Tabell’s Market Letter – January 13, 1956

aA- . Reprinted from. ,. . COMMERCIAl. and 3 q FINANCIAL CHRONICLE Thursday, December 29. 1955 to The Stock Market Outlook Forl9S6 and Beyond By EDMUND W. TABELL Director of Institutional Research Walston & Co., Inc. Members N. Y. Stock Exchange Mr. Tabell predicts much higher market levels for IODg. '. term, with iDtervening readjustment period. For 1956, based on statistical, technical, aDd psychological factors, expects highly selective action raDgiDg from a 520 DJ Average top down to a low of 430420. Looking . . ahead to the 1958-1960 period-with buUish elemeDts of increasing consumer income and demand, population growth, increased money supply, more favorable invest .t,. ,ment climate, long-term easy money, and technical fac- 1 lors; for s'Dsational DJ rise 10 750. As most favor. ably. simated groops, .uggests oils, Damral gas, food cbains, automatioB' issues, electronics, airlines', retail stores, better,grade Canadian oils, and nalural gas issues. As the year ends, the stock hIarket and most bUSI- ness indIcators are at an all-time high. The industrIal average- IS again near the September peak of 490 reached be- fore the announcement of PresIdent EIsenhower's Illness and appears ready to stage the tradItional year- end rally and attam new high terri- tory. The Federal Reserve Board index of industrIal activity has reached a new high of 144 of the ' 1947-1949 average WhICh is 16 points' above the level of a year ago The great maJority of busmess forecasts for 1956 predIct a'high level of activ- ity for at least the fIrst SIX months of the new year , WIth such a favorable pattern as a background, It is dIffIcult to be Edmund W. Tabell anythmg but optirmstic If we I attempt to look ahead five years, thlS optImism seems entirely justified. Four of the five long-term construc- tlve fundamental factors that I advanced ahoost 100 in 27 have contlllually stressed in Com- months. A continuation of the mercta! & Financtal Chronlde present rate of advance In the articles are still with us. They are stock market would mean a price roughly- Level of about 1,500 in the Dow- (1) The increase in consumption demand brought about not only by the Increase in consumer m come but by a more equitable dis- tributIOn of such Income. (2) Population growth m general but partIcularly in relation to the age groups In the popula- Jones industrials in 1960 which seems a bit fantastic for the long- term trend, even to a confirmed bull Ilke myself. . The price of a common stock depends fundamentally on four main factors. (1) earnings, (2) dividends, (3) bond prices and (4) mvestor coniidence. The fIrst tion. three factors are tangible and (3) The tremendous Increase change at a relatively slow rate. tn our money supply since the The last factor – mvestor confi- start of World War II and its ef- dence, is very intangible and sub- fect on earnings, dlvldends and Ject to extremes of optimism and money rates. pessimism. Investor confidence is (4) A mare favorable invest.. generally reflected in prjce-to- ment climate. The fifth factor-an easy money market – is temporarily unfavorable, but will, in my opinion, change in the event of even a ml1d business dIp. It still must be considered a constructive factor for the longer term. In addition to these constructive fundamental factors, my longterm technical work on stock mar.. ket action also presents a favorable supply and demand pattern. In my last paper in the Chronicle, published eight months ago, I predicted the possiblhty of 600 in the Dow-Jones industrial average in the 1958-1960 penod I am now inclined to raise my Sights to 750. earnings ratios, dividend yields and the spread between stocks and high-grade bonds. At periods of high lllvestor confJdence, like the present, the investor pays a high rate for 1.00 of earnings and dividends. The table below shows bow much was paid for 1.00 of earnings and dividends in three periods of stock market highs and also during November 1948 and October 1953, as compared with to- day. Additionally, in the table is the amount needed to buy enough dIvidend income to equal the in- come from 10 invested in high grade bonds. , -Per 1 00 ofJ!arns Dlv. Same Income 510 1n Bonds 1929 19.30 29.90 15.60 1960 Outlook Clearly Bullish The outlook for 1960 seems reasonably clear. However, at least as far as I am concerned, it is extremely difilCUlt to project the 1937 1946 1948 1953 1955 16.60 16.80 7.82 9.28 13.37 22.00 28.40 18.00 16.00 23.26 10.75 9.00 5.45 6.14 7.36 pattern for 1956 by itself. Cer- From the above, it can be read- tainly, it seems highly improbable lly seen that investor confidence to expect In 1956, the same rate of today necessitates paying at a increase in busmess actIvity that much higher rate for earnings and was witnessed in 1955 or to ex- dividends than in September 1948 pcct the same rate of advance in or October 1953 when my two the stock market that was expe- very bullish articles on stock -ienced in 1954 and 1955. The rate values were published In the of business increase in 1955 was Chronicle. While the ratios are two or th'ee times the long-term still below the three periods of rate wlnle the stock market has stock market highs of 1929, 1937 2' ….. ,I, .I' II , I , \ Benjamin Graham used in our momentum despite the fact that last Chronicle article, the normal the averages are advancing to new value of the market for 1956 is highs Thls divergence usually in- around 400-410. ThIS flgure- is ar– dicates either a decline or a long rived at by capItalizing the 10- ,year average earnings of the Dow- c,onsolIdatIng period.. ' Jones industrials at twce -'the f Near-Term Caution . yield on AAA bonds Since the' The action of the vanous mar- market rarely sells at Its normal ket averages also tends toward a value, 20 devlation is allowed somewhat cautIOnary attiude up and down for eIther nigh after the turn of the year, Actual- or low investor confidence. At' ly, the market as a, whole' l1as present levels, the market is' made little 'headway SInce July, A priced TIght at the top of the 20 few stocks have had sharp ad- overvaluation (480-500) for high vances while the bulk of the mar- investor confidence. , ket has moved, sideways. It is The Technical 'Pattern entirely possIble that the market Is-forming a broad distributional Since investor confidence or top. 