rorces ^Vhich iSdake Prices By WARREN F. HICKERNELL, Ph. D. Director, Bureau of Business Conditions, Alexander Hamilton Institute. Lecturer on "Panics and Depressions," School of Com- merce, Accounts and Finance, New York University. Formerly Mana^in^ Editor, Brookmire Economic Service. Author, "Business- Cycles," and numerous Articles on Finance. AMERICAN INSTITUTE OF FINANCE BOSTON OUR ''COMPLETE EDUCATIONAL COURSE" IN THE SCIENCE OF MAKING MONEY MAKE MORE MONEY This list is arranged in the order of proper reading. The books are accompanied by a series of test questions, key prob- lems and analyses outlines, enabling the student to apply the knowledge acquired to immediate stock market and investment -conditions. L Developing Financial Skill 2. Forces Which Make Prices 3. Manipulation and Market Leadership 4. Handling a Brokerage Ac- count 5. Market Information IL Investment Securities 12. Business Cycles 13. Measuring and Forecasting General Business Condi- tions 14. The Technical Position of the Market 15. Money and Credit •6. The Essential Features of .^ -r, ■ -n £i ^ . . -^16. Business Profits Securities 7. The Value of a Railroad Security 8. Industrial Securities 9. Oil Securities 10. Mining Securities 17. Launching a New Enterprise 18. Securing Capital for Estab- lished Enterprise 19. Internal Financial Manage- ment 20. Search for Bargains Copyright, 1922, by American Institute of Finance I V ^ ^ --i TABLE OF CONTENTS ( '^ ^ ,^ Chapter I. Buying and Selling Zones Page ;^ The Methods of a Seasoned Veteran 5 Times to Buy and Times to Sell 6 [v^ One-Way Pockets 7 ^ United States Steel 9 I Crucible Steel 9 ''b Baldwin Locomotive 9 Studebaker Corporation 10 Westinghouse Electric 10 N. Waves of Bullishness and Bearishness 10 Amounts Bought and Sold 12 Five Hundred Accounts in Steel Common 12 Eyes to the Front 13 Chapter II. Market Moves The Swing of Prices 15 Three Types of Moves 15 Dow's Law 17 A Little Scene in the Broker's Office 18- Perspective 19" ^ Chapter III. Price Moves from the Inside \^ Demand and Supply 21 The Market Dynamic in Nature 21 sy\ Board Room "Rust" 22 J "The Big Interests Are Buying" 24 V Surface Effects vs. Underlying Causes 24 ^ Cha{)ter IV. Twenty Years in the Slock Market •^^ Broad View of the Market 26 V ^ The Stock Market in Profile 26 Cycle 1900-1903 28 Stock Market Influences, 1900-1902 28 Stock Market Influences, 1903 30 Cycle 1904-1908 30 Stock Market Influences, 1904, 1905, 1906 31 Stock Market Influences, 1907 32 Bull Market of 1908-1909 32 Stock Market Influences, 1908-1909 33 447462 4 T able of C ontent s Chapter IV. Twenty Years in the Stock Market — continued p.^^,,, Reaction in 1910 33 Stock Market Influences, 1910 34 Irregularity 1911-1914 34 Stock Market Influences, 1911 35 Stock Market Influences, 1912-1914 36 War Boom 37 Stock Market Influences, 1915-1916 37 America in the War 39 Stock Market Influences, 1917-1919 39 America after the War 40 Stock Market Influences 1920-1922 41 What Next We Consider 41 Chapter V. From Gross to Dividends A Study in Corporation Finance .43 Shares and Their Priority Claims 44 Dividends vs. Earnings as a Market Guide 47 Chapter VI. Looking Ahead The Sinews of Wall Street 51 Questions Which Point the Right Way 51 The Profit Maker's Point of View 52 The Commercial and Financial Mainspring 53 Jay Gould's Statement 54 What's Ahead? 55 The Next Step 57 Questions Answers to Starred Questions CHAPTER I BUYING ZONES AND SELLING ZONES The thing to do is to watch Wall Street's eddies and cur- rents, exercise a little common sense, and in your speculations you ivill come out all right. — Jay Gould, Financier and Manipulator. The Methods of a Seasoned Veteran The attractive, but all too brief, advice given by Mr. Gould needs to be supplemented by the suggestions of another well- recognized authority in finance, Mr. Henry Clews, before the problem here set for solution is clearly mapped out. How secure profits in the market? Mr. Clews answers the question in this way: "The old veterans of the Street usually spend long intervals of repose at their comfortable homes, and in times of panics, which recur sometimes oftener than once a year, these old fellows will be seen in Wall Street, hobbling down on their canes to their brokers' offices. "There they always buy good stocks to the extent of their bank balances, which have been permitted to accumulate for just such an emergency. The panic usually rages until enough of these cash purchases of stock are made to aflord a big 'rake in.' When the panic has spent its force and the skies once more are bright, these old