AN ANALYSIS OF FACTORS

AND" CONDI'rIONS AFFECTI NG

STOCK MARKET PRICES

by

Bert J, Beihoff , B. S.

A Thes is submit t ed to the Faculty of the Graduate Sohool , Marquette University

in Partial Fulfillment of the Re ­qUirements for the DegreE) of

Master of Arts .

Mil waukee , Wisconsin January, 1954

2

. PREFACE

The analysis whioh is to fol l ow is in no way a

compl ete or fina l descript ion of ea ch factor and con­

diti on listed , a.nd shoul d not be considered as an attemp t

of such . Previous l y , to the best of this aut hor's know­

ledge , no study of this nature has ever been made , and

t h is explains the rather appar ent lack of references.

However I this inquir y into the sub j e ct represent.s a

comprehens ive survey of all the avai l able l iterature

on Investments; Bus iness Cycles, and the Stock ~J!arket .

:3

TABLE OF CONTENTS

P REF ACE •••••••••••••••••••••••••••••••••••••• p e. 2 .,

CHAt-TER I The Stock Marke t and I t s Yri ce Movcroent s •...•.•.••.•.••.• • ••••.•. p . 5 .

CHAP'rER II The Re l ation betwe en Busines s 'ondit i ons and Se curi t y 1?rices •.•.....•• p .12 .

CHAPTER III Pr i ce Val uat i on and t he Types of Factors and Conditions Affecting I t ••••• p . 2~ .

'HAPTRR IV Fa c tor s and CondItions Affect ln~ Stock Marke t Pric e s ••••.•••..•••••.••••• p . 37 .

CHA?TER V The Concl usion a nd It s Settini:, •••••••••• p . 68 .

BI BLIOGRAPHY •••••••••••••••••.•••••••.••••.•• p . 7 2 .

Approva l •.............•....... ." ............•. p . 7 6 .

4

CHART

The Hi storieal Rel a tion between Business Oonditions and Security Prices ••••••.•.••.•••.. p . 13.

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Be cause 01' the dynamic nature of our economy, and

because of t he many conflictlng forc es in the world to-

. day, it is i nforma tive to eXBlt1i ne t he validlty of the

wide l y a ocepted belief tha,t changes in the stock market

fore cast simllar ohanges in the volume and dir e ction of

business activity. If this relationship is true, an

anal ys is of the fact ors and conditions affecting stock

mar ke t pr i ces would provide an insight into thtl stUdy

of business cyoles.

'fhe role of t he Stock Exchange in our modern economy

is almost an indispensable one, for it provides a mech-

anism for the financinR of American business. The

Exchange 1s a market in the true sense of the word,

since the prices of securities are de termined str i ctly

by the demand f or, and the suppl y of, stoeks . "It may

s ave possiblemlsunderstandlng Iflt is stated a t the

outset that t he StoCk Exchange by itself does not deter-1

mine prices ," but merely records t he various pr ices at 2 which indivIdual inves tors are prepared to buy and sell

s ecurities.

The Bxohange mainta ins a continuous market f or

seour ities , thereby keeping t he vas t capital liquid and

mobile , and ItprQvlding;he mechanism fo r the fl nancln

of new ent erprise and the expansion of old ones.,, 3

lL-~G ~ Whyte, Prinei. l es of Finance and Investment ( Rogh.est er.a. G"B • .a. 949 01. I~ P . 1021 Tfie term Inves t ors useu as I nc uaive of i nvestors and speCUl a t ors. Unless ment ioned otherwise in a speciflc ca se, we will not di f f erentiate between the two f orms of activity, f or bo th in the ir own way , al~e concerned with f u t ure expe e tat ions.

3J'. Mi ndell, The Sto ck :Mar ket ( New York . 1948 ), p. 37",

By mai ntaining this continuous market, it harmonizes

the quoted priess and actual val ues, and in so doin

7

"enables investors to more intelligently direct the fl ow

of cap ital into profitable channels. Since investment

in securities can be ma.de for short periods of time,

the market affords a h i gh de gree of l iquidity to the

i nvestment capital, and a readily accessible diversifi ­

cation of investment opportunities among the listed

securities . Thus , the existence of the Sbock Exchange

is justified on the basis of its ability to furnish

these useful services to security owne.rs and businesses. 4

Be fore i nqui.ring into t he rela tionship be tween

stock marke t prices and business oonditions, we must

possess a knowl edge of t he vari.ous types of stock market

movements, their amplitude s and l engths, in order to

understand the i.r different natures. Ther e are usually

three price movements in the stock marke t avera..c:es t hat

can be dis cerned. They are the Major or Primary , trend,

the Minor or Secondary movement,. and the Day-tv-D'lY

fluctuat ions .

The Ma jor or Primary t r ends are lithe extensive up

or down swings wh i ch usually last for a ye ar or more,

8

. and result i n a general appr ecia.tion or deprecia t i on in

values. of more tha.n 20%. ,,6, 'rhi .s trend continues up as

10n3 as each successive rally on the price advance reaches

a higher level · than t he previous one, or continues down

as long as e ach suoces sive decline oarries prices to a

lower level . However, the decline on the uptrend and

the rally on the downtrend must fail to br~ng the movement

back to the top or bott~m of the precedi ng reaction.. It

is t his a;", jor or Primary trend which h as the tendency t o

conform to the business· cycle, and which is r eferred to

as a !tBull 'f or flBear~' market.

The fU nor ~r Secondary movem nts are more frequent

and shorter , l as ting from a couple of wee,ks to several

or ave~ lllauy months . They are the up; down, an.d side­

wise movements of t he avera~es which interrupt the pr o-

ress of the Major trend at various intervals by tem-

porarily moving contrary to it , and they result in the

declines or corrections which occur durinR tl1.e uptrend

and the rallies or recoveries which occur during t he

downtrend . 'fuese Minor movelOOnts gener al l y "retrace

from 1/3 to 2/ :3 of the gain or loss in prices registered

in the preceding swlng,,6of the Ma jor trend.

Due to the duration and amplitude of these Minor

movements , i t seems prob lil ble that they can be attr i buted

oR; Edwards and J. Magee , Technical Analysis of Stock Trends ( Springfield" Massn 1948 ), p . 13.

SIbid., p . 14.

9

to t he actions of the s peculators operating i n the mar ket.

These specul ators genera lly will over ... expand in attempts

. to t ake advant age of impending price ehanges , a nd then ,

over- contract in t he opposite direction in attempts to

correc t t heir previous errors . For this reason , t he

lnar ke t in t he rU nor or Seoondary movement va c i lla tes in

an at tempt to adjust to t he Ma jor trend .

ne shoul d not thi nk that t he. Minor moveme nts are

independent o f busine ss conditions and prOSp\3cts lor t he

f uture , for t hey ar'e not . However , t hey are set off by

events whose s ignifi cance 18 exaggernted by current

prominence , if the techni cal cond i tion of t he marko t 1s

ripe f or a rea ot ion. After they have r un t he i r oourse ,

so to speal{ , tbe marke t prices will again re SUID.e the

eneral direc t i on of t he Ma jor t rend and t he business

cycle . 7 Thus, when .the stock ma.rke t averages are moving

i n a. direction opposite to t hat of busines s , it is tem­

poraI'11y over .. bought or over - sold , and in time '11111 a gain

ad j ust to the Major or Primary tI'Emd .

The Day- to-Day f luc t uations are the t hird t ype of

stock market p rice movement . They l ast s everal de.y s,

usually l os s t han six, and rar ely as long as t hree weeks . S

"No cy clical pattern can be found for t hese •••• ex cept to

sun:i:j;est t hat extremel y s harp gains or declines f or a few

hours or days seems usually to be ' corrected ' by r ebound ..

7E . G ~ Bra tt , Busines s Cycles and Forocast lng( Homewood , I ll ., 1953 ) , pp . 496- 497.

80p • c it ., Edwards and Magee, pp _ 1 3-14 .

10

inl-t movements in t h e opposite direction. n9

These fluctu a tions are usually not predi ct able

-except on news of considerable moment ; such as t he thre at

of war or pea ce , the outcome of an election , a. strl~e or

any other event of Such a nature . Na turally ; a s timul us

of this ~y:pe, may be t h e beginni ng of a. SUbstantial Minor

movement , but the Day- t O) .. Day f l uotu..'l t lons , t hemselves ,

onl,y constitute changes of a,ccldental or trans itory

i mpressions of buyer s and sellers , and t hus , are no t of 10

impor t ance for thi~ paper .

In t h e d isoussion of these price moveIllents in t h e

stock Illa.rke t , we have spoken in terms of averages , but

we mu st not for fJ..et tha t Individul:al s tocks st ill have

reta i ned t heir own ind ivid.ual f l uctuations . '!'his mu s t

be noted , for at anyone t1me , at any phas e of t he

bus ine s s cycle or mar ke t movement, qlffer~mt c orporat ions

and industries are a t d Lf i'o::.--on ti sta.ge s of t he i r own

ind ividual cycl es , and not all can be expected t o move

dire ctly parallel t o ,business or even the gener al marke t

trend . Therefore , in times of pr os perity some depl~es8ed

fi r ms and i ndustries can be found , and in times of de -

,pression, some tha t are except i onally pros pe r ous . This

can be understood for the ve.rlous indus tr ie s with t he i r

different products are affect;ed to 0.1 vergent degrees ,

and amplitudes of firm ' s securi ty prices will vary with

' 9J-;C~C-iendenin, Introducti on to Invesbments( New York , 1950 ), p . 2 21

l01b1d., p . 224 .

11

changes in demand a nd profit s . ll However , the more cyclical

movements of t he s tocks will still reflect t o an i mport ­

ant dee.,ree t he movements of t he busines s dycle , fo r t he

primary basis of their value is in profits , and corpor-

at ions , as a whole , have seldom moved contrary, for an

extended time , to t he main swings in busine ss condItions,

IlG. W. DO\i;rie and D. R. Fuller , Inve s t ments {New York , 1941), pp . 133-134 .

CHAPTER II

The Relat ion between Bus iness

Conditions and Securi t y Pr i ces

12

BUS INESS ACT :! V ITY ~Q .~ STOCK

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e are now prepared to inquire into t he r elation

be t we en bus iness conditions and se curi ty pr ices . This

can bes t be a ccomplished by ch arting the h i s tories of

both series over t he past fifty- f ive years,

13

14

After examin1ni the chux-t one ean concl ude that

t he iie..Jor t r endaoi' t ll.e snook markQt land to some ext ent

e ven t he rU nor movemonts hQve gen@:r~\lly preceded chanc~e$

in bua ines f.) llct1vi ty • . ~b1le t h is 1s not true in all

OQli.!l e s , es pecially i n t he l ast fi ft een years due to t he

lUul t1p l1cl t y of fac tors which ca.n onus e pric() f l uo t uations ;

t he s tock It'HlU:,k t, t has at!ll sl.lijntly led the b US i n e s s

cycle .

This conC1UtLi on is 611tistant1s t ed by v '~ rl0tlS 3 tudl~s

Which have a l eo exami ned th~ r e lationship between the

tVIO s eries . We s l ey C. Mitohell ocmcl ude s t h a t nstock

Illarlicet t ransaot:tona tlnd pr1ees . . .. riae befor e t he t r ough

in aeneral bUSiness a c tivity 16 reached and fa,ll bet'ore

the peak,r 14t1mes on I\:he ri se and 1 3 t l 111ea on t he tlnll

1. in 19 ~iajor business 01c10$ trom 1'858 to 1933.

Huebner !rta tes th9t:

Without except ion every major busines s depression or boom in this country h ilS been disoounted by our security mar l!;:E'lts f r om six months to two years before t he dull t1mi s or tho pr osper ity be came a r e f.l, l l ty,.

ual-field Drew mention s t lu\ t; i n 26 mfl jor r e vel'sale

in t he past 90 years , o t {)clt pt' 1ces lli3.Ve lajjj,sed in 01.11 y

I; C('iS~iHJ; a nd t h e t hne o f an t i Cipation by t he s t ock market

i n t he o t he r 21 c ases ranged f rom 2 ,to (3 months . :$

Ayres in a study of' 25 cye1es f rOIn 18 129 to 19:38

concl udes t h !!'t in. t he typ1celoyo1e , the top of s took

--Xw. c. ~1tohell . Whn,t Ho:ppf.tns During fjU. S1:r:'l6 I~ S C:r)"oles ( Ne w YOI'k , 19 51), p . ? 2 .

