Ready for Escalation

Nervous and emotional, uncertain and perhaps a bit illogical, the stock market lost another $8 billion in paper values last week. Small investors sold more shares than they bought; big institutions stuffed their steadily rising funds into safer, short-term Treasury bills or corporate bonds and just waited. The Dow-Jones industrial average fell for four days in a row, struggled up just a bit in the final session, and closed at 864--down 16 1/2 points for the week.* Everybody on Wall Street was waiting for news from Washington and looking for a firmer fix on three uncertainties that overhang the market: Viet Nam, steel labor, and the immediate future course of the U.S. economy.

No Controls. Though Wall Streeters have built their fortunes on speculation, they dislike uncertainty, and they can scare easily. What worries them now is that a greater U.S. commitment in Viet Nam might somehow impede the progress of the domestic economy and lead to the kind of controls on prices, wages and credits that were brought forth during the Korean war.

But the situation is far different from what it was in the 1950s. The Government reports that it has no plans to impose controls. It figures that controls would not be necessary because both the private and the public sectors of the economy are large enough to absorb military escalation without much of a wrench. Treasury Secretary Henry Fowler, who during the Korean war was director of the Office of Defense Mobilization, points out: "When Korean fighting broke out, we had a defense budget of $10 billion. And there was no force in being to sustain large-scale fighting. By contrast, the defense budget for the past ten years has totaled more than $400 billion, and we have a much larger economic base."

Probably no nation has ever gone to war quite so well prepared to meet its defense commitments and continue growing at home. U.S. spending for Viet Nam is now about $1.5 billion annually, during the current fiscal year will grow to at least $2.5 billion; orders are already rising for such items as fighter planes, helicopters, rifles. At the same time, economic expansion should increase federal revenues by some $7 billion, even though corporate taxes have been cut during 1965. The Government may be forced to delay or moderate its plans to slice taxes further, but few of the costly, recently launched programs of The Great Society are expected to be markedly reduced.

Optimism in Pittsburgh. More realistic than the investment community's fears about Viet Nam are the worries about a possible steel strike--but even they seem to be extravagant. As negotiations resume in earnest this week, management negotiators and the Steelworkers' 163-man wage policy committee have already resolved most of the "noneconomic" issues, will now get down to wage bargaining with a probable Aug. 31 deadline. Publicly, management claims it will not offer more than a 2 1/4% increase in wages, while the union asks for 4.4%, or about 50-c- an hour over a three-year contract. Neither side wants a strike, and both are optimistic. Official Washington also does not anticipate a strike, but figures that if a stoppage does occur, it will be brief. Pittsburgh insiders doubt that any prolonged shutdown would be tolerated by an impatient President during a Viet Nam emergency; they would not be surprised to see a settlement calling for a 4% rise in wages, which would further dent but not necessarily destroy the Administration's 3.2% guideline.

As for the overall vigor of the U.S. economy--Wall Street's third major uncertainty--even the pessimists have been surprised by the durability of the expansion. The consistent Cassandras, who have been forecasting downturn for many months, have begun to hedge their predictions with such words as "may," "might," and "possibly." The clouds they see over the economy include high inventories, especially in steel, and the prospect of inflation. After staying flat for five years, wholesale prices in the past six months have jumped 2.1%--owing to a rise in farm prices and processed food costs. The increases are now showing up in supermarkets.

Balanced against the negative factors are the facts that personal income, retail sales and production continue to rise, and that the Government has committed itself to keep them climbing either by increasing federal spending or cutting taxes. Said Budget Director Charles L. Schultze to a congressional committee investigating tax policy last week: "We can't prevent every little wiggle in the economic cycle, but we can prevent a major slide."

High-Quality Profits. For Wall Street, the best news is the remarkable rise in corporate profits. Last week record first-half highs were reported by such giants as Du Pont, Socony Mobil, Standard Brands and Ford. Though the rate of increase is likely to be somewhat less spectacular in the second half, Washington policymakers figure that the gains already have been so great that the Government's official estimate of $61 billion in corporate profits for 1965 will probably be exceeded. Investors are reaping the benefits; in this year's first six months, cash dividend payments increased 11% to $9.2 billion.

Equally important, the so-called "quality" of profits is much improved. Reason: under the liberalized depreciation laws, companies are counting increasing amounts of their income as nontaxable depreciation expense, instead of taxable profit. As a result, "cash flow"--net income plus depreciation allowances--is rising faster than profits.

In a time of crisis, when more demands may soon be made upon its productive capacity, U.S. industry thus has both the cash and the incentive to expand. More and more industries are making longer-term plans, paying less attention to possible short-term fluctuations in the economy and more attention to likely expansion and markets over the long haul. The aerospace industry is making hard plans for ten years ahead and estimates for 30. Detroit automakers have already begun firm planning in the expectation that "normal" yearly sales will be 9,000,000 cars by 1970 and 11,000,000 by 1975. The steel industry, in one small area east of Chicago, is busy building enough new capacity to produce 71 million tons from basic oxygen furnaces and 15 million tons of sheet by 1966. In this atmosphere, it appears that Wall Street has been listening less to the hammer and clank of vigor than to the voices of doubt.

-One sign of the investment mood was that the short interest as of mid-July hit an all-time high of 7.2 million shares. When an investor goes short, he borrows stock and sells it, figuring that it will drop and he can later buy it at a lower price. A large amount of short selling suggests that investors are bearish; but for the longer term, it serves to support and lift the market because the short sellers eventually have to buy stock to cover what they borrowed.

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