Security Values, 1921 and 1931

WHEN the financial community is in a quandary as to the probable trend in investment values, it instinctively turns to the record of the past in the hope of finding some comparable set of circumstances which may serve as a basis for intelligent guidance.

At the present time, and throughout the depression period of the past year, investors have shown a disposition to appraise the investment outlook in the light of the known developments following the 1921 depression. Nearly every seasoned investor remembers how depreciated his securities became in 1921 and how marked was the recovery in security values during the succeeding years. The memory of that depression and of the record-breaking recovery which followed has undoubtedly tended to sustain the values of the old-line investment stocks during the past twenty months.

From an investment point of view, the years 1921 and 1981 present interesting analogies and contrasts. In 1921 the prices of both commodities and stocks were on a deflated level. The business depression of that year, coming on the heels of the most precipitate price decline the world had ever known, created a plethora of credit and greatly reduced interest rates. A contributing factor to the decline in money rates was the persistent inflow of gold. During the course of that year our net gold imports amounted to more than $650,000,000.

The current depression has witnessed a repetition of the same general conditions. The fall in stock and commodity prices since 1929 has once more produced a redundancy of credit — to which gold imports have also contributed. During the first quarter of 1931 the wave of gold importation, which had been gathering force over a period of three years, raised our total gold holdings to a new all-time peak.

To the holders of first-class bonds and preferred stocks, the significance of the present oversupply of credit is exactly what it was ten years ago. The rise in bond prices from 1921 to 1928 was the direct result of low interest rates and redundant credit — a condition commonly referred to as ‘cheap money.’ Inasmuch as the outlook for the continuance of cheap money is no less promising now than it was in 1921, there is reason to believe that good bonds, although high in price, will be worth still more during the years immediately ahead.

The prices of common stocks—and of the inferior types of bonds as well — are also affected by cheap money, but the influence of the money factor on the value of such securities is more indirect than direct. The fundamental factor in stock prices is corporate earnings and the outlook for earnings. To the extent that cheap money helps to stimulate business and to increase corporate earnings, it indirectly brings about a rise in stock prices.

CHEAP money was an important factor in the growth of corporate earnings and in the rise of stock prices after 1921. There was at that time a wide Hold for the employment of capital, and there was an urge to employ it. For one thing, we were face to face with an acute shortage of buildings. No sooner was the worst of the 1921 depression out of the way than building const ruction began to go forward at a rapid pace. Here was a field for the utilization of a vast amount of credit. By creating a good market for real-estate mortgage bonds, cheap money gave a tremendous fillip to building operations and general business activity.

In addition to the internal demand for capital for building purposes there was an urgent demand for capital in European countries for the rebuilding of their industries, the stabilization of their currencies, and the restoration of devastated areas. Attracted by the low interest rates in our investment markets, foreign countries and foreign industries naturally looked to us to supply a substantial part of their new capital requirements, and we responded by making loans to them on a vast scale. The net result of our foreign lending was that we gained an enormous export trade, because the greater part of the money derived from the sale of foreign bonds in our markets was used to buy American products.

Finally, cheap money found its way into the field of consumer credit. Sales managers were quick to see the advantages of the installment method in sales promotion, while bankers and others were pleased to supply installment credit and gain profitable employment for funds that might otherwise have remained idle.

Whether credit was used for making good the building shortage, for rehabilitating foreign countries, or for facilitating installment buying, all those uses-had the effect of promoting business activity and general prosperity. The steady rise in corporate earnings — and therefore in prices of stocks—after I92I may be attributed primarily to the abundance of cheap credit, we enjoyed and to the lavish use that was made of it for productive and consumptive purposes.

When it comes to estimating the future trend in terms of these past conditions, it, is not at all clear that corporate earnings over the next few years will respond to the influence of cheap money so quickly or to the same extent as they did ten years ago. Except for the use that will again be made of credit for financing installment sales, the visible outlets for the utilization of credit are none too promising. For the time being, we have an oversupply rather than a shortage of building, and a depressed market for real-estate mortgage bonds. The market for foreign bonds is also depressed, on account of unsettled political and economic conditions abroad, and our export trade languishes. Until we begin to show an interest once more in financing new construction or in furthering our export trade through foreign lending, it is difficult to see how cheap money is going to bring a speedy return of prosperous conditions.

With no building shortage to be overcome, with the credit status of many foreign countries in doubt, and with more credit on our hands than we know how to utilize, we are in the embarrassing predicament of being ‘all dressed up and no place to go.’ It is to he expected, of course, that we shall find some place to go eventually. In the long run, cheap money is certain to have its way in stimulating new lines of business activity. At the moment, however, it appears to be questionable policy for the buyer of common stocks to rely heavily upon 1921 experience, and that of subsequent years, for his 1931 outlook.