2°12. 0&. Huebner '. p . 39 . 30 . Draw ; Nsw !,~ethode f ol'" Proft t i n t h.e S took tEarke t

( Bos ton , 1948T . p . 19 . ~.-. . --_ . - - -

15

prices was seven months .in advance of the top of business ,

and tha t in t he downswing ; t he low of t, tock marke t prices

was flve months in adve.nce of the low of busin ess act -4 ivity.

Haney maint a ins t h l) t:

In all history , a t least s i nce 1884 , the r e are no more t han two cas es i n which it oan be s a i d th~ t t h e stock marke t has seriously or persistently i gnored busine s s. Of course , sine e t he 8 tock mar ke t generally aoticlps.te s t he trend of business ac t i vity , a c ross section a t a ny g iven time may reve al stocl{ down and bus i nes :'1 up or vice versa. Such divergencies , however , merely emphasize the inner- rel a tion". and they a r e naturally f ound near the 5u rning- polnt s on the bus iness oyole. ,

Despite t he fact t h At d ifferent figures were noted

in ea ch study , the oonclusions were sUbstantia.lly t he

same , and although thero were exceptions in each , these

excep tions do not disprove t h e general t h eory of t he

rela.tionship . However , since a number of these

exceptions have occurred i n the l ast fif t een years , we

will now speclally examine t he rel ationsh ip between t he

t wo serie s dur ing t hose years .

Stock market prices , a s r epresented by the Dow- Jone s

i ndus trial aver age , rose cont Inually during t h e mi ddle

1930 's, and never rea l l y br oke until after the drop in

the Federal Reserve Index of Indus tri al Pr oduction in

1937- 1938 . Stock prices again f ell aft er t he \\Iar began

4L •. Ayre s , Turning Po i nts in Business Cycles {New Yorlt , 1940 ) J p . 67.

SL . H. Haney, Business Forecast l eg ( New York , 1931), p . :510 .

16

i n Europe in 1939 , and continued to drop aft er t lle United

St ates entry in 1941. The psychology of the marke t re-. mained pessimistic about conditions until the average

rea ched a. l ow in 1942 . WhUe t his de cline took place ,

industr1.al produc tion , corporate earnin}.!.s and d i vide nds

were 8.dvancing .

I ndus t rial product i on de clined from l a t e 1943 to

early 1946 , but the stock market rose from t he low in

1942 unti l mid-1946 , paying no attention to the post-

war reconvers i on in 1945. s a matter of fact, t he

decline in business act ivity i n 1945 preceded the stock

marke t bre ak of 1946 by a fu l l year . In '~he sprina: of

1946 commodity price controls we r e scrapped , and a sharp

inflation in pr ices took pl ace for the rest of t he year

and continued upward until mid-1948 . It was thouHht that

a depress ion would occur in 1947 , but it never c ame as

conditions continued to improve until l ate 1948 . Stock

prices , on the other hand , s t ar ted to waver a t a l most

t he SRme da te i n 1946 t hat commodity pri ces be~an to

i ncrease. ' In other words , s tock pr i ces broke in 1946

at the same time that t he infla tionar y forces of World

War II began t o show the greatest eff ects in a decontrol led

price sys tem. Thus , although national income , indus tr i al

product i on, cor porGte profits and dividends were i mpr ov-

i ng , investors were pessimistic Bnd sold securitios .

Aft er the break in 1946 , there was no SiGn of a

~lgnlfic8.nt re covery until aft er mid-1949 , and t he 1946

17

market peak was not recover ed until 1950 . Through the

per i od from 1939 to 1949, industria l produotion r ose

from 109 to 176 , a 61~ increase; corporat e e a rnings

after taxes rose from $ 5 billion to $17. 3 bil l ion , an

i ncreas e of 246~ and dividends incre as ed from $ 3 . 8 billion 6

to $8 . 4 b illion, a gain of 121%.

From 1948 to mld .. 1949 bo'ch corpora te ear n ings and

stock mar kf,t prices fell , but no stat ement comcerninc.

a r e l a tionshI p be tween t he t wo s e r ies can be made , f or it

was only a s econdary drop ; and the break of the marke t i n

1946 coul d har dl y rece ive credit for an t l c ipatinR this

sli ;,tht re ca p- s i on i n busine ss act i vity . These , t hen, are

t he ma jor except ions in the rela tionship tha t have occur red

in the pas t fift een years .

Dur i ng the mi ddle of 1950 sto ck 'market pr i ce s dropped

sharply, wh ile industri a l production . corpora t e e arnings

and d ividends were s till climbi ng . Secondar y movement s

in t he stock mar ke t pre ceded t he drop •. ri s e , and drop

of i ndu s tr i al pr oduction 1n tha t order in 1951 · a.nd 19 52 .

Both s eri es r ose together th:rou~ the end of 19 52 t o t he

begl nni ng of 1953. The s tock ma.rket Dow-JoOt-') s I ndus tria l

aVe r afi: e f el l f rom 288 in January to 266 i n June , 1953.

During thi s peq-' lod, t he Indus tria.l Product ion Tndex of

t he Federal Reserve Boar d ros e 10 points f r om 23:') in

J anuary to 243 in March , but t hen s 11d off 3 points t 'o

240 by June of 1953.

SBoar d of Gover nors of the Federal Reser ve System, Feders.l nesor ve Bulle tin ( Washington , March 1950 ).

18

Nat ura lly , during the past few years, due to the

proximity of time, it becomes diffi cult to make any

accura te sta tem~nts regar d ing the r e la t ionship be twe en

business conditions and t he M.a jor trend of t he stock

market , a l though the stock market avera~te s have risen to

new h l s;hs exceeded only by 1929 ~ indicating t h e present

high level of prosperity. The corre l at ion of Secondary

movements , espeoially since 1 950 , has been remarkable,

and t he dr'op of t he averages in the early portion of t h is

year of 1953 , if the r elationship would hold true, indicates

a drop i n industrial production below 240 of the June 7

Indust r i al Production Index.

Af t e r examining t hese exce ptions, no po~itive state­

ments can be made RS to t heir causes. From t he 1930's ,

it is perhaps the many ref~ulations whi ch h a ve elimi nated

much of the manipulation of t h e stock marke t pr ices by

insiders, thus causing the prices to be influenced to a

greater degree by t he optimism a.nd pessimism of the

eneral public. This, in t urn, has influenced t he in'"

vestors whos e trading h~s lost its professional ~haracter,

and has t aken on , more o·f an investment nature. Then too ,

a pos s ible cause may be the change in the ratio between

a corporation ' a earni ngs and t .heir distribution to invest -

ors.

During the 1940 's the politioal actions , nat i onal

and international, h a.ve pre ::; ent ed an ever- incre6.01ng

'By December of 1953, t he Index of Indus trial Pro­duction had dropped over 10 points from the 240 in June .

t nfl uence over bus iness condit i ons and the e conomic

.worl d , onl y to be f ur thor accentuat ed by t he psycho­

l ?f; ical re actions primarily mot iva t ed by the fe or of

t he future .

Logically, h owever , s t ock mar ke t pri ces should

19

s til l i ndica t e i mpend lng change s in business, since

security prices ar e t he r esult of a consensus of opi n-

i on re f,l, ardint.l:. t h e prospects ·of' busine s s and t he probable

course of future profit s . 'llhe movements of s tock market

prices .should pr e cede the mor e i mportant changes in

bus ine s s a ctivi t y , f or t he s tock mar ke t is mor e re ­

sponsive t o t h e news of cha n(]!; i ng condi t i ons , e conomic

and othe rwi se. By t he t i me reactions, in the f orm of

chan~lne; demands , ar e re l ayed t hr ough product ive channel s ,

t he s tock lnarke t c an d iscount the ear lier f ormul ated

pl ans of the publ ic . From t h ls we ar e able to conclude

t ha t not onl y should secur i t y pr i ces have a r e l a tionsh i p

with business conditions a.nd pr eoede it in the basic

t urns , but when these Gurns are abou t ·co occur , t hey

should become publicly apparent i n t Il e s e curity ma.rket

before they show up in the bus ines s i ndexe s .

Whenever a.n inves tor buy s a c ommon s to ck , he i m­

medi ate l y becomes an e quity holder in t h e business rep­

re1;'ent ed by t hat s ecur ity. Just as i n any oth er business

he be comes i nt ere s ted i n prof it . In a general, but not

l e s s fundamentDl way , h i s own pr ofi t or loss i n t h ese

s ecurities will depend upon t he pro f i t or l os s of h is

business or company . 8 However , an inve s tor will not

wait for ohant!.es in earni nis , but will attempt to

anticipate t hem by examini ng t he faotors whi ch will

oaus e changes in future earnIngs, which he t hen will

discount to arrive at t he present value of stock.

Throu&l:h th'i.s pr ocess of price determination we arri ve

20

at another logicnl reason for t he r e lationship be tween

stock ~Brket orices and bus ines s conditions .

From a psycholog,ic tal approach to the probl em of

t he rela tionship, stock mar ket price s should lead.

business conditi ons , for when lt is generally expected.

by the public tha t economic activity and Drofits .vill

increas e in t he future , t h e opt~niBtic a ttitude will

permeate the investor's mind and a f fe ct his val uations .

On t he other hand , if it is generally bel ieved by 't he

public t hat the volume of business and. profits will be

re duced, the pes fc' imism will al so sway the inve s tor's

valut:i tions . Thus , t he state of confidenoe of t he £,eneral

public wil l oons ciously or unconsciously influence the

inves tor in hi s appr a isal of s t ock val ues . Si nce t he

inve stors do at t empt to discount f u ture earnin~s in their

deter mi.n', tion of prices , ' t hese prices should. f l uctuate

prior to cha.nges in busine s s act ivity.

Regar dless , therefore , of t he tremendous number of

factors that can affect st /) ck market prices in t heir

attempt to ant i oipate bus ines s , the psycholo;;l, ical e l ement

8R. W. Schabacker , Stock Market Profits{ New York , 1934 ), p . 29 .

21

1s always present. This necessitates the examination

of t he state of mind of investors, after e very force

~re aents itself , to see how t hey will react to it .

After t hey h ave made t heir eval Ltatlons , the marke v,

many times , will seemingl y fail to r es pond to important

economic ahan~es , when actually other f actors may be

out we i gh ing th em, and conversely , it may fluctuate

Violently without any traceabl e reason. In as much as

the ma r ket price r e sul ting 1'r'Om evaluations represents

the op inion of Investo~s regarding future expectations ,

the ~ to ck mar ket tends to discount ever yt h ing.

We mi ght note t ha.t pu()l ic op i nion has a t endency

to s way f rom over-optimism to exaggera ted-peasJ..mlsr.t,

and wh ile t hi s could not undermine t he f'undament A.l

economic cond i t ions to any great degra'a in the MSl j or

t r end , it does causa many of the extensive I'llinor r o­

act i ons whi ch deviate from the trend of t he mar ke t.

In t his chapter we have shown th~l t t ho s tock market

prices have h istorically preceded bus i ne s s conditions

and activi ty in most:; cases . When exoep tions to t h is rule

have occurred , e speoially in the mOlfe recent p ast ; there

wer e al ways event s and reasons 6f tremendous i nfluence

wh i ch pro~I:rted the distortion of the rela tionship.

For the f u ture, if conditions, national and i nter­

national, retur n to a more normal keel , t he predictive

ab ility of t he stock market should on a 10 ... 1ca l and

22

psycholoJ.1.1eal bases cont inue to show itsel f . It 1s o.n

th is assumption, t1 r eturn to a sta t e of nor ma lity , t hat

' we proceed with t h is d i s oussion .

