The Australian Stock Exchange Essay, Research Paper
The Australian Stock Exchange Assignment for year 11 Economics
By David Jones
Part 1
Telstra- 2272 shares @ $4.40 each = $99998.80, yield 2.5% (fully franked)
Telstra has been very strong on the market recently, as brokers have come out with increasingly positive assessments of it’s worth. Telstra is one of the few full service telecommunication companies in the world. After applying “indicative valuation parameters” to all of Telstra’s businesses, one broker told me that Telstra is undervalued relative to international peer telecommunication companies. The defensive, stable nature of Telstra’s earnings stream, combined with its pure domestic earnings focus, is considered a very attractive investment featured in the context of a deteriorating domestic economic environment, continued turmoil in Asia and a global non-inflationary environment. Taking into account that Telstra share prices have doubled in the last 6 months, being one of the two largest profit making companies in Australia (the other being National Australia Bank), I believe my prediction of Telstra shares quadrupling over the next 5 years is very minimal.
National Australia Bank- 4464 shares @ $22.40 each = $99993.60, yield 4.6% (fully franked)
In a special report, “The Emerging Global Player”, it recommends NAB as a strong long term outperformer. One broker I spoke to says NAB holds the most robust positioning of Australian banks to respond to global changes in the provision of financial services. Its recent alliance with BancOne in the United states signals that NAB is emerging as a global player. NAB’s current price is based on the Australian market. But as it becomes more global, I expect it to be re-rated towards global pricing multiples. Over the past decade NAB has successfully expanded overseas. It has targeted regional retail banking in countries with cultures and regulatory environments similar to Australia’s. Offshore businesses now represent 50% of NAB’s asset base and contribute 46% of profit. The recent weakness of the Australian Dollar has demonstrated one positive impact of the diversification. NAB’s two latest acquisitions (country investment management in Australia and Homeside in the United States) have given NAB a broadening of it’s scope. They reflect the move wider financial services, now one of the driving stratergies of most banks and insurers. All of the above have shown the impressive performance of NAB and I believe NAB will continue to pull desirable figures. NAB is one of the two largest profit making companies in Australia (the other being Telstra) and with future expansion and with the experience it is now receiving from overseas, I expect the price of $22.40 to double.
Australian Gas Light Company- 4587 shares @ $10.90 each = $49998.30, yield 3.4% (fully franked)
AGL’s share price has fallen from $11.78 since the release in may by the Australian Consumer and Competition Commission and the Victorian Office of the Regulator general of draft decisions on access arrangements for natural gas transmission pipelines and distribution networks in Victoria from 2001. The report concludes that the current rate of return for Australian gas and electricity utilities is too high. The environment of low interest rates and inflation suggests that future real pre-tax rates of return, currently regulated at 10.9%, should be lowered to 7%. Although they have no immediate impact on AGL’s gas distribution business in New South Wales, or the electricity distribution in Victoria, the rulings do provide a guide as to how tariffs are likely to be determined under the National Access Code. Despite not taking effect for some time, and the NSW regulator using different pricing formulae, the reports implications have had their effect on market valuations of utilities. I believe that AGL’s successful diversification from it’s traditional NSW gas and nationwide transmission businesses into Victoria, together with the recent completion of the Bellara-Mount Isa gas line, the start up of the Roma-Brisbane line, and a possible PNG-Queensland line, all combine to strengthen the group by increasing the levels of gas throughput and enlarging the number of energy customers. Greater competition from a deregulated market provides further opportunities as gas prices fall, demand increases, volume rise, and gas haulage revenues rise. As expansion and high profit making is to come in the future, I would buy now while the price is at a low. This investment is still a risky one and there are no foundations from which we can give fact that the price will definitely rise. Since this is only a 5 year investment, the full impact of the rise in the share prices will not be felt so I expect a price of $15.50 per share.
B.T. Hi Yield- return rate of 3.97% per annum = $250009.30
This particular cash trust seems to give the highest rate of return. It is very low risk, I have a guaranteed return of 3.97% per year.
Portfolio
Initially?