'Tops of thIS sort take a long psychology is best measured by ,time to form. The 1929 top needed, technical market factors, it might a year to form, the, 1937 top took be instructive to outline the pres- 10 months and there-were seven ent technical pattern As noted months of congestion before the before, the longer term mdications f1946 top was'formed. Tbe present' remain favorable, but the 1956 Ipattern has the anoearance- of, a' pattern is far from certain idiamond ,or expanding top. For- From a partially techmcal ap-' Imations 'of I th,s type usually con-' proach to business and banking rsist of fIve phases. Four have conditions we note a few signs of already been completed.', The a possible change in the business 'present advancing phase may be activity pattern, A study of eight i,the fmal step business indicators that usually The first phase was the advance change their trend some SIX Ito the July top at approximately months or so before general busi- \;470 The second phase was the ness, reveals that a number of to the August low of 445 these indicators are beginning to !,The third phase was an advance show signs of a possible change In the September high of 490, trend later in 1956 These indi- ,above the July high The fourth cations ,are as yet far from Iphase was the October declIne to sive but do suggest a certaIn a decline below the previous' amount of caution 'low of August and the fIrst time An analysis -of bank credW 'sInce the advance started in changes also indicate a cautionary 10ctober, 1953 that a prevIOUS attitude. Some I of this work indi- had penetrated The fIfth cates that it is quite unlikely that iphase IS the present advance from a major new leg to the bull mar– lthe 0 eta b e r low has ket can develop without either a' ! equalled the September hlgh of Iprior correction or a long 'consoli- 1490. ' – dation period. , If, the pattern of expanding Breadth-of-the-market highs and lows continues, the a study of the market the as eivnitdeernncael da-cbtyionv'oOl-f ;market 'should Iterritory on the reach new present and high reach Ume, advances and declInes; new Ithe uptr,end line connecting the high. and lows, oda' lots, etc 470 and 490 highs of July and rather than a study of the'market September. This uptrend line now a'verages, indicate that the mar- stands at about 508 but will reach liet shows signs of waning upside 510 by the year-end and about 520 4i (,(.l.' '6. 'J.,j' I J i 1 by early February. If such an ad- work to complete. tn most in- vance occurs, it will most likely stances, these issues are ones which be accompanied by a heaVIer vol- have advanced very sharply in the ume of tradmg in the low-priced, last year or two and are selling speculatIve issues that hitherto at very high price-to-earnings have done 11 ttl e marketWise. ratios and extremely low yields Strength in thIS type of issue has that are based on possible future been the mIssing mgredlCnt In a earnings and dividends rather complete market cycle. During than, on the ,present. They could such an advance, the higher grade ,be quite vulnerable in the event Issues may do lIttle more than of a change in the high investor churn back and forth and enlarge confidence prevailing today. This their potential tops IS almost the exact reverse of the In all our technical discussion so far, we have considered only the general market and the aver- ages AU of the varied technical approaches of business indicators, bank clearings, breadth-of-themarket .graphs of the averages, both on point and figure charts SItUation in October, 1953 At that time we said, The market is dis- .counting a 15 to 25 drop in earnings We are m a period in ,which investors are placing more stress on What they think IS going to happen than m what is actually happening and on vertical line graphs all On the other hand, there are confirm the fundamental fmdings also quite a few issues today that that the bull market has reached a have been more or less neglected mature stage and may be build- marketwise and are still selling at ing a major distrIbutIonal pattern fairly reasonable price-to-earn- with stocks passing from strong ings ratIOS. Issues of this type hands to weaker, more speCUlative would suffer little marketwise in holders. If thiS turns out to be the event of a general decline and the case, the market will follow might even move agaInst the one of two possible correctionary trend if fundamentals favored patterns before the long-term ad- theIr group. vance is resumed One possible pattern could be a sharp 1946-type Piecemeal Readjustment decline of 25 or so, followed by The broad economic pattern and a re-accumulation are a. T his the more intelligent approach to could carry the industrial average investing that has prevailed 1n back to the 400-360 area some recent years, favors a possible time in 1956 Thc other