CHAPTER III

Price Valua tion and the

Types of Factors a.nd

Conditions Affeet ilJ.e It

2:3

24

Stock market prices are an expression of value which

is determined by the total forces of demand for and t he

suppl y of shares in the markt) t . However, ea,oh investor

arr ives a t hi s own appraisal of va l ue by estimating t he

future income , and t hen discounting this income of the

corporation to the present . It is , therefore , t he vnry-

ing opinion of inve s tors regarding discounted fu ture

expect ~rtions that determines the basic for ces of dema nd

and suppl y s ·t every successive r ange in price . Thus ,

t he capi t al value of' a stock "is simply future income

,I discounted ; or in other words capitalized , ' and since

thi s valuation is a human prooess , the dis counted future

exp ectntions will vary with 6a.ch investor ,

In t he market t he prieing process works IilS follows:

01 ven t h e valua tions of al l the inc11 vidlJ.a l investors , we

ar r i va a t the total markot demand and supply . As long

as the price is such t he. t t he quant ity of shares whi ch

t he investors want to sell , do not equal the quantity

which t l1ey want to buy,. there will be a tendency for the

price to change .

If the market pr I ce is such t hat sellers in t he market as a whol e wi sh to sell more t h an t he buyer s in the mar ket wish t o buy , t hen the price mu s t fall. I f the marke t price is Buoh tha t buyers as a Whole );113h to buy more t han se llers wish to sell, t hen the priee must rise . 2

Eventually t her e will be a pr i ce r ea. ched at wh ic h t he

11. Fishe r , The Theory of _fEteres t( New Yor k , 1930) , p .. 12 .

2K. E. Bouldirl{j" Economic Ana lys i s ( New York , 1948 ), p . 60 .

25

quant i ty t h a t buyers wish to buy e qual s t he quanti ty

t h at s e l lers wish to sell , and t his 1s c a l led an

-equili brium price . However, at this price t h er e s till

are sellers who t h ink t he price is too low, and buyers

who t hink the price i8 too high , and they will not t r a.de

wi t h ea,ch a t 'her until someth.1ng chana es their de s i re t o

rema. in in t he srune financi a l position. lffuen "investor s

ohange t h e ir views , buyers will outnumber sellers or

3 vice ve r s a , and a n ew price moveme nt wi ll be set Up . ff

To r e ite r a te , t h e pr i ce of a s t ock is dete r mined

by the jud AIllents of inves t ors a s to t h e d iscount ed v a l u e

of f u t u r e i ncome . This discounting or ca.pitaliza tion

proce s s comb 1ne s t he t wo f actors of pr ospe ct ive yield

or retur n and t he p r e spectl va course of t he mark et r a.t e

of lntere et . 4 'rhus , t h e value of a s toCk will be t he

capitalizat i on or dlscount ln& by investors of t he

company ' s an t i cipa ted income a t t he current r a t e of

Intorest . 5

The r ate of inter est at whi ch an inves t or d i s counts

earni nR:s include s t he basic interest r a te plus an addition-

0.1 inor exl1 ent for t he r i sk Invol ved in any par t :t cu lar stock .

St a. t ed i n a s i mplif1ed f ashion , t h e va l u e of a sha r e of

st .)ck refle cts principally t he exp e cted futur e earnings

d i scount ed at a r a t e cOmL~ens urate ' wi t h t he r isks involved ,

and then adjus ted for a ctua l div idend prospe c ts .6

0 L. L. B. Angas , Inve st'l'i e~(l{ew York , 1930) , p . 1 43 . 4A• Marg e t , 'r h a Theory o f Pr i c e s( New York , 19 38 ) , p . 240 . bOp . c l t., lUndell, pp . 1 26- 127 . SOp . c i t ., Jordan , p . 113.

26

An e.xampl e of di scounting or capitalization of

earnings may more clearly illus trate the procedure by

which present vL\lue i s deter mi ned . If t he anticipo. ted

earn:tnR.s on a shar e of stock are $3 . 00 , and t he capital­

i zation rate is 10%, t hen. the valu.8 of the s tock is

$:;0 . 00 , If the ea rnings remain the same , but t he r a te

of capit a l ization -ls r educed to 6%, then the value is

18 . 00 . Thus, the value of the share of a back may change

t hrough t he inf luence of t h e interes t r a te at which

earnings are discounted , despite the outlook for e arn­

Inf~s remaining the same . Oonversely, the capitalization

rate may r emain t h e same whi le expected e arnings change ,

thereby also causing a Change in value of the8tock ,

rPhe description just concluded is d efinl t e ly over-

eimplH'led and many a dd! tional factors whi ch occur in

reality have been ex cluded . In theary we have assumed

only one ca.p italization r ate, wher eas fl there · is no unifor m

rate a t any one time , but r a t her a hierarchy of different

r a.t es de pendine, 7 n d iff e r ent factors." This point will

be e l aborated i n the s ection of Interest Rat e s i n Chap­

ter IV.

Fur t h er more , wben referr i ng to the ex.)octod yie l d ,

we have as sumed one retur n , in spite of the f a ct th1,! t

t here may be sharp d ivergence s between the yiel d estimates

of var i ous i nvostors . CombininJ?: both determin~J.nt s , the

rate of cap italization and t · e y i e l d p r o s pects , we must

70p • cit .; Mindell , p . 119 .

27

further realize t ha t naIl things were held constant U 1n

our analysis , wh ereas in real ity , changes Bre constantly

t aking pl a ce which would require add itional qualificat ions

1.n t heory.

Havin~ examined t he procedure for detorrnin lnb s t ook

ros.r ket prices , we are now pr epared t o anal yze t he types

of f ac tors fl nd conditions t ha t affec t t h em.

There ar e two types of f actors and conditions whi oh

affect sto~k market prices . First t here are the fun~

damental wh ioh orig inate and ex.i s t outside t he s t , ok

mar ket 1n the economic world . Thes e are t he basic or

unde r l y i ng causes of price changes wh i ch over a. lon

period of time must have t he major i nf l uence on t he

market pr i ces . Se cond , there are t he t echni ca l which

opera te entirely with in t he marke t mechanism or beC ~l'l.lB e

of it , These a f fect s tock market prioes regardle s s of

what t he f undamental oond itions or f aotors may be , but

th e i r eff ects are s!'lOr t - li vad e The s e two types of f a otors

and condit l ons may work together , or as oppos i ng foroes ,

thus causin8 the mar ke t to be "technically weak:' but

"fundo.ment ally strong: or the contra.ry whi oh a lso may

be true .

The funda.ment al fa c t ors and cond ltions are t ho se

economiC , politioal- national and international , psycho­

logi ca l , a nd nat ur al for oe s outs ide t he mar ke t which

control the marke t trends , either fo r ind ividual stocks ,

or for all stock s as a whole . Si noe there are t housands

28

of investors ope rating in the ma rket , e ach attempting

to f oreca st t he trend of prioes to some degr ee , their

dec i sion , as to the trend , will be primar ily based on

t heir estima te of the strength or weakness of these

fundamental condit i ons as t h ey affec t earn 1. ngs . It is ,

there fore , e arnings that const i tute t he most i mportant

single f aotor in determining stock mar ket prices .

An inve stor , however , mus t eval ua te al l the fun­

damental f a ctors and conditions u s they present them­

selves i n terms of an e f fe ct upon future earning power.

They will , then, attempt to operate in the ma rket on

these val ua tions prior to t he actual changes in e arnings ,

since t hey will d iscount the future to arrive at t he

present value of a s t ook . By doing t his an investor

minimizes oha nge s in diVidends , whi oh he con6ider~s

secondary to earnings , and merely t heir reflect ion, and

so will concentrate upon prospective ohanu:es in earnin

power . By t his reasoning , a fundamen t al condi tion be­

comes any faotor whi ch indicates a change in future

earnln~s , for t h is is the primary basis on which invest­

ors as tablish stock nw.r ket pri ces .

Technical f ac·tors and conditions are t hos e which

arise within t he market meohanism its elf, and are con­

trasted to the f undamental conditions which we h a.ve

just discus sed . We migl:1t indicate a few of the more

important techrlcal conditions whioh allegedly affect

market prices , but no analYSis will be made as t o the

29

de a.r ee of t h e i r i nfl uence . This mu s t be noted , for'

i f anyone f a ctor or condition had a. part lculareffect .

for a period of time , it is cer t a in t hat traders , attemp t -

in;, to cap italize on it , would des troy its val idity .

It is ~enerally cons idered th ~l t volUlne goes with

t he t reml . If t his were true , volume shoul d increa s e

on the r a.llies in the uptrend and d ecline on reactions ,

while in the downtrend , t he volume would iner e':l se on

r eactions a.nd decline on r a l lies . Also , heavy volume

at the end of a cons i derable movement 1s thought to

indicate the end of the trend a nd a. turn:i.ng point .

It 1s believed t n nt t he rrarke t 1s "t echnically s tron,, 11

when s toele i s accumul a ted by "s tron,ger hands " such as

institu ti ons , i nvestment trusts , and the like . Buyer s

believe tha t t h ey c an hold stock agains t mos t r eactions

for a def ini te rise . On the other hand , when s tock i s

held by "weak ha.nds , " the market is considered "t echnica l l y

wea.k , ft for a l anl;e amount of s t .) ck is be i nn: held on

me.r~ins toosll1all for comfort .

The presence of stop orders to sell 1s cons i dered to

make t he marke t II technically wes,k , II for i f it hits t h a t

l evel , the orders will be thrown into t he mar ket , t hereby

forc in!J: t he prices further down . Short selling also

make s t he mar ket "te chnically weak , " al l othor thln~s

being equa l . Eventually , however , if shor t sell i n -'

decline s and a l ar b6 short interest 1s accumul ated , t he

flU r ke t become s "technically s tronger , II since short sellers

30

must cover to a grea ter extent .

Resisi:;e nce level s are popular devi ce s with traders

who seek to f ind tldouble and tr i pl e top s fl t h a t are

supposed to indi cate "technical weakness" i n the sens e

t hat the market has been unable to peTI3 trate t hrough

t hem in previous r a l lies . Conversely , the market is

supposed to be ·'technically s t rong" when it f a l l s to

some "double or triple bottom. "

It i 8a180 th.ought that the longer a trend continues

without a react i on in the .oPPosite direct i on , the "t e ch ­

nical ly weaker" t he bull market would become , a nd t h e

"technically stronger" a bear mar ke t Vlou l d become ; for

t r aders will not postpone profi t - t aking much lon~er .

The Dow t heory in its use by i nvestors 1s a t ech­

n i cal f actor for it is often possible t o detect 1n the

mar ket 8. notioable r al l y or de cl ine when the t wo averast8.8

f1co nfirm" a trend . The Dow theory will be discus s e d

i n det ail l ater in this chapter .

~'hi l a t here i s no a c cur ate wily of measuring the

comparative 1nflueneesof the t e chnical and fundamental

conditions u pon the ma rket , a f avorite t heory of finan­

c i al writers i s to re l y upon. the techn i c a l f actor::! to

expl a in t he short-te r m r evers a ls i n the l'1a. rket . However ,

it 1s doubtful if the!'€! ls an ade quate basis for t i1.1s

procedure , We , neverthe l ess, vlill admi t tha t t he tech ­

nical fact ors will more l ikely i nfl uence the a ct ivities

of t he prof es sional and specul a tive i nterests , r a t he r

31

t~an those of the long-te r m inve s tor , f or t hey seek t o

capture only a few points a t a time , a.nd by doing so

attempt to make profit on the Mi nor or f econdary move -

ments in the mar ke t . Therefor e , t hey care little for

t he lb:l. jor t rend , but a r e gr eat l y concerned with t he

r al l ies and r eact i ons on t h at t r end which mayor may

no t r un paral lel t o I t.

Pr evious l y t hese traders ~ere l a rgely mars i n t r ader s ,

bu t with t he de cline of ma r gin tr A.d inl:.~ many of t hem have

become cash traders , but t he.:tr ob jective is s till t he '. -

s a:lle .

It is def initely true that the t echni oal factor '"

of a pr ofess i onal nature have dec linod substant ial l y in

i mportance a s compared wi th the conditions prior to 193..; .

Manipul at ion was once a ma jor t echni cal foroe alone:; wi t h

corners and pool activi ty , both of wh i ch ha ve been the ·

oretioally e l imina t ed . In addition , many r egul at i ons

by t he New Yor k Stock Exchange and t he Securi t ie s Exchanbe

Commi ssion h ave r educed other technical force s s o i mportant

in ear lier years , and in do! so h as helped the ma r ket

t ake on more of nn i nvestme nt character .

In c?ncludillt.> the discus sion on the t e chnical factors ,

we feel obl i gnted to note the i mportance of t he Dow theor y ,

whi ch has pl ayed in t h e past , and doe s pI ny i n t he present ,

a. definite t e chnical r ole in t he s tock marke t . It is

with~ut que s t i on t he most widely a ccepted indica t or of

oarket moveme nt s by bot h i nvestors and inves t ment servi ces ,

32

a.nd t herefore should be oonsidered her e .