Shares
SecurityPriceNumber HeldValue
Telstra$4.4022727$99,998.80
National Australia Bank$22.404464$99,993.60
Australian Gas Light Co.$10.904587$49,998.30
Cash Trusts
Trust NameReturn RateMoney InvestedYears Invested
B.T. Hi Yield3.97$250,009.305
?After 5 years
Shares
SecurityPrice Number HeldValueGross ProfitNet Profit
Telstra$17.6022727$399,995.20$399,995.20$299,996.40
National Australia Bank$44.804464$199,987.20$199,987.20$1,899,993.40
Australian Gas Light Co.$15.504587$71,098.50$71,098.50$21,100.20
Cash Trusts
Trust NameReturn RateMoney InvestedYears InvestedGross ProfitNet Profit
B.T. Hi Yield3.97$250,009.305$303,735.88$53,726.58
Total Net Profit$2,274,816.50
My total profit after expenses are taken into account is $2,274,816.50. One requirement to be met was my expected return rate must average out to in excess of the current government bond interest rate. The government bond rate today is 5.75%, my portfolio has over 5 years matured to 401%, a very successful investment portfolio indeed. My investments are diversified and 20% of my securities can be easily converted into cash. I have invested 50% of my money into B.T. Hi Yield Cash Funds which is a low risk investment and have met all the requirements my portfolio was expected to obtain.
Part 2
Industrial shares, Mining and oil shares, Company debentures and Government bonds
(a) Industrial shares
(b) Mining and oil shares
(c) Company debentures
(d) Government bonds
What effect will an increase in the general level of interest rates have on a, b, c and d.
When interest rate levels rise, companies tend to borrow less. This cause them to invest less in themselves and on employee wages, in some extreme cases employee wages can drop or employees can be sacked. The demand will decrease for a, b, c and d.
What effect will a general downturn in economic conditions have on a, b, c and d.
When this happens the economy is obviously not producing enough and therefore supply for all will go down. Demand will also decrease because investors do not want to invest in poor producing companies.
What effect will an increase by Japan in it’s economic output of manufactured goods have on a, b, c and d.
There will be an increase in demand of Japanese goods. Therefore we must export more to repay our debts, demand and supply both increase for a, b, c, and d.
What effect will a marked improvement in our balance of payments have on a, b, c and d.
All will have an increase in demand. An improvement in the balance of payments mean that the whole economy is doing well.
What effect will a rapid increase in the world price of gold have on a, b, c and d.
As gold value has increased there will be a decrease in demand for a, c and d. Mining and oil shares (b) will increase in demand, because obviously to obtain gold it must be mined.
Part 3
Buy And Sell Theories Of Shares
The Fundamental Approach
Economics, financial management and accounting from the basis of this approach, but don’t let that deter you from using it as an investment strategy . The details of this approach can be learnt, yet all one really needs is an advisor with a strong company research to support his or her recommendations.
A practical procedure for the investor is to learn enough to recognize why an investment has been recommended, to cultivate the ability to ask the right questions, and to delve into the reasons for the recommendation.
With the fundamental approach, the emphasis is on the company: it’s past, present and potential performance. With this approach, the analyst or investor seeks companies which are undervalued. A major objective is to determine the long term value of particular securities. Put simply, it’s a matter of working out what is a cheap price to pay for a security.
The search involves examining company details which may indicate that a company is currently undervalued in the marketplace: balance sheets, auditor’s reports, profit and loss statements, annual reports, half-yearly reports, sales growth, earnings, management ratios, capital structure ratios, market performance ratios, and so on.
Fundamental analysts usually declare their findings as ratios which have been calculated using the balance sheet or profit and loss statement. An examination of the industry, cyclical industry or recessive industry? The fundamentalist is seeking companies that have been ‘mispriced’ in the market. This type of investor works on the proposition that if you study the market, study industry and study individual company’s ratios and statistics, such as earnings per share and net tangible assets per share, such mispriced companies can be found.
The Technical or Chartist’s Approach
There is no siren that sounds or light that flashes when it’s a good time to buy or sell a security. There is, however, a series of devices that one can use to select particular securities. By matching the prospects of these securities with your own investment objectives, there is a far greater chance of being a far greater investor.
