The Effect of Depression on the Security Outlook

by C. T. REVERE

IN every period of depression, the task of recovery has been approached from two divergent angles. It might not be going too far to say that the financial community has been divided into two schools of thought. One lays the major emphasis on the element of psychology—restore confidence, change the ‘state of mind,’and we are once more on the road to prosperity. The other holds to the view that our problem is not so simple of solution, that it is involved in the appalling complexities of world economics, and that a sound and permanent solution can be worked out only along fundamental lines.

Recently the ’fundamentalists,’if they may be thus termed, appear to have had the better of it. The ’Pollyanna’ element, committed to the dictum that the stock-market crash of Oclober-November, 1929, had discounted the worst, has been sadly discredited. What was regarded a year ago as largely a domestic crisis has attained almost cosmic proportions under the cumulative influence of exaggerated fear and pessimism.

ONE plain conclusion seems to be emerging from this tangle of perplexities. There are limes when confidence may lead us out of the wilderness and there are times when it must wait on the assertion of underlying forces. There are occasions when a benign psychology will be helpful, as In 1922, when both industrial activity and the stock market halted after the improvement that began in 1921. Rut even then the situation had the fostering aid of a nation-wide building movement, and the expansion of the automobile industry was just getting under way. Evidently fundamentals must be right 1o permit confidence to function.

As matters now stand, the most atrabilious pessimist does not have to resort to imagination to paint a gloomy picture, and it might be just as well to give primary consideration to this darker side. There is worldwide overproduction of basic commodities. Prices for wheat, rubber, sugar, coffee, copper, tin, silk, cotton, and other raw materials are around the lowest levels they have reached in decades. Some of them recently have established record low levels. The decline in silver to new lows for all time has been accepted as a paralyzing influence on the purchasing power of the Far Fast. Generally speaking, the low levels for many commodities have impaired their exchange value and thus seriously affected the buying power of communities and even nations to a distressing degree. Obviously a price around one cent per pound for sugar dot’s not permit Cuba, for example, to lake freely of cotton textiles and other products of industrial countries.

Here again we get a groping effort at a solution of the vexed world economic problem. In some quarters the argument is pul forth that, if commodity prices advance, the effect upon world purchasing power will be pronounced, finding its repercussions in an increased demand for the output of industry and exercising a wholesome effect upon the entire economic structure. Others take the view that, if the security markets improve, this development will be accepted as a barometric indication of widespread revival and thus bring about a greater demand for raw materials.

Apparently the solution of our basic economic problem is another variant of that ancient question, Which comes first, the hen or the egg?

THOSE who take the view that security prices have not yet discounted the full effect of depression in this country and elsewhere hark back to the situation in 1926. Probably the selection of this year as a yardstick is traceable to the fact that stock prices on the average are close to the levels prevailing in 1926, as measured by the most comprehensive average available, namely, Standard Statistics, Inc., weighted average of 404 common stocks.

The pessimistic formula is expressed in substantially the following terms: In 1926, we were getting under way to the full swing of prosperity that reached its apex in 1929. We are now in a period of depression that, according to major indices, compares unfavorably with 1926. On this basis security prices should fall below the average level of 1926, and this would mean a further substantial decline.

Closer examination, however, does not confirm the full validity of this conclusion. Some security groups are selling considerably below the levels of 1926, while others are substantially above the prices prevailing in that year. Groups deflated below the 1926 level arc those representing industries now most severely affected by this depression and whose outlook is considered unfavorable. Among these are stocks representing rawmaterial industries — textiles, leather, paper, and so on. Groups remaining relatively highest are related to industries with brighter prospects and more favorable records. In this category fall chemicals, electrical equipment, utilities, and various specialties whose earnings have steadily increased, and which seem likely to continue to grow.

Earnings for these classes of stock have increased since 1926, and even during 1930 their earnings for the most part did not react to the 1926 level. Therefore, it must be concluded that the deflation in stocks has been decidedly selective and based largely upon future outlook, perhaps even more so than in the past when security deflation apparently was more universal than in 1930.

IT is difficult to account for the difference in the degree of deflation even after giving consideration to the prospects for each group. One reason may be that there exists a general belief that increases in productivity will continue at the pace inaugurated in the 19201930 era. Prior to 1920, the rate of increase was relatively low. It is also possible that investors have come to attach greater significance Lo the future growth and the application of science to industry than they did previously. Another reason may be that investment knowledge is more widely diffused, and investment, therefore, has become more scientific than formerly.

Financial opinion generally appears committed to the belief that a sustained upward movement in stock prices must await tangible evidence that business likewise is improving. In 1921, the industrial upturn indices slightly preceded the rise in the stock market. In 1927, stock prices paid little attention to the moderate setback that occurred then.

AN exhaustive analysis of the business and industrial situation prepared by one of our great corporations takes a rather hopeful view of the outlook. The broad conclusion is reached that the maximum point of depression will be recorded in January or February, with recovery starting soon after. The expectations for improvement seem to be based chiefly upon prospective stability in certain important commodity divisions. Attention is called to the fact that the physical volume of department-store sales has not dropped below that of 1929. The demand for consumption goods has been high, and reduced purchasing power has been reflected chiefly in such items as automobiles, residences, and such.

One vital point that should be kept in mind is the probability of increased corporate earning power on a reduced turnover. Only those who have kept in the closest touch with industry can appreciate the extent to which efficiency has been increased, overhead reduced, and improved methods installed to prepare for increased volume when it appears. Many well-managed companies may be expected to make a surprisingly favorable net showing on gross earnings somewhat below normal.

All of which goes to show that the foundation for prosperity is laid in just such times of adversity as we have been experiencing.