The Dow t heory was originally simpl e and wholl~

empirica l f It was based entire ly on Charl e s Dow's study

of t he stocks whi ch comprised the Dow- Jones averabes ,

w!1 i ch he al so originated .. At no time d id Dow himsel f

attempt to define his t heory , but he wa s merely content

to present observa tions in the Wal l Str eet Journal alon-

wIth t h o8e of his associa te , S. A. Nel s on . The t heory 's

princ i p le s were l at er formul a ted and popularized by

illiam Hamilton during h is ed i t orship of t he J our nal

until 1929.

rrhe t heory does have a very oonside r able fol l owinf:) ,

and 1s without qU6 ;,J t:!.on t he best known of all systems f or

i ndi ca ting stock marke t t r ends . It ha.s been extensivel y

defended and widely critized , but 1 t is still not a

system for beating the mar ke t , a.nd WfiS not so cons i dered

by e l t h er Dow or Hall'l ilton. Irrespec tive of its soundness

or wor kability , no s t udent of the s t ock mar ke t can be

s a i d to be well-versed, if he does not know its essential

f ea tures , and for t h i s reason an expl ana t i on of t he t heory

finds n pl a ce 1n thi s t hests .

Much has be en written a bout t h is t heory, and several

men have amplifi ed , extended , or modified the or161nal f ollows, h owever , wi ll be

theor y . The discussion whioh . confined a s far as possible to t he ori&lnal t he ory , a s

it was pre sented by Dow and Ne lson, and developed by

Hamilton.

33

Both Dow a.nd Hamil ton believed that t he theory

could forecast ch anRes in businoss. In f qct, that appoars

to have been i t s ori~inal purpose , rat her t han to indica.t e

stock mar ket trends . Lat er the t heory developed wlde ­

sprea.d popul arity becaus e of i ts alleged a.bil ity to

f orecas t t he stock market . Tha t t he theory could f ore -

cast business vms t hor oughly believed by both men . Said

Hamilton , fl our barome t er do e s pr edict the cond it i on of

business mnny months ah ead , and no othor index or com­

blnat.i on of indexes Oan do that . fl8

AlthOUfi!h Hamil t on wa s convinced of t he ability of

t he t h eory t o a l s o forecas t t ie r ke t, he deni ed t ha t

it was a s cheme for flbnating the marl{o t. fI He r ather

cons i dered it t o be a t heor y whi ch could benef it t he

i ntelligent investor ·'1'/1:10 would find i n it a method of

protect in~ himsel f a~-l;ains t cban;.:;es in the t r end o f the

1.1ar l{ot by a careful s t udy of t he ac tion of the I'lver ns..;e s ..

The theor y is b8. sed on the fundament al premise

that at all t i mes there are t hree movements i n t he s tock

mar ket ; the primary , t he secondar y , and t he da ily , all

of wh i ch operate Simul taneously. Thes e movement s corres -

pond in t ype and action to those enumerated i n t he f t r st

chapter . Another assump tion of the the ory is t hat the

stock mar ket cyc le will be irregul ar, and t he us e of t he

t heor y will i nd icate when e i t h er a bull or a bear market

has begun . but it will not pred ict how lon~ it will l as t .

8~;1~: H : ~ii~il ton , The Stock MaI'ke t Ba rome t er( New Yor k , 1922 ) , p . 56 .

34

Both Dow and Hamilton used 'ehe Dow- J ones industria.l

and r ail a.verages a s t he key to t he market interpre t '. tion .

To g ive a posit ive i ndi cation of the trend , these t wo

uver at:>e s nm s-t cor.roborate each o ther . The manner in which

th i s hanpens will soon be dis cus aed .

Business conditions and t he bus i ness profits depend

not onl y on present orders and back or dors , but also on

pT'ospects f or f uture or ders . The indus t r i al stock

uver!tw.e should r efl ect t he investor's appraisal of

f ut ur e earnings of the r e spective compan i es , wh ile t h e

r a il averac e should show t he sa.me for the f u ture e arnings

of t he var ious roans compris ing t hat averae "" . The I'a ils

will show t h e mo¥ement of boods in commercia l and indus t-

r ia.l channe l s , although they are less copabl e of do i n

this accurately today , since many compet l n£'l: B.Jl:enc ies

now carr y a large volume of tra ffic formerly handlod by

t he roads . Hence, the two aver ages , i n theor y , wil l

show t he investor 's di s counting of fut ure earni ngs ,

production , and t he movement of goods ~

The other basi c premise of the Dow t heory i s t hat

a movement is indicated onl y a f ter a conf i r ma tion t akes

pl ace . This happens when one aver a·ga f ollows t he other

in the same direction, and only \-men t h i s occur s is a new

moveme n t e stabl i sh ed . The confirma tion may t ake t he for m

of e i t her a "mak ing of a l :1. ne and br eak "' out , II or II no,'

h i ghs or new lows;! by t he averages .

Technically speaking , rtm'1k1ns a line n is an action

35

which occurs when an average fluctuat es within a narrow

r artN.e f or a number of weeks . This r ange may be al t haI'

three or four po ints . Dur i ne; t h i s time and spr ead the

market is in a period of indecision , for t \· ,e buying and

sell inll. f orces are approximately equal. It should be

pointed out that both averA~e s neEi'd not m.alie t he 11ne

at t he same time , but may be days or even we t1ks apar t .

Once both averages push above this line or narrow band ,

however , a bul l i sh signal is g iven . On t he other band ,

if bot h averages break out of the so- ca lled IIdown- side , "

the indi cat ion 15 bearish . Unfortunately , the average s

do not indicate if this confirms.tion i s of a primary

or se condary movement.

The other .manner in which a confirmation is pos s i ble

is by both indus tr :l al and rail a verag,es e xceeding t heir

respective previous highs or f al ling below t he ir previous

lows. Ac cording to the t heory t h en , the bull market

will continue as long a.s eachllverage ma. kes a. new h igh

as compared t o previous pea.ks , or oonverse l y , a bear

Il'.arke t will continue as lank!. a.s e ach low point is lower

than t he previ ous low point.

Ac cordi nb to Hamilton , as expl a i ned by Robert Rhea ,9

the mar ket i s said to fore ca st solely by movements of t he

e.ver9 ~es whi ch d i s count everyt h ing . There fore, t here is

no ba.sic need to consider volume, t o intDoduce other

series, or us e extensive charts or recor ds . Ne i t h er are

studies of doubl e tops or bottoms and like forma tions

9Ft ; Rhea , The Dow Theory( Blnghamton , N. Y., 1932 ).

36

essentia.l.

These are the basic principles of '\:;he Dow theory ;

and without cr1 ticizln~ or defending them,. we will

mere l y ma.int a. in tha.t in spite of any short-comings it

ma.y possess , it still is the mos t gener ally accepted

a.nd widely- used t heory of indica t ing changes in the a t.oak

ma.rket price movement s .

OHAPTER IV

Factors and Condltions

Affectin}! Stock Market Prices

37

38

The f a ctors and conditions which affect stock ,

market nrices were previously d ivided into t wo gener al

·cate lZ.orie s - fundament al and technical . I n t h i s chapter

we will list and d iscu s s t he diffe r ent fundament al f '\ ctors

i nfl uencing stock market pr i ces under four sub-divisions ,

beginning wi th economic , t hen considering the politi cal-

nationa l and lnternation~ll , psychol ogical and natur al i n

that or der .

ECONOMIG

Esrnings

EarninJ.'(8 must be regar ded as t he fundament al bas i s

of marke t val ue. No other faotor has as much direct

influence on stock marke t price s a s t h e net pr of i t of a

corpol'ation, and al mos t all other factor s are viewed i n

t he ir r e l a tion to , and af f ect on earnings . Becau s e

earnings are more s ens i tive to chang :tng condit ions t han

any ot her f actor in price de t ermination , t hey ar e likel y

to r eflect , more .accurately, t he improvement or dec l i ne

in t he pos i tion of a compan¥ ' s stoCk , l

Na t ur ally , t hen , a company which cons i s t ent l y '::min-

t nins ne t pr of it s i8 l ess vulner able to pr ice drops i n

t heir s tock , even when o t hel" r a ctors a.r e f orcinr.: t h e

lI1a l"ket i n t o sha.rp decline . A gr owth s t ock is more s t a.ble

and commands a pr emium i n price , for inve s t ors are con-

slder inR t he fut ur e potent ial s and o r e wi ll i ng to pay

T See f or ·thi s view, E. Me ad and J . Grod l ns ky , The Ebb a nd Pl ow of I nve s t ment V9l ues( Uew Yor k , 1939 )-. -

39

on the anticipa tion of the f u ture increase in pr ofits .

However , d i ffi culties confront one in an evaluat ion

of' a particul ar s tock , for e arning s a r e not mCHsured by

an absolu t e s tandard . The net inc ome 1s alway s a. r e ­

sidual amount , but 1s only ob tained uft er incl udinI.J: and

deductin~. other items , many of whi ch depend on mamit"er iHl

di scretion. Thus t he accountin~ pr a cti ces of the firm

ca.n resul t in the over or under-vnlua t ion of net income ,

and conseauentl y , t h e over or unde r - eva l uation of its

8took ~

Even if net income were properl y determined , the

apprais als of indi vidual s r egar ding it wou l d di ffer , and

t he r e woul d be 8 l a ck of agreement over its r e l ative

sibnificnnce . Since investors a ttemp t to dis count futuI1e

earnings , before t hey are announced or even made , e a ch

investor will arrive at his own valuation . Only aft er

this is added to the remaining vrtluntlons in the marke t

will the total forces of demand and supp l y det ermine t he

stock pri ce . Thus , it is the varying opinion of invest­

ors re~ " rdin~ discounted future expectations t ha t deter­

mines the demand fo r and the suppl y of securities a t

every success ive r ange in price .

Dividends

Dividend s are anoth er i mportant f ac tor which can

exert an influence on stock market pr i ce s . Or dinarily

dividends a re payments out of pr esent e nd/or pas t

40

earninlls , 2and , since undistributed corpora te earninks

oannot be spent by t he stockho l der , dividends wer e (it

one t i me regarded as the domi nant f actor in t he val uation.

However , in r e cent years t h i s t heory h as lost ground for

dividends are t he produ ct of e arnings , end over a peri od

of time they must/be adjus ted to changes i n earninb power

despite a possibl e lag in t h e i r d istribution . Then t oo ,

"dividend policie s may r ef l e c t , numerous additional fac tors , tl 3

like t he plowing- ba ck of s arnine s into the corpora t i on ,

wn i ch would eD-hance t he fu t ur e value of the stock re ba r dl e s s

of t he present l a ck of dis tr ibu t ed d i vi dends .

I t is of course to be expected that a stock of a

more specu l at ive na ture wi ll r e quire hi fl.her d:l.vidend s

t o maint a i n a price level , than wou l d a s t ock of a time -

pr oven quality or investment t ype .

'rhe antiCipated or increA~ ed dividends of one company

or i ndustry can pr oduce a subst an t i al increase in t he ir

stock prices , and can also affect t he s t ock price s i n

similar or r el ated lines . I nversely , a s t ock pr ice may

subs t anti ally drop when a d i vidend ,i s r educed or an e x-

Dected increase does not ma.teriallze . 'rho s ame is true

when rumo r s spre ad reg ar ding a de crease of a dividend .

However , in the l a st sta, e s of a bull mar ket div idends

and even earnings !llr e somet i mes i gnored by overly o ;J t l mistl c

specula tors who s till hope to sell a t a still higher price . 4

ZOp . cit ., Ol endenIn , p . 47 . :!lOp . cit ., Dow-r ia and Fullor , p . 534 . 4R. E. Badger and H. G. Gutl1mann , Investment Princi ples

And Pr nctices ( New York , 1942 ), p . 823 .

41

Thus , div i dends will affec t the va.luo.tion of investors ,

for buyers a r e generally influenced by t h e return on t heir

investment .

