. First, a U.S. tax cut will be a stimulant to Cana dian industry and corporate profits through the spillover of demand into the Canadian economy which every period of good business in the States produces. Secondly, however, a tax cut in the U.S. will literally force action to be taken by the Canadian Government to do likewise if we wish to retain the competitive advantage that our recent devaluation has given to us, and which is showing up so nicely now in our external trade figures. Thirdly, a tax cut in the U.S. may well cause or force us to inaugurate a whole series of tax reforms which will once more give proper incentives to proper people to expand our output and our economy into the prosperous thing it should be. I would hope this will be the outcome of the current sitting of the Royal Commission on Taxation.

The Canadian economy in 1964 faces many of the same influences which are favourably at work in the U.S. I will enumerate a few that you no doubt are fully aware of:

(a) Inventories. These are well under control and in fact the inventory/shipment ratio in manufacturing is at low levels historically.
(b) Unfilled Orders. These jumped over 5 per cent during the third quarter.
(c) New Orders. These are up 3 per cent in the third quarter.
(d) Monetary Ease. Money supply is expanding at about a 6-7 per cent annual rate and money remains easy. Despite favourable business, the rate of increase of total loans has been moderate as compared particularly to 1962 and even 1961. I think it should be pointed out here that our long-term interest rates structure is quite high in relation to that of the U.S. (roughly 5.15 per cent vs. 4.15 per cent or a 1 per cent spread) which gives us plenty of room to manoeuvre if, as I think quite likely, U.S. long-term rates start to rise in 1964. (e) The Russian Wheat Deal. This will prolong monetary ease to a time later than it could otherwise have lasted. (f) Our Import/Export trade balance world has been improving for years now and our balance with the U.S. is also improving and this is important since this is where our biggest trade deficit is.

This is far from a comprehensive rundown of favourable factors in the Canadian picture, but I think it points to the influences of similar developments ni Canada along the lines suggested by Mr. Stahl for the United States.

Nevertheless, Canada in my opinion, and consequently the Canadian stock market, faces many divergent problems, some of which have been caused by political actions, some of which are due to economic factors, and some of which are structural. The long-run future of our stock market depends on all three, but only as the political and structural factors impinge upon and produce the economic factors. Economic factors (modified by the psychological mood of the moment)--things like savings, credit, etc.--produce the level and direction of our stock market, but these economic factors may well be created by political environment and the structure of demand and supply for stocks.

We can say that at the moment there is nothing in the economic outlook immediately ahead in Canada which calls for a major revision downwards in stock prices. In fact, if anything, the outlook might be termed as calling for higher prices, other things being equal, which they never are. This would be based on such factors as the devaluation of 1962 which is only now beginning to take hold, the Russian wheat deal with its consequent monetary ease for a longer time, the inevitable increased demand which the U.S. tax cut will create, and the inevitable later Canadian tax cut which the U.S. one will force on us but which I hope will be based on some sound sense on tax revision coming out of the currently sitting Royal Commission on Taxation, rather than just a programme of "me-too-ism".

These then are sustaining factors and areas which could presage some sort of an economic boom or hope of a boom into 1965. Against this favourable background I see some short-term factors which may call for some readjustment downward in Canadian prices both absolutely and in comparison with U.S. stock prices, but more important some very grave structural factors at work over the longer term which may call for a realignment of our price-earnings ratios downward, and consequently of our stock prices. In fact, unless something is done to remedy this structural situation which is developing, we may be close to the ultimate peak in stock prices for many years to come if we have not already passed it in Canada.

Let me first of all discuss briefly the short-term factors. These are based on the interrelationship of the Canadian with the U.S. market. Suffice to say, the United States stock market is in a somewhat dangerous short-term position. While leading averages (I would not dare mention Dow Jones when Mr. Stahl, the President of Standard & Poor's is sitting right next to me) have been posting new highs in recent weeks, yet the balance of stocks as measured by the number of advances and declines is obviously below the peaks of early Summer 1963. This type of divergence in the past has practically always been the prelude to a sharp downward correction in stock prices over coming weeks or months regardless of how high our leading averages may hit in the meantime.