pOSSIble pIecemeal readjustment over a pattern could be a 1951-1953-type period of a year Or so rather than of consolidation WIth the averages a sharp decline In the 1951-1953 holdmg m a broad trading area market, the averages ranged in a while indiVIdual iss u e san d 15 tradmg area for two years groups adjust piecemeal with while some individual groups some groups declinmg while at were advancing and declining at the same time other issues and the same time, For example, the jrroups are advancing but even- steels reached their highs in Jan- tually the whole market correct- uary 1951 and declined 33. The ing any temporary overvaluations. textiles reached their high In Feb- A study of the graphs of over ruarv 1951 and declined 40. The 1 200 indIvidual Issues suggests distilling – issues reached their that the 1951-1953 pattern is the peak in October, 1951 and declined more probable one. At the pres- over 30; the coppers their hlgh ent moment, many indlvldual is- in January 1952 and declined sues indicate the possibility that 33 , the oils their high In March they are forming dlstrlbutional to July. 1952 and declined 25; tops that may need some more the farm equipment issues their 5 , highs in October, 1952 and de- profIt potentials with the small- clmed over 30. The ralls did not reach then hlgh untIl Jan- est amount of downside risk would include OIls, natural gas, uary, 1953 and declined 20 food chains, automatIOn issues, WhIle all of thIS was happening electromcs, airlines, retail stores other groups were resltng and 'and for a speculatIOn, better- slowly forming reaccumulabon grade Canadian Olls and natural patterns in preparation for the Igas Issues. 1953-1956 rise. Whether the 1956 pattern wlll , There will undoubtedly be some lexcellent buymg opportunities resemble 1946 or 1951-1953 IS not durmg 1956 and it would seem certam. I favor the latter at the 'advisable to use current strength moment and in such an event, 1 I'to elIminate from your list both believe the 1956 range ,will be a lovervalued and marginal Issues 520 high .. and 430-420 low as Iduring periods of strength in Inagainst ,a present 485. the event price level of of a 1946 pat- ljng to buIld up a potential buy- reserve. Undervalued Issues tern, r'believe the range will be Ishould be retamed and added to 500-520 'high and 400-460 low. ;on minor weakness. 1956 should The groups that offer the best ,be a year of extreme selectivity. ,. I I , , i I I, . I 'f' i , I I ! ., I 6 ;' . .. and 1946, a certain amount of caution seems necessary at these advanced levels to offset the possibility of a psychological change in investor feeling. The SItuation is further compli- -On BasIs of\ 10 Yr Av 19M duPont 155 165 General Elec 33 43 General Motors 35 36 Stand. Oil N J. 85 105 Umon Paclfic 128 150 Today 230 54 47 150 180 cated by the fact that the figures U. S. SteeL 39 46 58 Iabove relate to an average of stocks and not to individual is- On the basis of present dIVi- sues. Today's market, lor ex- dends and 10-year average yields ample, is quite different from and 1954 average YIelds, the six 1946 when the advance in the stocks would sell at the foHowing' Iprice level was quite general. High-grade and low-grade, in- -On Basts of10 Yr AV, 1954 Today vestment stocks' and speculative duPont 199 217 230 stocks all participated in the advance. Today's market has been much more selective. The steepest advances have been in the bett.ugrade stocks that have been eligible for institutional investment. General Elec. GSteannedr.alonMNot.oJr.s Union Paclfic U. S. SteeL 43 33 111 140 35 52 54 38 47 117 150 149 180 44 58 Many second-grade and specula- J The results are approximately tive issues have done little marketwise in recent years, and, in the same under both methods with the exception of duPont and Gen- Electric where the dividend many cases, are comparatively payout was a bit above average undervalued in relaUon to some ithis year m relation to earnIngs. of their better regarded neighbors. It might be interesting to note .These figures are not meant to be 'a prediction, but simply Illustrate what might happen if some now, at what price level six better- unknown factor caused a lower- grade issues would sell if, for ling of-not earnings or dIvidends some nOw unknown reason, investor confidence dropped price to 'but simply investor confidence. ISuch a study is subject to the crit\icism that recent developments earnings ratios back to the 10-year Ihave changed the quaJity rating of average ratios or even back to the 'Isome of the compames concerned laverage pIe ratios of only a year ago. Estimated earnings and and that they are entitled to seU, at a higher ratio than in the past ThJs could apply particularly to present dividends for 1955 on U. S. Steel but I have attempted these six issues are Est, Earns duPont 9.15 General Electric 260 ito select six companies that al- Dlv 7.00 ways have had a relatively high tquality rating To extend thIS type, 'of reasoning to justify either a 2.00 relativelY high or low general General Motors 430 2.50 ; ratio smacks somewhat of new Standard Oil N. J. 1050 anion Pacific 1700 U. S. SteeL, 5.80 6.00 8.00 .era thinking. tIfication of iratios would One possible ,justhe present higH be that the long 2.60 undervaluation might be offset by If past average PIE ratios prevailed, the stocks would sell at ,a relativelY long period of over'YauaUon particularly in a period I when earnings and dividends are the following prices on present advancing. earnings as compared with pres- On the basis of the Central ent price. Value or normal value theory of