Interest Rates

"Once earnings are deter mined and dlvldend<1 are

paid , t he r a te of i nterest be come s an i mportant long ­

t erm determinant of conmlon s tock marke t pri ce s . ,,5 liThe

rate of interest may be regarded n ot only a s a ' cont ­

factor ,' but a lso as a 'c apitalization f ac tor' . ,,6 In

t his discuss ion we will first treat the latter function

of the rate of interest , and. by do i ng so , ca ll f urthe r

attention to t he difficulties encountered in attempting

to es t ablish "t hen rate .

Norma. l l y , t he usua l a ns wer to t he que s tion: at

what r a te sh ::m1d f u t ure income be capi t ~lized ?-1s t h e

current r a te of intere s t . But wher e is this r a te to be

found? What e conomi s ts p;snerally ca ll the l ong - term

r ate of intere s t is i n .re a l i t y not one r a t e , but a

varie ty of diff erent r a tes . There is a d ifference between

the r a te of return on capit a l o.ll'"'e ady inv€ls t ed and t he

rate at which new funds arc a va ilable for i nves t ment .

Thero i s a lso a wide spread between t he various r ates

at which funds fire a vailable for various use e a t any one

time , 1l1ons with t he f a ct that r a\.; es wi ll vary on any

part i cular investmen t a t di f fe r ent times . In other

-- OJ . Grodinsky , Investmen t s ( New York , 1953 ), p . 37:? 60p • cit ., Marget , p . 232 .

42

words , there is no singl e r a te whicb a r.m be churac t er-

l zed as the current r ate of interest .

The so lution to t he probl em seems to l ie in what

is t ormed t h e natur a l r a.t e of interest ffwhich is neutral

i n r espect to commodity prices , and tends neither to

r aise nor to lower t h em. 117 I t i s the ro.te a t which the

demand for loan capita l and the s upp l y o f savings exa ct l y

rlLree or which more or l es s corresponds to the expected

yiel d on the ne wl y cr eateti caPi t a l . B

At any p articu l ar time t he deviat i ons of actual

rates from t h e natura l rate on t he d ifferent investments

are due primar ily to t wo f aotors - the difference of risk

and the vnr i anoe in the demand for and s up .,l y of savinlts .

The form.er i s true bec ~mse t here will always be rel a tlve

pOS itions of pre f erence a ccordinG to r i s k , and t he l a tt er

i s t rue due to t he difference be t we en the amount of

i nvestment funds actually offered from the a va ilable

su pol y of sav ings , and the tot a l amoun t o f f unds demanded .

If the total amount o f f unds offered are breste r t h an

t he sup ')l y of s a Vings , the additiona l nortlon 1s pr ovi ded

by bank cred it , while if the s av ln~s fi re hoar ded r a t her

thnn invested , and if t here 1s no call for credi t ex-

oan$10n, t h e t<l> tal supp l y of funds may fall short of

t ho s e demanded . We have t h e natur a l r ate of intere st

only s t t h e p .)i nt where the suppl y of ss.vinlJ:s and the

de~a~d for loan capi t a l i n ters ect .

'7K. Wtcksell , Intere st and Pr i ces ( London , 1936 ) , p . 102 Sct . N, Ha.lm , Mone t ary Theory(York;" Pa ., 1948 ) , p . 330 .

43

It is to be expect ed t h l'l t t he market r at e of interes t

will devi at e from the natural r a te of interes t owin

t o the l ack or over - suppl y of s avi ngs , but i t will a lwa.ys

tend to coinci de wi th t h e e ven , ever-chane,ing natur ell

r ate . 9

The influence o f t he interes t rate as a "cost - f act oI' ll

i n doing business is generally minimi zed for it is felt

t hat t he cost of borrowed money 1s generally smal l 1n

r olation to t he prof i ts derive d from bus iness or price

l evel change s , exoept perhaps in the heavy indus tri es .

The range of possible varia t;ion in the otber f a ctors t h Rt enter i nto t he calcu l at ion of expected prof it and i n t he es timates of the pr obability t hat t ho given expected profits will materi ­a l Ize , a re so wi de , in mos t fields , that ohanss e in int erest cosbs are u s uall y too small re l 9.tive to t hese other sources of

10ariat i on to have a

major i nfluence .

The influence of i nteres t rates a s a cost-fac tor

1n stock s pecul at i on has been c a st i nto doubt . The

t he ;)r y was thAt cheap !!loney made funds ava i1aol e for stock

po cul a tion a t f avorable r ates . 1'he spe cul a t ors vnul d

t)or ro Vt' fund s a t low rates a nd receive a. hIgh return

from t he i r stock ownersh ip , and becaus e of the d ifferentia l

between t he stock yield and t h e cos t of call rooney , t hey 11 would no t a hands ome pr o f 1 t •

As a mq tter o f fa ct , however , t he cost of borrowed

funds is luuch less i mport 'mt i n s pe cul at ion tha n has

90D• cit . , Wlcke ell , p . 117 . l OOp . c i t ., Mindell , p . 124 . 11G. L. Leff l er , The Stock Market( ~e w York , 1951 ) , D. 477 .

44

Lenernlly ceen su:p')osed . The spocul ator who borrows

money to buy dl v1dend- pRying stoc ks r a ce! V€HI only

slight. profi t when commiss1ons snd t <:lx (:. s are doductEH.;. ,

and a (iseline of 11 fe w potnts in the price of the s tock

w~uld wipe it out complet ely. It is only wben a spec ­

ul a tor expec ts tis. con sldo!,tli:J l e r i ne in s eourity p rloes tr

hat he !l ow1ll hardl y be deterred by 11 hiM interes t rate . ,f1 2

Thon , evon n high intor e s t r a te , pn i d onl y for a fe w days ,

Is fa small item of eos t compared to a sul.>s t ant1al rise i n

stock pr ices .. This expl Q1ns in part the failuro of a

hh,l1 i n t erest rate to check specula tion l>

A etDtls tlcal examina tion of interest r~tes and

stock prices foi" t he poriod from 18 71 to 1922 was mlide

by Owens and H.~I'dy~3 he two series were compared from

the view of t h e d1ffe t'ent movements- day- to- d ay ,

seasonal vurlutlons , aIrl cyclical chan~es . For the firs

two 1tems , t here was no evidenc e o f an influence of

interest r~.tos on stock Ilarket prices , but i n the last

Ii C(~t'tctin d elJ.X"{l)e of corre l a tion was f ound . 'l'b.e o.u thOl?8

concluded , howe ver I thqt this implied no c a us a l I'elat1on-

ship , but t h " t both interest r a tes and stock lT1'lrknt

pr tces v;ere influonc ed by outside f ac tors t:1ore t h an

t hey wero i nfluenced by each othar .

12~, I:' •

fi'Or' I'1A t 1

We do not con t end t h'l t t hore is no r f>la tlonship botwElon thes e m8!'kots , but we fee l oe1'\; '1 1n thnt lnt(n~est r'o. tea arc only one of emny fac tors

"._,.. .. _ _ • Cred1 t and CHp1 t D 1 h i t iW O Y) Z: ....

I SH. H. owe ns Spoculation( lle w

erest 11a. t es and_S~;>.£J! 5' ., "~

whi ch deter.r.1ine t he c~urse of p11i oes i n the stock mqrket . l

45

ita mi gh t note hero tha t r'i sing inter est r ates Are

,considered de f l a tionar y , end much of the !le.r ke t r ise

of recent year s has bean based on the f act tha t i nfl a tion

las ;...ripped our economy . An inf l at i onar y t endency wi ll

al so a ffe c t the s to ck market , s ince sto cks j especially I t hos e companies possessing natural r e sources , are con-

iderod i nflationary hedges t o protect t he purchasin

power of c~p i tal .

Disposabl e Income

Change s i n the l evel of d isposable i ncome have a

dire ct and indirec t i nfl uence on stock market price s .

and also the entire e conomy . Directly , it wi ll a ffe ct

11 prices , stock and otherwise , t hrough the change s in

purchas inQ power wh i ch s ometimes r esult s ; indirectly, i t

will affect t he whole economy by the changing Inter -

relations o f its components .

Di sposabl e income is divided i n to consump t ion and

savi ngs , so that by de f i nit i on the part of i ncome no t

consumed. will be saved . The St o ck mar ke t and the price

structure of t he country is directly inf l uenced by the vol-

urne or amount consumed and saved by t he public . The

Gmount consumed will present it s elf i n the form of chang-

i ng dem'lnd s f or con sumers ' products , and t he amount s aved ,

along wi th pos s ibl e credit cr e a tion , will provide t he main

14I bid ., P . 1 3:"> .

46

source of loanabl e f unds .

'rhe availab i lity of t hese l oanabl e funds affects

th~ leve l of pri ces of all Roods and the dellmnd for t hem.

Here a bai n t he intere s t rate pl ay s an important ro l e f or

it equF.l, t; e s t h e demand and supply for t hese funds , a.nd

yet is i tself grea t l y det er mined by t hem, and in so do i n&,

dire ct s t heir use into the various chnnnel s .

I n a nar r ower sense t h e supply of the se funds a t

t he disposal of t he i nvestor affe ct s his willinaness to

buy and sell securities , and hence influence s stock

mar ket prices . Thus , t hese loanable funds ar e the po t ent-

1<> 1 source of investment funds ovall able for the purcha sin

of securities .

Thel"e is still another as pec t of t h is problem, and

that is the ind i r ect inter- r elationship of savin.!':s and

consump t ion as t hey i nf l uence t h e level of all prices .

Shift5 from consump t i on to saVi ngs , or vice ve r s a , l ead

to correspond ing shi ft ~~ in t h e dem.and for capt t al boods

or for consump t i on good s and ser vi ces . Consumptlon-

~oods industrie s may r e spond to an expans ion in di s posa ole

income oy i ncreasing production and inventor i es . Con­

sumer s , however , may dec ide t o use le ss of t heir i ncome

for consumption , and may t hen tran s f er more to banks or

ot her savin~s institutions . A sudden increase in savina

may lead to a de cline :1.n de ':land for , and t he prices of ,

many consumer- goods sto cks by i mpairing the ea,rni n '

nd d ivide nd ou tlook . On t he othe r hand , t he reverse

may be t rue . C::m sumer s may consume more a s t heir incomes

47

i ncrease , thus caus i n <.;:, a decline i n s avings , whi ch roLlY

t hen r esult in an i n cr e a s e in profits and dividends i n

consumer· v.ood s i ndus t r i es e spo ci a lly t hos e o f a dur able

na ture .

Aba1n in this i nt e r - r e l a tiol'1 s::1i p quest ion , i nt erest

r a tes and changes of t h em, help determine 't he dec is ions

of consumer s . A h igh rat e of int e r es t shoul d divert t h e

ava,l l able f und s from consumpt ion to s avings and hence

inve s t ment , while It a l ow r a t e shoul d dis courat,e risk ­

t ak i ng ond encou~a~e con ~umpt ion . ~he ac t ual e ffe c t ,

h)wever , i s no t easy to trace , and much dep end s upon the

i ndiv idual. 11 1 5

I nvestment

The e bb and flow of investment expend iture s a s a

cause of business cy cles has ~ttained wide ac ceptance

and undou nted l y i s , under nor ma l conditions , the dynsmtc

f ac t or i n de t e r mi n i n.,; t he l eve l of n 'l tiona l income and

production . 'rhe su ppl y of loanab l e funds arising ma i nly

f rom s avi ngs and credi t cree.tion is the potent ial source

of invcstmt~n t cap i t a l . fl.' ) pl'esen t a more comple t e p ictur e ,

t he s upply of .funds and the demand fo r t h em is equAted ,

yet a l s o partillu l y de t er mined by the interest r a te as

we have pr evious l y ment ioned .

I n t h i s s ect i on our chief concern is priVa t e domes t ic

i nves tment whi ch emhr a ces t h e funds expended for producer s '

plant and durable e quipment , r e s i dentia l and ot he· ...

l 50p • cit . , DOVirie and Ful ler , p . 34 .

48

construction , and net ch ange s in inventory . irhese items

inc l uding net for eign investment make up wha t is termed . r eo l investment or the purcha.se of new capit 13 1 t:l:oods .