In Canada, too, since the anouncement of the budget last May the balance of advances and declines has been consistently downward despite the fact that the Toronto Industrial Average is now 140 versus 137 in May 1963. Only in the last week has the market seemed to broaden out. I am afraid, from a short-term point of view, we may well be in for some sort of a shake-out. The second temporary factor does not call for a shake-out but simply a gradual alignment in stock prices in Canada and this is due to the U.S. 15 per cent equalization tax which if it becomes law should result in a decreasing demand for Canadian equities from the U.S. until a point of balance arrives where the disparity in prices compensates for the 15 per cent or some part of it. Actually, at the moment there seems to have been since last July about a 3-5 per cent realignment already taken place, again if we use leading U.S.-Canadian stock prices averages.

Given a strong economic climate in late 1964 and early 1965, and assuming that our short-term technical weaknesses in both markets are worked out, the equalization tax should simply adjust the rate of rise or fall of the Canadian market in relation to the U.S. It should not be, therefore, a serious factor in Canadian investment portfolio management by itself.

When we get to a consideration of certain structural factors, however, I think we ought to pause and give some thought to the probable long range effects. These are two long range developments at work in Canada which I call structural changes which in my view mean eventual lower stock prices. These are first, the attempt to force repatriation of Canadian equities from abroad (chiefly U.S.) by fiscal measures, and second, the Quebec type of pension scheme. Incidentally, nobody seems to have questioned the major governmental thesis that increasing foreign ownership of equities is bad for the country. The thesis seem to have been taken on faith alone, yet how do we account for the fact that net dividend outflow in relation to Gross National Product is no higher now than in 1946 and is very appreciably lower than in the 1930's?

Let us now discuss repatriation itself. Freshman economics tells us that if you increase the supply (and this is what repatriation does) unless you also increase the demand, the price goes down. Ottawa's tax moves will increase the supply all right (and the wrong kind of supply at that, as I will show you in a moment) but it does nothing to increase the demand. The long run effect can only be that over time stock prices will move lower than they would have if Mr. Gordon's tax measures had not been put into effect.

But let us look more closely at the quality of the supply we will have to absorb. These will not be rapidly growing companies in our resources industries which are plowing back earnings into further growth. No, what we are going to get on the Canadian market is a bunch of secondary "dogs", companies which are mature and have been paying out earnings to their American parents rather than reinvesting them in further Canadian growth. Rather than suffer a 20 per cent tax on dividends they will only have to pay 10 per cent, if upwards of 25 per cent of the equity can be sold off to Canadians, and the Canadian investing public will be saddled with some lack-lustre investment which does virtually nothing to develop the country. But this is not all; the proceeds of the investment to us poor suffering Canadians will not be reinvested in Canada but will be moved out of the country to the coffers of the U.S. or other foreign parent company. So we get increased supply which puts prices down but the wrong kind of supply, and we temporarily worsen out balance of payments.

Let us finally look at what I call the Quebec Type pension plan. This, if it is successful, may become a possible pattern for other provinces. Quebec hopes to collect several hundred millions a year out of its scheme to tax individuals' salaries and wages and fund them in a gigantic investment pool. But this pool will not enter the equity markets as such. It will be used to finance the burgeoning provincial needs in education and social capital as well as perhaps such things as the steel complex. Regardless of the merits of the scheme, from a social point of view, the inevitable effect is going to be less demand for marketable equities.

With more supply of the wrong sort and less demand of the right sort, it is in my opinion inevitable that over time these factors will have a profound effect on the comparative level of Canadian stock prices. If we add to this the probability that if the Equalization Tax becomes law in the U.S. it will remain On the books even after the end of 1965, because I for one do not believe that the U.S. can solve its balance of payments problem in anywhere near two years, let alone five. We risk the eventuality of an investment climate in Canada in which nobody will want to buy equities. Thus the whole thing becomes self-defeating.