The technical analyst (chartist) relies on the stock market to reflect the true worth of a share using charts as forecasting tools. Unlike the Fundamentalists the technical analyst believes that an individual company’s share price and indeed the total market can be predicted or at least anticipated by studying by studying past trends in market price and/or the number of shares traded.
It has been said that the chartist looks backwards, while the fundamentalist looks forward (with an occasional glance over the shoulder). This is not quite correct because both approaches require an element of prediction; both look at the data of the past in an attempt to predict the future.
Technical analysts produce charts to study daily through to monthly price and volume changes in securities. They record the price, or index if they are plotting general market or industry movement, and volume of transactions on the vertical scale, with the horizontal scale recording time (except in the case of point and future charts). When examining charts and the recorded volume and price changes, the aim is to gauge the strength of demand and supply, and then on the basis of such observations to predict future performances.
Chartists believe supply exceeds demand when particular shapes, patterns and formations are evident. Other patterns suggest supply and demand are more or less equal, or demand exceeds supply. There are probably as many different charts as there are chartists. However, it is recommended that both index charts and charts on individual companies be used if adopting the chartists approach.
Index charts give a broad view of the market. Examples of indices which are often charted are the All Ordinaries Index (Australia), Dow Jones Index (USA), Hang Seng Index (Hong Kong) and Barclays Index (New Zealand).
The Contrarian or Psychological Approach
It has been said that there are two major emotions that drive many an investment decision-GREED and FEAR. Historically investors have failed to learn from their previous mistakes, still preferring to follow the crowd buying when the market is booming and selling everything when it crashes. This is mass psychological or herd mentality at work.
For those wishing to avoid following the leader, an alternative approach is that of the contrarian. The contrarian buys the security that are out of fashion. This approach has been around for the last fifteen years. Put it simply, it proposes as an investment strategy not to what everybody else is doing. Avoid the crowd mentality or, specifically, the ‘public phase’ of the market cycle.
phrases describing this approach are: ‘Buy straw hats in winter’; ‘buy when blood is running on the streets’; ’swim against the tide’; ‘Sell in strength buy in weakness’.
This approach sounds easy in theory yet it is very hard to sell when everybody else believes the near future will provide higher prices and greater profits. It is also hard to by today’s bargain when everybody else feels it will be a better bargain tomorrow. There is more to this approach then simply being contrary. Some strategies associated with this approach are:
1) choose only larger companies that are financially sound, with debt to equity ratios of no more than one.
2) Make your selections from the top 150 companies, ranked by market capitalization.
3) Narrow your selection down to thirty companies with the lowest price/earning ratios.
4) Buy shares with high dividends, preferably fully franked ( that is, potentially tax free).
5) Seek out companies with an increasing earnings pre share.
6) Select a verity of industries. It’s the total portfolio that should perform, not just securities.
7) Select companies with a proven track record of sound management.
So although it is the alternative approach, it can still rely on ‘fundamentals’.
Part 4
Rules and Regulations of the ASX
The principles on which the listing rules are based embrace the interests of listed entities, maintenance of investor protection and the need to protect the reputation of the market. The principles are as follows:
-Minimum standard of quality, size, operations and disclosure must be satisfied.
-Sufficient investor interest must be demonstrated to warrant an entity’s participation in the market by having it’s securities quoted.
-Securities must be issued in circumstances which are fair to new and existing security holders.
-Timely disclosure must be made of information which may affect security values or influence investment decisions, and information in which security holders, investors and ASX have a legitimate interest.
-Information must be produced according to it’s highest standards and, where appropriate, enable ready comparison with similar information.
-The highest standards of integrity, accountability and responsibility of entries and their offers must be maintained.
-Practices must be adopted and pursued which protect he interests of security holders, including ownership interests and the right to vote.
-Security holders must be consulted on matters of significance.
-Market transactions must be commercially certain.
ASX has an absolute discretion concerning the admission of an entity to the official list (and it’s removal) and quotation of it’s securities (and their suspension). ASX also has discretion whether to require compliance with the listing rules in a particular case ( i.e., apart from waiving the rules). In exercising it’s discretion, ASX takes into account the principals on which the listing rules are based.