This definit ion excludes any f inancial i nves t ment wh i ch

1s mer ely t he transfer of existin& c apita l a...mong differ-

ant owner s . Thus , part of this r e 8.l inve s t ment may b e

f i nanced by the iss ue of new securities in the stock

market , but this is not t o be confused with t h e tradln'·

of exl s tin~ shores of stoCk . l S

In r isinp.: markets , the oompa nies who h ave the l ar ge

increases in capi t a l investment generally ha.ve the ,Dea t -

est increa s e i n va l ue , whereas , in the falling mar ket s ,

cRpit e l investm.ent can reduoe e arnings by increasln

t be cost of oper a t i ons , and t his will produc e a. furthe r

drop in vta lue . Al so , new security issue s may especially

a f f e c t the s tock marke t , when t here is a shortage of

invostment funds or when new is sues do not f i nd i mmed iate

subscribers or buyers . Thus , a.s 10n/.1; as t he flow of

investment · continue s to increas e , busio(:s s wi ll inovit -

a1) l y expand , and a s it slows down and dr ies up , business

will cont r oct .

Popu l a.tion

Ghantt.es in the popul a tion of the nation and t ho s e

of the wor l <l will have a continued influence on the stock

ma r ket , bB cBus ~ t he demand for ods and services whi ch

IOA•lI• Hansen , Businoss Cyc l e s a nd Na t ional 1nco "16 ( New York , 1951) , p . 77.

49

continually affe ct s t he leve l of na Ciano.l produc tion

i s dependent on these cbanges . 'rhe popul a tion a lso affects

and j;.,ra otly controls t he supol y of sav ings , and bank

cr edit , and thus , the /1,cneral price level.

t\ 'rheas effecUil c an be c Bu sed , to a l es ser degr e e , by

chanl-o.a s in i mmi gr a tion and birth rat e s along wi th t he

composi tion among age groups , cheir geot!,r aphlca l dis -

pers i on , and even from shif t s from one r egion to anot h er . 'I

S ~nce all t hese chan ... 8s wil l have an effect on t he s truc ture

of t he economy , t hey will a l s o affe c t earnini!,s of t h

varIous compani a s who will profit or lose f rom t her,. .

'EJnployment

Cha,nges i n the l evel of employment shoul d normally

e,ffect stock pr ice s becau s e of t h e cb anlSe in buyi ng

power r esulting. from s uch empl oyment . While t here wi ll

al 'liays be a ce r t ain pepcentab6 of unempl oyed people , an

i ncrease in t hi s number can seriously a ffe ct t he economy

as a whole . Eve n the pr e sently ava il able Unempl oVTnent

Insur anoe cannot completely subt~ t 1 tute for wa ge pay-nents

even dur lng t h e bene f it weeks , and the eventual resul t 1s

reduction in t he nat ion's purchasing power . 'l'h ls

'7lsans both savin J2'. s and consumptive expenditure decreases ,

and s o l ess for investment s and smaller earnir~ 8 for

corpora t ions , especlally thos e more he8 ~ ily concentrated

in consumer ~oods . Thus , t hese chanbes alon~ wi th the

psycholobiclll a t ti t udes r esultins [ rom t hem , will i nfl uen ce

stock marke t pri ce s .

50

Commodity Price s

The l eve l of commodi ty pr ices a t the var i ou s .sta.c,e s

of d l-s tribution have a d i r e ct i nfluence on t he e urnin£;, s

of corpor a t i ons concer ned , for every pri ce of a selle

ls 13, cost t o some buye r . These cost - pri ce relat ionships

9re the primary bas is fo r profi t abl e operation , sinc e

t he price or cost of pr oducts do not vary with t h e s ame

amplitude and timi ng a t the various s tages of di s t r i bution .

Thus , the e arnings of firms may be r educed or expanded

by onl y small changes i n the 'Or i ee level.

Statis tical ly, t he ava i l ab l e commodity price indexes

ar e usual l y r e l a t ed only to prices at t h e f a r m, at whol e ­

sale , and a t re t a il , but t h e pri ces at any point will

affe ~ t t he stock marke t direct l y t hrough t h e e arn i nRS

of f irms , and i ndir ect l y , t hr oubh the con sumption , savinRs

and nonce i nvestment of the publi c .

Farm In come '>ud Production

The i:lcorne of farmor s and their r e s ultant degree of

pros per ity or d '}r ession , has an i ndir e ct inf l uence on

stocl{ mar ke t pl~ic e s . Thi s is true oy vi rtue of t he ir

purcha.s es , which i n cl udes not only fa.rm machiner y a nd

ne cess i ties , but an e ve r - increaSing amount of luxury

goods . Thi s purcha.s ing power reflects it se l f in the

ear ni nf,l; s of 911 indus t rie~ nff ected by t he farmer 's

spendlrlb o

The government ' s s upport of f ar m pri ce s has f;rea tly

st a.bilized t h e f armer ' s income s i nce the 1930 ' s . Shoul d

51

the t.,0ven'llUent s top subsidizing or support ing farm prices ,

a dro'P in production and income woul d resul t . Wi t hout

ue s tioninl:, the advi sab i lity of such a move , we c an

concl ude t hat it woul d advers ely affoct earnings and

sto ck market pr i ces .

Foreign Tr ade

~'he a otul'i.l volume of f orelon trade , i tsalf , has

limited i nfl uence on stock mar k e t pr ices , e xcept as it

affects t h e tota l of i ndustria l production and t h e suppl y

of loana.ble funds . noweven, the earniniSs of luany indus tries ,

dependent in part or entll'el y upon f ore i gn f;rade , will be

s eriously affected by any l a r ge change in vol ume of either

expor t '" or i mports . 'rhe for mer w')uld be t l'lue ch i e f l y

due to t he chanv.:es i n t he potential market , and t he latter,

to the pos s ibility of a change in the intens i ty of

cOlllpet l tion f rom foreign fi r ms .

Taxation

Taxa tion is not only tremendously influent ial as

it breatly af fec ts t he level of d isposabl e income , but

al so to the degre e t h qt it affe c t p the inveAtor ' s val ­

uation of s tocks and the earn ing,s of the comp '; n i es . The

impact of taxa tion, therefor e , can reduce avrd l abl e

i nco:Tle for r onsumpt ion , s avings and investment, but a lso

di minish the incentive to invest , especia l ly f'hort - t e rm,

and t he potential s ource for d l vidends . Natura l l y t axe s

make cert Hin investors decide be t wee n t a x - e xempt and

hieher -yie i d ing t axable investment s , 1-110nt.: wi t h the

a~tractivenes s of se cure or hazardous investme nt , i n

vi ew of the hi;a.h income taxes . Because of these many

as pec ts , t axBtion will a l ways gr eatly infl uence th~

price val uations of investors .

52

Ne might ment i on here t he i nfluenc e of the exce ss ­

ryroflts t ax , f or i ts ten t ative expiration date i s Jan­

uary 1 , 1954 . In t he pa st this t ax has par ticul arl y

affected s t ock ma rkot pr i ces for it s h f.' av i l y t axed

corporqt lon earnin[,s over a specifi ed amount . While

at one time i t VOlaS do signed to eliminate excess war - time

pro f its , i t has caus ed a hardship on ~rowth compani e s

whose profits did no t r esult · from t he war , and they .

therefore , will benef it substantially fr om its eliminat i on.

I nventories

When s a les a re maintained at t he re quired pa ce ,

Inventori e s are no burden to t he bUSiness , and , hen ce ,

t he influence of them on the e to ck market is i ndeed

limited .

f Ail t

Howe ve r , when bus i ness slows up , !:'I nd inventories

hl'lve a normal t urn. over , when deb t s on them

mature Bnd credit r es tri c t ions are ti8ht , t hen inventories

be come a IJI'ominent ftlc t or i n t he determina tion of profits .

If pr i c es rise , inventorie s may be sol d a t higher

levels t han pr e vail ed when they were pu r chase d , thus

increas i m', the m9r e,in of profi t . ')n the other hand , i f

53

price s fa l l , the inventory l osse s must oe assumed and

normal prof it mar g ins r educed or even eliminatfld , thus ,

affec tIng earn ings and s t oek market pr i ces .

Construct ion

The bul1dinb, i ndus try is one of the l ar bss t bus ine sse s

i n t h is country , besides beinv.: one of the m03t f ar - re l'lch­

i ng , sin ~ e it involve s so mr.my f i rms whose pr incipl e

activi t y is non - re l Rted . Becaus e of t his , not only will

t he profit s of th i s industry exert a.n i n f luence on t he

prices of specific stock , bu t a l s o on t he mar ke t i n general .

PJe mi bht note t h a t bui l dint:; statis t ics whi ch $.re

r eadil y a va ilabl e are an ex cellent indica t or a s to t he

activi t y i n this f i e l d . The se f i gur es c ~n fre quen t l

f .)r et ell bus i ness eondi tion a and even s t ·.)ck mar ket pri ce s ,

s i nce t hey are an excellent gauge of expans ion and future

prof its . Thi s is due t o t h e time l ag from t hr e e months

t o over a year be t ween t h e is su ing of the pe r mit t o t he

compl e tion of t h e buildi ng . Thus , postponed prof it s

can be antic i pa t ed f rom the volume of t he !)e rmi ts .

Technological AdVance s

New i nvent ions , new methods and t echniques , ne w

materi a l s , and new i ndus l;rie s , all i n t heir own way can

exert an i nf luence on oarni ns;t; s and stock mar ket ? r ices .

While t he announc ement of some thing new can increase t h e

stock of some specific company or even an industry , the

54

influe nce of thes e d i s coveri e s can aff ect t he marke t a s

a r.hole wh en t h ey produ ce an i n crease in profit s . An

exampl e of t h is r e cen tly h a s been t e l e vis i on wh i ch has

cres ted new opportunit i e s fo r incre ,a s ed employment and

new l:)Us inesse s a l lover the na tion . In this one mus t

i nc l ude t h e manuf a ct ur e s , th e j ob :)e r s , t h e r et 'lil stor e s

al ono with t he t e chnI c i an s , the r e pairmen , the wri t ers ,

t he per f orme r s , and advert is i ng age n c i e s . Not onl y

wer e i ndividu Al s to ck s a ffected , bu t t h r ough its medi um

of adve r t is i n t" changes h ave o c cu rred i n many s t ocks .

It al ~ o f oll ows t ho,t s ome stocl{s may drop rap i dly

\,1hen t he ir i n come s ar e r educed by a d evelopmen t in a

competi t ive i ndu.s try . By again r e f e r rinJl t o the t e levis i on

industry , we can readily unders tand t he advers e effec t

it hlld upon the earn i ng s of t he motion pictur e i ndustr y .

'l'hue , 1 t be come s appa rent t h a t t h e ne w deve lopment s in

t h is s cientific age !'la ve an e f f e ct on earn in!ts and t her·;:l -

oy t he stock pr I ces of var i ous compani e o.

Bankrup tcie s

Th0 bankrup t cy r a t e w111, to a cer t a in limite d degr ee ,

aff e c t tbe g f'o eral ma r k e t . Wh ile very r ar o l y do l ar • . e

compant es go i nto bankr up t cy , the e xceptions have created

nat ional s Cf1nd al. It i s t he s mal ler bus i nes s e s t h a t

us ua l l y compri s e t h e number a nd typ e of bu s i ness fa il­

ures, and these t hen aff e c t t h e vn~olesal ers and manu­

fa ctures when t he increas e i n fai l ure s p a s s e s alont!, an

55

incraa ~' e in t he cos t of busines s . Th i s ma.y refl ect

it se l f in an i n crease in pr i ces and /or a r educt i on in

profits , and so wi l l a f fe c t the earnings o f t h e business ­

es whi oh are invol ved .

Strikes and Union Aotivi t ies

Whil e a p r olon,ged str ike can a.ffe c t the earnings

of a partioular company , s ome s trikes 1n industries

l ike coal , s teel , or t ransporta tion , may har m e O.rninlIs

directly , and t he entire "l'Iarket indirectly by the pe!" ­

simism amonb the publ i c and investors . Short strikes ,

eneral l y , do not advers e l y a f fec t the market , and the

ol d axiom of "do not sellon strike news" 1 s usua.l l y

i nter preted a s ordinary str i ke news , s ince los ses in

produc tion , s a l es and profits durinf'- the strike wi l l

soon b e re covered .

Strikes whi ch re su l t in an i n cr ease of wage s wi l l ,

more or l ess , re duco the prof i t of the company unt il

adjustments t ocompene a t e f ', r the increased costs can

be made . 'femporar l 1y , thi s will a ffect t he ear n ings ,

and so t he prices of stocks .