fellows, who have been resting ju- diciously on their oars in expectation of the inevitable event, which usually returns with the regularity of the seasons, quickly realize, deposit their profits with their bankers, or the surplus thereof after purchasing more real estate that is on an up grade, for permanent inv^estment, and retire for another season to the 6 F r ce s quietude of their splendid homes and the bosoms of their happy famihes. "Those who follow this method always succeed," continues Mr. Clews. "If the venture is made at the right time — at the lucky moment, so to speak — and each successive venture is fortunate, as happens often to those who use their judgment in the best way, it is possible to realize a net gain of fifty per cent per annum on the aggregate of the year's investments." Times to Buy and Times to Sell The extent to which leading stocks upon the Exchange rise and fall in price each year will indicate, if we examine it, whether TABLE I Price Changes of Ten Leading Stocks 1921 1922 1923 STOCKS High Low Range High 1 Low Range; High Low Range American Can 351^ 23H 12 110 32M 77M 107^ 73K 341^ American Woolen . . . 83 J.^ 57 ley^ 111 78M 32 M 109% 65 U% Baldwin Locomotive 100^^ 6214 38^ 145 H 93M 51^ 144^ UOK i^H Baltimore & Ohio. . . mi oQ% 12 60M 33M 26% 60% 403^ 205^ Corn Prod. Refining 99M 59 40K 134M 91M 43H 160H 114%! 463^ Studebaker 93K 43^ 49K 141M 791^ 62% 126H 93M| 32H The Texas Company 48 29 19 52^ 42 10,14 ^2% 34% 1834 Union Pacific 131K HI 20K 1543^ 125 293^ 144 J^ 1243^ 20% U. S. Steel 86 H 70M 16M nm 82 293^ 1095^ 851^ 243^ Woohvorth 13934 105 U% 223 137 86 290 1993^1 9Q-'i Average $72M |$27 $102 $45 | $112^ i$36i^ Fluctuation 37%| 44%| 32% the opportunities to profit mentioned by Mr. Clews do actually exist. The accompanying table shows that during the three years examined, the ten prominent issues cited have fluctuated annually an average of more than $36 per share. This represents a change each year of from 32 to 44 per cent of the price of these Buying and Selling Zones 7 stocks, a considerable range from low point to high point. Con- firming as it does the observ^ations of Air. Clews, this table shows that each year there are times to buy and times to sell. \'iewing the matter now from the standpoint of the specu- lative investor, and disregarding for the time being the trader and the investor, let us recall from Text I how the market undergoes from period to period changes in its price le\'cl. The distance from the market's low points, reached during panics and periods of depression, and its high points, touched when prosperity is general, let us divide roughly into four zones, the upper one in which prices are high, the bottom one in which prices are low, and the two others in which prices are mod- erate. When should you buy and sell? Lord Rothschild ex- pressed the matter tersely when, upon being asked how he had built up his fortune, he said: "Buy cheap and sell dear." This matter-of-fact rule let us apply to these four zones. The upper is the "sell" zone; the lower a "buy" zone; and the other two "remain neutral" zones. Here we have mapped out m broad outline, rules of operations which Mr. (lOuld, Mr. Clews, Lord Rothschild, and hundreds of other successful financiers for that matter, have proved effective. The realness of the zones, taken in connection with ihc table just cited and the figures presented in Chapter 1 1 : "Opportunity" in Text I, represents a condition laden with possibilities. What results? Faced as he is with these opportunities to profit, what does the average person do with them? One-Way Pockets The accounts of half a dozen men who traded actively from July 1, 1915 to February 29, 1916, have been studied by their broker who in revealing in his book, "One-Way Pockets." what he found, prefers to conceal his identity under the nom-de-plume of Don Guyon. So closely do the findings, based upon the purchases and sales made through his own brokerage office, tall\- with the results of other investigations and <)bser\ations that the facts now to be presented ha\e decided \alue. 8 F r c e s These traders, like a great majority of his firm's customers, had been bulHsh on the munitions and standard industrial stocks, and now that these stocks had enjoyed an advance of from 15 to 100 points each, followed by a reaction of less than forty per cent of this advance, the investigation could be expected to disclose substantial profits. POSSIBLE PROFITS U S STEEL 31?8 CRU- CIBLE SOTs BALD- WIN 90'; STUDE- BAKER 118^8 u WESTING. HOUSE 27'/s AVER- AGE 0934 ACTUAL LOSSES iVg, ovs iVfe 3?8 