ASX may waive compliance with a listing rule, or part of a rule, unless the rule in question says otherwise. The listing rules necessarily cast a wide net. However, ASX does not want to inhibit legitimate commercial transactions that do not undermine the principles on which the listing rules are based.
If ASX decides to grant a waiver, it may do so on conditions. The conditions must be complied with for the waiver to be effective. Waivers are published by ASX periodically and are also advised to the ASC.
The listing rules themselves are to be interpreted:
-In accordance with their spirit, intention and purpose;
-by looking beyond form to substance; and
-in a way that the best promotes the principles on which they are based.
Once again if any entity does not comply with the listing rules, it’s securities may be suspended from quotation or it may be removed from the official list. An entity seeking listing must be admitted to the official list of the ASX and then, for trading in its securities must be granted an official quotation. There are prerequistis for both admission to the official list and official quotation. When applying for admission to the official list an entity must provide the prescribed documentation to the ASX, demonstrate compliance with the listing rules and pay a listing fee.
As you can see the ASX has strict control and regulation of its members. Many types of problems can occur within the stock exchange, for example an entity could list on the ASX without meeting a requirement for general admission which must be met to the ASX’s satisfaction. One particular requirement for general admission is No.8. The entity must satisfy either the profit test or the applicable net tangible assets test.
THE PROFIT TEST
To meet the profit test, the listing rules require that an entity must satisfy each of the following.
1) The entity must be a going concern, or the successor of a going concern.
2) The entity’s main business activity at the date it is admitted must be the same as it was during the last 3 full financial years.
3) An entity must provide to ASX financial statements for the last 3 full financial years which are prepared to Australian Accounting Standards. Financial statements for foreign entities may be prepared and audited to other standards acceptable to ASX. The financial statements must be qualified in a way that goes to whether the entity can continue as a going concern or has satisfied the profit levels required.
4) The entity’s aggregated profit from continuing operations for the last 3 full financial years must have been at least $1 million.
5) The entity’s profit from continuing operations for the last full financial year must have been at least $400,000.
6) If the entity’s financial statements for the last full financial year cover a period that ended more than 2 months before the date it applied for admission, the listing rules require the entity to give ASX each of the following.
a) Financial statements for the period since the end of that financial year dated no more than 2 months before the date it applied for admission, reviewed by a registered auditor (or overseas equivalent), showing that the entity is making profit from continuing operations. The financial statements must have been prepared to Australian Accounting Standards. Financial statements for foreign entities may be prepared and audited to other standards acceptable to ASX. This rule does not apply if the financial statements would cover a period of less than 2 months.
b) If the last full financial year ended more than 6 months before the application is made, and half yearly financial statements have been prepared, a copy of those statements reviewed by a registered auditor (or overseas equivalent).
THE NET TANGIBLE ASSETS TEST FOR AN ENTITY
To meet the net tangible assets test, an entity must have tangible assets of at least $2 million, after deducting the costs of fund raising, and satisfy each of the following.
1) Either:
a) Less than half the entity’s total tangible assets (after raising any funds) must be cash or in a form readily convertible to cash; or
b) Half or more of the entity’s total tangible assets (after raising any funds) are cash or in a form readily convertible to cash, and there are binding contracts to invest or spend enough money for the proportion to be reduced to less than half. The binding contracts must not be subject to conditions precedent except ones relating to the satisfaction of a minimum subscription condition of the fund raising, and admission to the official list.
2) The entity must have enough working capital to carry out it’s stated objectives. If the prospectus or information memorandum does not contain a statement that the entity has enough working capital, the entity must give the ASX one form an independent expert.
3) The entity’s business must be developed to the point where it is reasonably likely that the entity will generate revenue from its ordinary activities within 3 years after admission. If the ASX requires it, the entity must give ASX a written statement to that effect from an independent expert.
As you can clearly see the profit test and the net tangible assets test are very complicated. Although the above two are not of my own work and have been extracted form the text “A Guide To Listing On ASX”, I saw the necessity to show and explain in specific detail. Both of these tests can be explained in a simpler form.