Now I am sure that our leaders in Ottawa must by this time have seen some of the light. I only hope they will go into this more thoroughly and reason things through. In my opinion, there are two areas where constructive action can be taken. The first is a major revision of our tax structure coupled with a sharp cut in taxes on medium to higher incomes. These are the incomes of the basic risk-takers of our country. The experience of the U.S. in 1948 and 1953 was that tax cuts become rapidly invested in increasing demand in the economy and in higher subsequent tax revenues. There may be as in 1948 a period of a year in which the public prefers to work down indebtedness, or the effects on demand may be immediate as in late 1953. Japan has also experimented successfully with the unorthodox tax cut route to stimulate the growth of the economy. It has worked marvels in that country on several occasions. What is lost temporarily in tax revenue is made up almost immediately from lower tax rates on higher income with no overall loss in the end. Great Britain tried it this time last year with a substantial tax cut on automobiles.

Secondly, we need to look seriously at fiscal measures to increase the demand for equities. This can be done effectively by a progressive step up year by year in the tax credit to individuals on equities. Currently 20 per cent, it should in my view be stepped up over four years, say, to 40 per cent, 60 per cent, 80 per cent, and 100 per cent. Its impact this way would be gradual rather than one-shot. If any compensation for this is necessary, I would without hesitation remove the 20 per cent tax credit on preferred stocks. I see no reason for this tax credit. Are we trying to encourage equity buying or are we trying to create a special privileged fixed income security market?

In conclusion, what started out to be a simple "What is the Stock Market going to do?" type of speech has ended up as an exhortation against obvious long-range dangers that current economic political and structural trends are forcing upon us here in Canada if we are not very careful. Our own studies of money and credit trends in the U.S. point to the probability that we are still not too far advanced in the current expanding business cycle, despite its apparent length from late 1960. Our studies of money and credit in Canada point to approximately the same situation although there has been some turndown in the rate of change of money supply in Canada and in our various Canadian liquidity measures not yet apparent in the U.S. figures. The directions of the two economies are at present basically the same and in fact, it is impossible to have the Canadian economy going one way while that of the U.S. goes another. For these reasons, therefore, I am reasonably happy about the outlook for the Canadian stock market over the balance of the current economic expansion which I should think could easily last into 1965. But I think we must keep in mind an historical fact. Except in extraordinary periods like 1929, Price/Earnings Ratios tend to decline well before the final peak in stock prices. This is because in later stages of a boom, earnings (often aided by spurious inventory profits) rise faster than prices. This happened for instance in 1936-7 and it can dupe the unwary investor into believing he is not paying too much for stock because of a falling Price/Earnings Ratio.

If there seems to be a note in this talk of some concern as to the longer-range future of Canadian equities, it is I think mostly due to the uncertainties which have been imposed upon us by various fiscal measures in Canada and the U.S. Such recent questions as, What is going to happen about the Interest Equalization Tax? Will there be a tax cut and when? What new measures or further amendments has Mr. Gordon up his sleeve? What will be the outcome of the big Pension debate?, inevitably leave the Canadian investor up in the air. Out Of such indecision, however, often come remarkable investment opportunities. Thus, we should be spending our time, if evidence of a later turndown in the economy starts accumulating, looking through the veil of today's uncertainties in order to take advantage of what may well be the outstanding investment bargains of tomorrow.

In conclusion, given proper leadership in Ottawa, in our provinces and in business, we may yet live up to Sir Wilfrid Laurier's prediction that the 20th Century would be "the century of Canada's and Canadian Development". We will not, I trust, through improvisation, faulty reasoning, and lack Of foresight allow our Canada to become the economic Sparta of the current age.

Thanks

Thanks of the meeting were expressed by Past President Sydney Hermant.