The devol opment of unions , t h e i r position of power

and prestil1;e , t he i r incr eas ed s trengt h and membership ,

and pol it ic al inf luence , all p l a.y an important part in

the determinqtion of earnings and the forma t ion o f

inv0~tor t s pr i ce va lua tions .

56

Trust Funds

(rne i nvestment policy o f trust f unds and the tot a l

moun t of money i nvested , i ncr ea s i n g because of hit..;h

t ax. ratos , both i n come a nd i nherit ance , h ave had a

st lbll1z1nJ1.. i nfluence on t h e stock mHr kc t . Investme nt

t r tlst s , seneraIly , purchas e stocks in large t1uant t t ie s

for port fo l i os , and dispose of them onl y when the ind ivid-

unI stock seems comp~ratlvely unat t raotive .

'rbe admini s t r a t ors of t he i nvestment t r us ts ',) r e

experienced i n m ark(~t fundp.Jllent;a l and t e chn ica l fac tors ,

and in for ecastlnw. , and he cause of t heir ab i l ity h ave

t i med t he buying and sel linh of s t ocks t o their advant aGe .

Wh i l e investment trust s C"lnnot under mine the ma j or

t renu of t he ma r ke t , t heir inf l uen ce on the Mi nor

tn w ement is great , for shoul d t h ey d ec :"de t o d i s pose or

incr ea r- a t heir hol d i nbs , t hey can r apidly chan~e t he

pr i ces of t he s tocke con cerned .

Investment Couns elors and Service s

'l'he bu sines s of couns eling in investment s has resch -

ad a h 1!1:h degree of professional diGn i t y and f:l o ceptanc t~ .

i'he i nfluence o f i~he counselors , and of course , ser Yiae s

whi oh deal in counse ling , can aff e ct stock ma r ke t prices .

A re commendation by a s e r v i ce can a c tual l y make a stock

price rise one or more po i nts , and the coi n cidence of

sever al services s e l ectinE t he i denticMl s to ck can

even cr eate a s l 1J"ht boom in t ha t st ock . However , t he

57

advi ce of e i t her t he coun se lors or services is al ways

tempered by the genera l condi t i on of t he ma.rket and of

t he existing trend .

POLI TI CAL

NATIONAL

Gover nment Rebul a t i ons

Government r egul Rti :ms can a ffee t t he earnings of

an i ndividual cor pora tion or the entire i ndus try by

cr ea t i nb o b s t~cle8 and pr oblems f or one busines s or by

f avori nb another . The s e tj,a.y be consc i ous or o t hor wi s e ,

tbr many t i me s a r ebu l at ion meant for t he hood of one

i ndu s try can ad\rer sel y a ffo c t ano t h e r , and by this penal t y

cnu se s. pr i ce drop i n t ha t i ndustry ' s stocks .

Some !::,overl'l!1lent r e gul at ion s can affe ct t h e entire

market , but not genera lly , f or ove r a period of ttme ,

other f actors are usual l y more power f ul . Ra t e de c i sions

affe ctl~ corpor a t ions , anti- t rus t sui ts , l abor l aws , and

t llrif f s , on l y t o mention a f ew of the many fie l ds wh i ch

Dr 6 infl uenced by the A,overruucn t .

While th i s i s har d l y a. compl ete anal ysis of t he

scope ond weight of e,ove rrunent inter vention by re~.ula t ions

and l aws , i t sh ould ,nake one consc i ou s of t h e f a c t t h a t

the s tock market sh ou l d a l ways be i n t er pre t ed wi th a

view t o t he poli t i ca l f a c t ors whi ch aff e ct s t ock prices ,

as wel l a f' the Ren er a l economi c ~'tnd bus ine As factors .

58

Gover'nment Ownel' sh i p

In the pa st t wenty y ear s , the fede ral bove pnruent

has incr oj;lsed its ownersh ip of various en t erpr ises ,

un til the ~overnment is now t h e nation ' s lart o s G insurer ,

elec t r ic power producar , lende r , l andlord , gr a in owner ,

wareh ouse operat or , and ship owner . l ?

Th i s e ncroa ch'Ylent of ou r Government i nto t he fi e l d s

of over 100 typo s of bus i ne s s ent erprises has g r ea tly

affected t he lndustries whi oh a re compe titive to t h e

overnment . Wh ile some are a. s of business mus t b e run,

of nece s sity , by the govermnent , other s Vlould be more

economically manaf,e d under pri va te ownership . Because

the kovernment i s owning these operations , i t i s 108in

revenue in taxes , a nd i s depress! companies and even

i ndustries , whi ch f i nd it increas ingl y d iffi cult to

cmnpete with a l>2:overnment - owned business .

Governmen t Budbet

For lnliny years t h e l a r ge s t expenditure of the

bovernment has b een t hat f or defense . It has h ad a

tremendous i n f luence on the nation ' s eC Jnomy , but e ven

a breate r affect on t he ear nings of t he cor porations

which suppl y the required ma t erial s . A r educ tion of

e;,overnment s pendinb for defen se purposes would e specially

af fect t h e many heavy i ndus tri e s , a nd t h ey , in t urn , the

su.ppllers of raw ma terials . I f this r educt i on wou l d

l?Ti me Maga zi ne , J ul y 13 , 19 5~ , p . 8 4 .

59

occur on any large scale , and i f priva t e demands could

not f ill the gap , the bovernment VJould , of necessity ,

have t o supply s ome prot~ram to coun t er - bal anc e the

decr'ease in i nvestment to pr event a re ces sion or poss i ble

de pression .

The continued incr oase i n fe der;al debt , by ha.viniT

expHnditures l a r ger t han r evenues , has been i nfl at i onary.

However , de ot ret irement on a.ny l arge s c ale , a fte r I;h is

prol onged r ise , might s pell de f l a tionary trouble f or

the economy . Ei t her cours e of a c tion will a ffe ct stock

t:1a r ket pr ices .

INTERNA :" I ONAL

Cris e s

An i nternat i ona l orisis oa n ha.ve a. t remendous i mpa.c t

on s tock market pr i ces . The mar ket , in t he past , ha s

us ual ly d iscounted t hese events i n t he l ong- run , but ,

never t heles s , t he news will br ing about a sudden .chan.;,e

in evaluation s and causo , if disastrous , owners to di s ­

~os e of stocks a t a l mont any price .

Dur:tno wa:i:Js , t he war r equi rements gr e a t l y increaso

nationAl produc tion , a nd t hi s fo r ce s a. r e - appr a. i s a l of

t he 8 t oo){S in t h e ma.rke t , where in cer t a in indus trie~re

benefited . Then too , wars which · i nvolve othe r coun tries ,

a.nd no t our own , s t i ll in.ay have an eff ect on the mar lce t ,

fo r t he t ota l volume of export business OAn either be

adversel y or advs nt s 0 eously aff ec ted , t hus c Bus ing chanbes

in t he l eve l of p r oduction and Barnin[,s .

60

PSYCHOLOGICAL

Public Op i nion- Optimism and Pessimism

The stock marke t or1cos ca.n be affect ed by publi c

opinion i n the form of o ) timism or pessimi sm which may

bring An incre 9s eo number of tmyers into the market , or

inversely persuade investors to dispose of t heir stoci{s ,

t he r eby causin~ a. decided dl'OP i n prices . As previ m sly

di scussed , while this Goul d not undermine the Major trend

of t he ma.rket , it may cause rises and f a l l s whleh a r E:

merel y t he result of ma ss emotionalism on t he p ar t of

t he buying publi c , a.nd which a t times in the past , has

even risen to &. point of hyst er i a . Na.turally , t he op i nion

of the publ ic may further a ccent ua te or weaken a trend

when it is continually movi ng opposite to it .

Business men , t hems elves , can devel op either opti ­

mistic or p e s s i l1 i s tic expectnt ions rega.rding t he fut ure

outlook f or pr ofits , and whi l e t h is is usually associ ri ted

with the J<:enera l f ee l in;" of t he public , i t moy be thn t

bus iness me n are looking a ~reater di stanc e into the

f uture . They may then e xpand or curtail pr oduct ion ,

i ncreas e or decra ~se inventories , plant facilit i es and

even prices .

'l'hus , the attitude of the general pub l ic and especial ­

ly bu.sines s men will i nfluence t h e a ttitude s of i nvestors

in t he ir desire to buy and 1:. e11 , and s o 1n t urn, stock

ma rke t pr ice s .

News

'l'he day-to- day market r eact i ons usual l y r efl e c t . 18

tlie e bb and fl ow of emotiona l f eelin.v.8 to t he news .

Si nce s tock market p rices are e x()cptionally semli tl va

t o t h e re acti0ns of peopl e who ar e i ntere s ted i n the

61

trend of bus i ness , t he manne r i n which news is r eport ed

and pr esent ed may have a definite effect on stock mar ket

prices .

Some news i s di s count ed by a suf f i c iently l a r a s

number of buyer s whose long- t erm pl ans wil l ignore

f actors which at o cher t imes coul d h ave a tremendou s

i mmedi a t e i nfl uence upon t he marke t ~ or which are out ­

weltJ1ed by oth er , pos s i bl y e ven hidden , factors . Some -

t i mes (jood news wi l l advers e l y af f ec t the mar k (; t, Just

as it Clia when t h e Korean tru ce wa s sifjned , for' i nve s tors

bel ieve t hat t he earn inbs of corpora t ions may de cline .

One row t a lways rem(~mber t hat t he financinl

developments ns they become news a ctually r epresent a

l a ter stage of t h e un folding· of a con s t fm tly f l owin!<l'

e00nomic process . Before t his s t age emerge s a s news ,

s ome i nvestors a re abl e to fore t ell the changes , and t h en

will Bert prior t o t h e publication if:' a t a l l possibl e .

St at ement s bx Gover nment Officia ls

Stn te tl'lents by ebovernment off i cia l s on t he pres ent

ous iness conditi "ns , on f utur e cond i t ions , on the s t ate

1 8 01' . eH ., Mi ndell , p . 65 .

62

of the nation , and the l il{e , all i nfluence the public ,

hence invostors and s tock market prices . The general

public are apt to be lieve a Gr e nt porcent au8 of such

information , since it come s from offi c ials of our t>overn-

TIent who they think are weil- informed , and would not

bive <my infor ma tion which \\ould do injustioo to t heir

position . Such informqtion , wh en well - a round ed ca n

affect -th e market considerably , but unfortunatel y , many

s t atement s a.re made wi thout t h e necessar y study 'lnd for

poli tical reasons . 'l'h ose , too , affect t he market prices

of stock , but withou t justifi cation.

On the other hand , off icia l rep~rt ~ are u suc lly

t he ac cumul a t ion of informa tion by various government al

bureaus whose j ob is to collect such infor ma tion , and

then officia. l l y announce i t , mtmy t lmes in sta tlet lca l

form. '!'hese r eports and statistics !'I re va l uabl e f or

invest ')r ' s appraisa l s of 'ms i nes s a ctivity , lnl~pite of

t he t ime l ag s between the occurrence , the ga ther i ng ,

and t he publishing of the data .

St at elncnts bl BUsiness Men

statement s by r eco&nized l e aders of our nat i on' s

businesse s are usual l y received with even br e Bter accep t-

ance by inve stors, for t h ey are se l dJm u l tGr i :')rly motiva ted .

'fhe effec t s , howe ver , are b'1si cal l y t h e s ame a s thos o of

overnmen f f icials .

63

With reference to bo t h , we mi ght say tha I:, spe c i a l

de f erence will always be paid by t he public and i nves tors

to those men whose positions onabl e t hem , or so it i s

t hOUbh t , to more a ccurut e l y Hppr a ise t he f u t ur e . The

e XDreas lons of the i r opinions t hen wi l l a f f ect t he

valuat ions of the investor s of t he va r ious stocks i n

t he marke t .

Scandal s

In r e cent ye '"l rs the :ro have been no na tional s canda l s

8uf f:tciently f a r re a ch i nJt to a f f ect t he stock roa I'ke t a s

Ii whole , although s candals i nvolv i ng offic ials of oertain

compani e s have af fe cted t he st :)ck pri ces of t ha t par­

t icul ar firm.