In general a company may be eligible for consideration if it:
-Issues a prospectus;
-Has (or will following the issue of a prospectus) at least 500 shareholders holding a marketable parcel (i.e. a minimum value of A$2,000) of shares;
-The issue of each share to be listed is at 20 cents;
-And either:
-The company:
-Is a going concern which has an aggregate audited operating profit, before income tax, over the past three years of at least A$1,000,000. A$400,000 of which comes from the 12 months immediately preceding the application; and
-The company has been in predominantly the same business activity for the past three full financial years.
-Or the company
-Has net tangible assets less than A$2 million; and
-Either has binding contracts for the investment or expenditure of at least 50% of its funds; or
-it has sufficient funds to carry out its stated objectives and can provide a statement in the company’s prospectus by an independent expert to that effect and the independent expert provides a written opinion that there is a reasonable expectation of the company providing 3 years.
As it was stated earlier, one particular requirement for general admission is No.8. The entity must satisfy either the profit test or the applicable net tangible assets test. Firstly it is important that we see that the two tests are flexible and not all requirements have to be fully met. The ASX has evolved rules of conduct and procedures to monitor the activities of it’s members. These are contained in ASX business rules. It has developed rules that must adhered to by listed entities, known as the listing rules. This self-regulatory process, operating within the general framework of the Corporations Law, constitutes a flexible system designed to preserve the integrity of the market.
Regulations on companies wishing to list on the ASX that concern assets, finance and money matters are in place incase the well being of an entity is in jeopardy. For example, I.C.U Optometrists are on the ASX and go broke. Yet they still owe there shareholders money for the part ownership they have in the company. I.C.U Optometrists have entered the ASX on the condition that they have assets to they have $X worth of assets, these assets we now be sold to compensate for the money they owe to there shareholders.
Another example of rules and regulations of the ASX would be that of insider trading. For example, XXX Gold Mining Corporation is listed on the ASX. Their shares are trading at $5.70 each. Their exploration team finds a massive gold deposit, bigger than any deposit found in the world. The ASX forbids XXX Gold Mining Corporation from running out to the public and secretly telling them to buy masses of XXX shares because they will boom in price due to a discovery of a massive gold deposit. Another example of insider trading would be selling unregistered shares (those not listed on the ASX) to the public.
So basically as you can see the ASX can stop and punish the buying or selling of shares on the basis of price sensitive information not generally available to market players, insider trading. In 1980 this became a criminal offence. If one is caught they will receive a mandatory fine which equals the profit made, in addition when they attend court they will receive another fine up to two times the amount of the profit made and possible imprisonment .
More Government Regulation Of The ASX
Kevin Smith has just retired, he was an accountant. Kevin has now received a lump sum of $250,000 and wants to invest all of his money. This lump sum is a substantial amount of money and Kevin wishes to invest this money and use the return as a form of income. He goes his financial adviser Fredrick Williams for some advice on the best way to invest his money. Fredrick tells Kevin about property investment, bonds, cash trusts, stock market, etc, etc. Kevin decides to invest in the stock market as he believes this form of investment suits him best. He goes to a Donald Hendricks the Stockbroker and Donald tells him that Quintex shares are very attractive for many reasons. Kevin put his money on the table and tells Donald to make a purchase of $250,000 worth of Quintex shares on his behalf. The transaction is made and Kevin is a happy man, two weeks later Kevin’s shares are excluded from the stock exchange. The chairman of the company Christopher Skase took all the money he could get his hand on and went to Spain, where no one can touch him. Kevin’s wife is so shocked she leaves him and files a divorce, Kevin now has no money, is to old to work and lives of a small pension with a broken heart. As you can now clearly see, with all the rules and regulations the ASX has today, it is still not enough. These such incidents rape people of there money and the ASX says, “well, that’s just too bad”. The ASX needs more government regulation to protect the well being of all shareholders.
Although I believe that there should be more government regulation on the ASX, I don’t believe much more can be done. This is a very rigid topic we are dealing with. As we saw in the above example, the way some stocks fall in price or in some cases fall of the exchange is not the fault of the ASX at all. This has given the ASX the label of a high risk investment.
If the ASX were to go through all companies on the stock exchange and make sure that all the companies were clean and honest, this would surely be very reassuring. It is impossible, absolutely impossible. It is also hard for the ASX to make sure that everyone is following the rules and regulation due to the growing size of entities on the exchange. More government regulation is needed, but how will it be implied?
Part 5
The Crash of 1987
In particular the crash of 1987 experienced some highs and lows, but much like the 1927 crash it is important to understand some of the most significant events that led to the crash. In the case of 1987, these events are not to the fault of poor running of the market, but more or less the economic structure and operations carried out within the economy. These events take us back to 1982.
In 1982 the U.S double digit inflation was under control, the Federal Reserve eased credit, and taxes were reduced. The recession was over and the bull market began. The bull market of the 1980s began in 1982 and continued until October 1987. The Dow Jones Industrial Average increased from 777 in August 1982 to 1,896 in December 1986. In 1987 the rate of increase in prices accelerated and by August of that year the Dow reached is maximum closing of 2,722. Its intraday high was 2,747 on August 25, 1987.
On the morning of October 14, the government announced that the merchandise trade deficit was higher than expected. On the same , the House Ways and means Committee proposed legislation to eliminate tax benefits associated with the use of debt in corporate takeovers. Also, the recipients of greenmail were to be penalized by a special tax. Risk arbitrageurs in takeovers and incentives to reduce their holdings.
At the end of the day the Dow was down 95 points on a volume of 207 million shares. It had closed at 2,506 on October 13, opened down at 2,480, and closed at 2,411 on October 14. While stocks opened at lower prices on October 15, they recover during the day. Then, in the late afternoon, there was a selling avalanche and price dropped to close at 2,354, down 57 points for the day.
On October 16, the Dow Jones Industrial closed at 2,246-down 108 points on a volume of 338 million shares. This was the largest single-day drop (in points) in the history of the exchange. The maximum drop during the day (to 2,223) was even larger. The Dow had fallen 260 points in three days. October 16 was a Friday.
On October 19, selling started in Tokyo, continued in London and moved to the United States when the markets opened. There were a tremendous number of sell orders and few buy orders. The Dow closed at 1,738 (the low for the day), having fallen 508 points (23%) on a volume of 604 million shares. October 19 was competitive with other record-making bad market days and could be called the worst day in the history of the New York Stock Exchange because of the magnitude of the price drop.
On October 20, selling again took place in Tokyo and London prices declined dramatically. However, in New York there was a buying panic. In the first hour of trading the Dow rose 200 points. Prices during the day were volatile. At one point the Dow dropped below 1,720, but then recovered to close at 1,841-a gain of 103 points (the largest single point gain ever!).
One factor supporting the market was the buy-back programs of corporations. They purchased their own stock at prices they thought were low. The motivations were diverse. During the period of October 19 to October 23, 129 of the standard and poor Index companies made purchases. They purchased 90.4 million shares-3.9% of the total volume of trades on the New York Stock Exchange. On October 23, the purchases accounted for 6.5 percent of the total NYSE volume (and a much larger percentage of the specific companies doing the buying). The eleven companies whose purchases were over 50 percent of the total volume lost 13 percent of the value. Non-purchases lost 16.5 percent of value.
The morning of Tuesday, October 20 (just before the U.S equity markets opened), the Federal Reserve announced that it stood ready to supply liquidity as needed by the financial system. This statement acted to reassure the market and probably helped bring about a turn around.
The equity market’s ability to handle transactions was strained to the limit. The system came close to collapse because of the number of transactions.
After Tuesday the equity market needed a ‘rest’ and took it. The excitement was over. From the close of 2,506 on October 13 to the close of 1,738 on October 19, the market had lost 768 points (31%) or approximately $1 trillion of value.
However, if we take the close of 1,840 on October 20, this is approximately the same value as the Dow had in December 1986. During 1987 the market had shot up and shot down to approximately the same level as at the beginning of the year. One concern that the even trigged was the speed with which the prices had fallen. An investor who knew it was time to sell based on one set of prices would, after a delay in completing the transaction, sell out at a much different price (either better or worse). Prices were extremely volatile and delays in execution of trades were common and large.