However , t he pol itioa l a nd t ax s canda.ls of the l as t

doo.<>cie ha ve frequen tl;! i nvolved of fi oia ls t o t he det r i ment

of t he cOll'lp(my by whom t hey were employed . Approxi ma tely

a s COrO of years af:!..o , t he r e we r e 8. numbe r of s candals

f such mabnltude t h nt t h ey not only a f f ected t h e pr inci pl e

company i nvolved , bu t a l s o many companies in r e l " ted

indus t rie s .

Genernl Buyi ng Sprees

Ne ws and op i n i ons have f requentl y orea t ed buyin&

sor ees on t he pant of t h e gener al pub l i o . These natUr al l y

star t an art ificial shortu."e of merchand ise , and so

infl uence the produc tion whe n t ':1 8 aoce ler a ticm of purchases

64

i s f ar in exce s s of pr e sent or future needs . The

increa s e s in d ema nd encour qge i ncrease s 1n production

whi ch , when demand l eg "ens , will f orce los s e s especia lly

on the m'1nufactures , bu t a lso to a l es s er 6 0sX'es on job ­

bers and r eta i l ers . Thi s , t hen, e ff ect s the individual

stock price s of certain firms and indus trie s throu~h

chanbes i n e ~rni ng8 , and even the marke t to a s light

deLree due to t he clmnbe s in the d isper s ion of d ispos ab l e

i ncome .

Shortal;;,es

Al though shortAge s are an e conomic f a c tor , t hey

are caused , a s jus t expl a ined , by other fac t ors e1 t he r

psycholoGica l or na tura l , Rnd henc e will be trea ted

betwe en t hese t wo s ections of the pa per .

Sh )rt p ~cs s eem to i n fluence t h e puoli c to t he extent

t .la t , upon t heir r e cogni tion t h nt a shorta6e eXists , it

w11l be furthe red by additional unne c es s ' r y purcha8 e s

of t he Lood conccrne(i , and so add to the actua l sh ort r".R,e .

Creeted short llt.l:6S oc cur when manufactu res , especially

t hose prod1.lcinb a t ype of product which by over- oroduc t ­

i on mi ght cause a hardsh i p to t he producers , del:l.ber ate l y

con t ro l t he volume of production to bnl ance , as much as

pos s i b l e , t he d e:nDnd and supply . This a ction a t t empt s

to over - come any natura l t endency in the ~eakness of

price s becaus0 o f the over - production . For example ,

oil comD~n:l.es are controlled by s t a te l aws in cer t a i n

state s , And the d i amond i ndustry has an internationa l

control ove r pr oduction.

Natural shor ta,ges a lso occur and pr e sent mu ch of

65

t be same infl uence on prices . An example of thiS is when

t he t.,. ovornment needs b flso l ine Cor warfare , or when su;.;:ar

or butter is 8car ce . I t is onl y natur a l t hat a shortaao

of t h is type wi l l , w~thou t price con t rol ~ r at ionine ,

,ffect t he price s and earnings of t h e compan i es con cerned •.

W1 til respect to any short age , t hey VJ i ll p l ay a ce:et ain

)!lr t in a ff e ct ing uroflts , and s o the pricos of t h e

part icul ar stoc \{ , bu t ')nly in a vor y limited way , will

t hey a f re ct t J1 8 stock marke t in Il,ener ::tl .

NA'PURAL

Ca t as trophe s and Ac t s of God

'rhe e f fe ct on tho ~l tock ma r k e't o f a catas trophic

s ituat i on or an a c t of God is read i l y s e en and unde r ­

stood , whe n one conside r s t h e l o sse s wh i ch can occur

t o companies advers e l y affe c t ed by such mis f ortunes .

Fl oods have damaged plants and have r educed t he

pr ofit s of s ome companies s o breatl y that the s t. ock pricos

dropped very 8ubs t 'mtla l l y , wh e n the news o.f this dis­

aster re ~ ched t~e publ ic .

Tornadoes ean affec t t h e earninhs of a numbe r of

comoani e s in a par ticul ar ar ea , and t he r e;.uction of

oarn lm,s will cause a drop in mar k e t val ue s .

Mi sfort unes , A.S t he drough t i n Texa s , the h oof-and -

1

66

mouth disease , gr ea t forest f ires , epidemics of pol i o ,

and the l ike can r educe the a Stl' ets of orp:anizut ions ,

destroy capi t al and pUI'chasing p ower of firms and

i ndividuals , a ll have a definit e par t i n a f fe oting

earni '1.tt. 6 and stock market Dr i ces .

Wea.the r

Weather wh:tch :ts unfavorabl e for crops wi l l defi nitely

affoct the busine sse s whose profits are determined by

the cost s f or produce- goods . The effect s can r each

f urt;he r thD.n jus t t hese compani es 'Who s pecinlize i n

canning produce , by actually affect l ne; compani es whos e

pr ices of' cat tle and po.rk 'May a c tually depend on the

desire of the farmer to dinpos e of livestock because of

t be cost of fee d . This , t h en , demonstrates t ha.t ~cather

Crl n 110 tuall'y chan ge for b otb t h e f armers and compani es

t hoil' profits and income , a nd s o affect stock mar ke t

prices .

Seas ons

'rhe various seasons o f t he ye a r have been shown

bit~t o r:i. cally to have an i n f luence on s t oclc marke t pr i ee s .

In compar l ne; t h e seasons f rom y e a r to yean , s o h igh a

d€l £tr ee of parallel action is ind i c a t ed that the season

seems to prove i t does have I'm influence by i t s very

pattern.

Nat ural l y certain bus i nesses are especia lly a.ffect ed

by s eusons , and a l s o ce r t ain firms t ha t r eport t h e i r

pro f it s by t he quar t er may show Rrea ter e arni na.s a t

6 7

ne spec i f ic part of t h e year , a nd i n b ot h cases , t he

prices of their s tocks may be i nfluenced in this mS.nner .

Re s ources

A d i s covery of na t ur a l res ources may af f e ct on e or

more co.npani c s in s.n indus try , bu t i f such discover i e s

ar e of a very wide s cope , t hey may actua lly af fe ct lii ll

r e l s.t ed lndus t r i e s .

An example of the forme r \"la s t he dl s eover y o f a l l

on t he l and own ed by 20 t h - Centur y Fox, or t he d i scovery

of urani um on the l and of t h e Can ad i ruL- Pa cif ic r a il ­

ro ad which d i d affect those par t i cu l ar s t ocks .

Wherea s , an example of t he l a tter was t he d i s covery

of ti t an i um, a new strong met a l , a nd this no t onl y

a ff ect ed many fi rms , ou t added Iii d e f i nit e i mpe t us t o al l

s t)ck s whose bu s i ne s s e s bene fi t ed f rom t he d i scover y of

t his new n Qt ur a l r e source .

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69

In t h i s paper we have t es ted and substant iat ed t h e

bel i e f t h at chanr;c s :tn s t ock mar ke t price s generally

f ore cast s i mi l ar cl~aage s i n the vol ume and d i r ection

of bu s lness a c t ivi t y . Th e next 108 ical step was t aken

when we analyzed t h e f a ctors and conditions a f f ect in

stock market pri ces . We must conclude from thi s anal ys i s

t h a. t t he cross cur r ents of these f a c tors can exert th.sir

i nfl uen ce eithe r col l ectivel y or as opposing f orce s .

Si nce t hero are s o many of them inter- l ocked and i n t er -

'/'Ioven i nto our national economy , the emerRence of t he

stronger or a cO.tnbina. tion of the s tron8~r wi ll f i nal l y

show t he ir i nfluence on earnings , and on the va l uations

pl a ced on stock by the buyers and sellers 1n t he market

who actually e st£lol ish the s e cur ity pr i ce .

To understand t h e f orces unde r l y i ng mark et prices of common sto cks , it is ••• ne ce s sary t o l earn how such price s adjust t h e li1s e lvo s t£ the Charl£1:i n g f low of e arning:s ,

a.nd t he e s t i ma t e s of i nve s tors fl ba.sed on human de c is ions ,

which t hemselves res t on pers is t ent , though var i eQ:a t ed

f actors . 1't2

Economic activity 1s gear ed to prof it maki ng, and

becau s e of this 111n our anal ysis ••• we must recogn i ze that

profit mak ing 1s the central proc e s s among t h e conge ries 3 t hat const itut e t he a c t i vities of D. bus ine ss e con vmy . 1I

Economic ac t i vi t y and t he f u ture of busine ss , t her ef or e ,

wil l depend on t he va l ua tion of pr ofit expectations .

I Op e cit ., Grodlnsky , p . 371 . 20p . cit ., Mindell , p . 83 . 3W. C. Mi tch e l l , Bu sine ss Cy cles :

Se tt i ~b ( "ew York , 1927 ) , D. 183 . nd I t s

70

FBvorable profit expectations depend upon t he profi t able

rela tionships between cost s and prices in the r e cent

past , the pr esent , but mainly on t hos e o f t h e f utur e .

'rhus , t h e study of t he fa ctors a nd condi ci ons af'fectin

prof it expe c tations has l ed u s to the net work of 1nter-

r elationships wh:1.ch hold toge t her the entire economi c

system .

Thi s net work of inter - re l a tionships , however , 15

continually changing , and t he i nfluence of the various

forces ol1 n show its , effect in sudden , easily expl a inai)le

or al?parently une xpl a inable flu ctuations in t he stock

market a verages . It 1s t hese flu ct uations , when abbrega ted ,

t ha t cause t he .rise , f al l or cont i nued trends a s the

appraisal of t he se f orces 1s made by the buyer~ and

s elle r s i n the m r ket .

Becaus e st ock marke t price s Bre always more or le s s

dependent on f u ture earn ings of' cor pora t ions , the ch ief

consideration must always be direct ed to t h e i nfluence

of the vf.lr iou8 factors and condi t i ons whi ch we have

dis cussed in this thesis .

Many conflictint=, f orce s a ct on the format ion of stock prices at anyone time , and it is d i ff icult to unravel t he ir respective i nfluen ce s . Expl an-tions mus t b e t en t At ive , and mus t be

801.16h t in terms of changing cOlnbin­a t ions of these forces , and t heIr ever v "r ying rel ative i mportance . 4

It i s i mpossibl e to accurately determine t he we i bht

of al l the cro ss cur rents Iilld t he qualifyim, factors

4tlp . cit ., blindell , p . 286 .

71

which eIther contra c t or lengt hen the movements of the

stock mar ket , or which otherwise chan~e t h e cOlllPosition

of the i nfl uences . Ther'afore , beoause of thi s galaxy

of forces , it is best to observe the factors and condit i ons

carefully , <lnd t hen s ummarize t hem to ob t ain t he general

t rend .•

Thus , the countl e s s e cono.r8.i c, poli ti ca l - national

and Int~!'(lat ional , psy(~hologi c al , natural and t eohnical

f actors and condit ions affect e ither cor oorate oarnin~s

and/or t he opi nions of t l1e ind ivIdual i nvestors , and

t her eby his di scounted futur e expectations . He , then ,

with h is val uat ion an d wi th t hos e of a.ll t he other invest­

ors i n the m'~ rket wil l determine s t o ck prices . Since

t he se stock ma.rke t ,)ri 006 generally f orecast cha nu:es in

business ncti vit y , the anal ys i s of the f ractors and

conditi )ns a ffecting t hem do t',i lve an economi s t additional

inf orm!'l t1on f or t he study of bus iness cycles .

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Br a

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T3us1ness Cycl e s a nd ~ 'omowood , 111 , n15;~ .

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DOin ' io , Ge Ol'bo W. and DOUbl a:;; H . Ful 1el~ . I nve s t ments . New 'l or k , 1941 .

Dr

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1" e<1 . h e ll . ";a at11. "1~ t o n ,

I"lnher , I rvir)f, . '!'he 'l·lte ~ry of In t E;~ r~~ t . Hew York , 1950 .

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Grod insky , Julius . I nve s t ments . New York , 1 953 .

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Ha.mHton , V~ . H .. 'l'he Stock Morke t Ba.rome t er . New YnX'k , 19 22 .

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t h e St ock

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74

Mitchell , Wesley C.. Wh a.t Happens Durin!;;;. t3u s iness Cycles , 'few i o rk , 1 951 .

Its

a.tion

OW0.ns , Richar d N. a nd Charles O. iIardy . Inter est Rates and Stock Specul ation. l' i ew 'Y ork , 19 25 .

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75