The United States now had a Black Monday in 1987 to accompany the Black Tuesday and Black Thursday of 1929. The 31 percent four day fall of 1987 can be compared to the 34 percent fall of October 24-29, 1929 (from the close of October24 to the low for the day of October 29, 1929).
The Factors that seemed to have triggered the selling on the U.S equity markets in mid-October 1987 were:
1) The announcement of the United States trade deficit and resulting uncertain currency markets.
2) The announcement of tax legislation that would have reduced the number of corporate takeovers.
3) A slowdown in growth rates in many of the primary economies of the world.
4) An increase in interest rates.
5) Large price earnings ratios (the average was above twenty)
6) Large market to book values (above two)
7) The Dow Jones Industrial had already started to slide form the August high of 2,722 to 2,507 on October 13.
8) Continuous changes in the tax laws (especially in 1984 and 1986) that were not favorable to corporations and investors.
9) The continuing federal deficit.
We do not know why such a dramatic fall took place from October 14 to October 19, 1987. We can conjecture that the market was too high at 2,722 (or 2,747) in August. But there were many reasons to think the rise would continue. We must take into account the introduction of computerized stock selling, the speed of the transaction well and truly could have lead to the quick dramatic fall, but I personally have my doubts. One of the more important factors was the purchase of equity investment by foreign (especially Japanese) investors. During the 9 months of 1987 Japanese investors purchased $15 billion of United States equities. However, expectations of the future value of the dollar were becoming increasingly important. The announcement of the trade deficit accentuated fears of further drops in the value of the dollar.
ASX Boom of the 1960’s
The ASX experience a significant boom in the 1960’s. This boom was felt tremendously in Western Australia and sent the markets soaring to amazing levels. It more important for us to understand the reasons why the market performed so well, it was not just the case of the companies doing good.
The 1950’s were an era for tremendous growth for Western Australia. The Korean war raised the price of wool, there were significant uranium, iron ore and aluminum discoveries. One very significant discovery was that of a spectacular oil find at Ruff Range, this sent investors queuing in the streets for shares.
A credit squeeze in the 1960’s caused the market into a down turn. WA’s economic recovery was again due to performances of resources, but this was not only by gold. The Vietnam was created a huge demand for nickel. The nickel boom was the biggest event for the ASX, it lifted the whole market. One particular company, Poseidon, climbed to holding a value of more than $200 per share.
This boost in the Perth Stock Exchange meant that the exchange must expand to keep up with the performance of the companies. The Perth Stock Exchange took the following steps in improving their market, they:
:Hired their first employee
:Established a secretariat
:introduced post trading
:installed direct telephone lines and
:published their first annual report.
The crash of 1930
There is a great deal wrong with our understanding of the 1930 sock market crash. Even the name in inexact. The largest losses to the market did not only come in October 1929, but rather in the following two years. In the calendar year 1929 the market lost only 11.9 percent of its value after having gained 37.9 percent in the previous year. In December 1929 many expert economists, felt that the financial crisis had ended and by April 1930 the Dow Jones Industrial Average had recovered a large percentage of the October losses. The 1929 Crash, like the 1987 Crash was preceded by a market top. In 1927 the top came on September 4th. As in 1987, the new highs in late summer did not cause much fuss. The market had been in a strong bull for years and new highs were almost taken for granted. In fact, the 9/4/29 Wall Street Journal did not even mention the new highs.
Before we give reasons to why the market crashed, it is important to understand some of the most significant events that led to the 1929 stock market decline. In 1920 Warren G. Harding was elected president of the United States Of America and in 1924 Calvin Coolidge was elected. These two presidents do not rank high in performance and their appointees left something to be desired. At the beginning of 1929 the Federal Reserve Board consisted of Harding-Coolidge appointees or reappointees (three members of the board-Edmund Platt, Charles S. Hamlin, and Adolph C. Miller-had originally been by Wilson). Unfortunately, these appointees were not the most talented or best prepared for controlling the United States banking system. The Federal Reserve Board in January 1929 consisted of the following six members (omitting the two ex-officio members: Secretary of the Treasurer A. W. Mellon and Comptroller of the Currency J. W. Pole):
Roy a. Young, Governor. Young had been governor of the Minneapolis reserve bank before joining the Board.
Edmund Platt, Vice-Governor. Platt was an ex-newspaper editor and ex-congressman from Poughkeepsie, New York
Adolph C. Miller. Miller had been a professor of economics at Harvard, Chicago, and Cornell.
Charles S. Hamilin. Hamilan was a Bostonian Lawyer who had been an assistant secretary of the treasury of with Cleveland and Wilson. He was the first governor of the Federal Reserve Board.
George R. James. James was a Memphis merchant.
Edward H. Cunningham. Cunningham was a farmer from Iowa.
Young, Hamlian, and Miller had relevant experience or academic qualifications, but the other members of the board required on-the-job-training. Neither Young nor Hamlin were very insightful or forceful and did not supply the leadership needed by the board, although Young actually opposed many of the board’s actions in the first six months of 1929. Miller was far the most decisive member of the board and became the de facto intellectual leader. While an academic background, his style was that of an autocrat. Hamlin Kept a diary that is an important source of our understanding of what happened in the meetings of the Federal Reserve Board.
Benjamin Strong, the most respected of the United States bankers, was the head of the New York Federal Reserve Bank from 1914 until the fall of 1928. In 1925, when direct pressure on banks to control speculation was recommended by the board as a strategy Governor Strong disagreed pointing out that direct pressure could not succeed in New York unless the federal Reserve Bank refused to discount for banks carrying speculative loans and that it would mean rationing for credit, which would be disastrous.
Although he died in 1928, Strong’s influence extended to 1929. From 1921 to August 1928 the real genius and power in the United States was Benjamin Strong, governor of the New York Federal Reserve Bank. Strong was an acknowledged leader of international finance and truly a giant in U.S. banking. Most importantly, Strong’s intellect and personality led to New York being the Power center of U.S banking from 1921 to 1928. This frustrated several members of the Federal Reserve Board, especially Young and Miller.
In the summer of 1927 the united states was on the verge of a recession. Productivity had dipped down and significant economic signals were negative. In addition, Europe was losing gold to the United States and European bankers feared an international disaster.
Strong lead a move to reduce the discount rate and to increase the Reserve Banks’ holdings of the United States securities. This easy money policy succeeded and the recession was avoided. Later Miller was to blame the resurgence of stock speculation in 1928 on Strong’s easy money policy of 1927. Miller was very influential in leading the board to avoid this mistake in 1929.
This was the mistake that lead to the incident that has been written about more than any other financial crisis in history, that lead to Black Thursday and $15 billion going “down the drain”. Although the Prohibition controversy was absorbing, public interest in the first year of the Hoover administration became diverted by an event that shook the very economic foundations of the nation, namely, the stock market panic of 1929. The United States had enjoyed a boom after World War I, in which wages were high and production and consumption increased. During this period many had developed a tendency to invest savings and earnings in speculative ventures, particularly the buying of stocks on margin?putting up as little as 3 percent of a stock’s price in cash and borrowing the remainder from the broker. The booming demand for stocks and the prosperous state of the nation as a whole led to a general rise in the prices of securities, which in turn led to increased investments in them.
The rise in stock prices reached its height in the so-called Hoover bull market during the first six months of the Hoover administration. In this period, individuals invested billions of dollars in the stock market, obtaining the money for such investments by borrowing from banks, mortgaging homes, and selling sound government securities, such as Liberty Bonds. In August 1929 stockbrokers were carrying on margin for their clients approximately 300 million shares of stock. By October 1929 the feverish wave of buying had exhausted itself and gave way to an equally feverish wave of selling. Prices dropped precipitously, and thousands of people lost all they had invested. This collapse frequently meant complete financial ruin. On October 29 the New York Stock Exchange, the largest in the world, had its worst day of panic selling. By the end of the year declines in stock values reached $15 billion.
This graph shows just how dramatic the Drop of the Dow Jones Industrial Index was.
We do not know whether stocks were too high in October 1929. There is a great deal of evidence that leads us to conclude that the high level of stock market before the crash was not the result of a well founded optimism on the part of a well informed investment community. And if the market was not too high, then why did it fall drastically in October 1929, and again in 1930, 1931, and 1932?