Figure 1: "One-Way Pockets" The results here pictured are based upon transactions of 46,600 shares, in five stocks actively dealt in. Note the very large possible profits, and what use these traders had actually made of them. The stocks selected for study — United States Steel, Crucible, Baldwin, Westinghouse, and Studebaker — had all been dealt in actively by each of the six traders, to the total extent of 46,600 shares. The six accounts taken collectively, as though they represented the operations of one man, and their results sum- marized, this is the situation disclosed (see Figure 1). Buying and Selling Zones 9 The following tables present with some detail the results summarized in Figure 1. They present the main features with respect to each of the five stocks and the actual price at which purchases and sales were made by the traders. United States Steel Opening price, July 1, 1915 595^ Low price for period 58^ High price for period 89 J-^ Total advance 315^ Closing price, Feb. 29, 1916 825^^ Net advance 23 Customers' average buying price 81J^ Customers' average selling price 80^ Average loss, less commissions J^ Crucible Steel Opening price, July 1, 1915 31/^ Low price for period 29 High price for period 109J^ Total advance 80J^ Closing price, Feb. 29, 1916 73i— H ■l ■ ri - ■ ■ ■ H--' "LP Lj ' -^ _, -^- 1 -n d] IW tti Figure 2: When the Public Buys and Sells This diagram reveals closely the public's habit of buyinR on bulges and selling on de- clines. The columns at the bottom show the extent of this bad buying and bad selling. Periods when customers were loading up with slocks were followed in each case by a lower range of prices and, with one exception, periods when they sold were followed by higher prices. 12 F r ce s The diagram indicates this "bad" buying and "bad" selling very clearly. Amounts Bought and Sold There remains another item of importance in this investiga- tion, which is the relative amounts bought and sold at the two price levels. From the table showing the total number of shares bought and sold the following summary has been made: Bought during advance 883,600 shares Sold during advance 613,300 Excess of purchases 270,300 Sold during declines 437,000 Bought during declines 366,900 Excess of sales 70,100 Customers at high prices bought more than twice as many shares as at low prices, in other words, they used big margins when stocks were low and small margins when stocks were high. Having held Steel in 200 or 300 share lots at $60 a share, they took on lots of 400 to 600 shares around $80. Similarly with Crucible, Baldwin, Studebaker, and Westinghouse — these stocks grew more attractive and were held in larger quantity as they went up. The higher the price the heavier the load, roughly speaking, describes the situation. The market operator in this situation is unsafe. When his account is thus rendered top-hea\^^ a decline of ten points from high prices wipes out whatever profits were made on a twenty point advance from low prices. Five Hundred Accounts in Steel Common These results disclosed by Don Guyon are confirmed by a study of 500 accounts in Steel common made several years ago by Thomas Gibson. Mr. Gibson selected as his period of study July, 1901, to March, 1903, because Steel sold at approximately the same price at both the beginning and close of this period and Buying and Selling Zones 13 hence from a mathematical standpoint the situation was about 50-50. Whatever was actually done, therefore, that threw the results out of the 50-50 class would be pretty clearly an index of the traders themselves, their mental processes and methods of dealing in stocks. The examination of these five hundred accounts disclosed this as the final outcome. What the Results Were Total deficit on losing accounts 81,245,000 Total gain on profitable accounts 288,000 Number of shares, long stock 820,000 Number of shares, short sales 292,000 Average price, long stock purchased 425^8 Average price, short sales 35 ^4 Eyes to the Front The two studies, one made by Mr. Gibson sixteen years ago and the other by Don Guyon in recent markets, indicate certain errors persistently made by numbers of persons in the market. Practically every well-informed person in Wall Street observes day after day in market after market that such is the case. What, then, is the problem, vital to profits, which we now face? The realness of opportunity must be conceded. Profits in generous amount were, are, and will be, possible. Attempts to take advantage of these opportunities were, and are, clumsily made. The wrong methods here dis- closed would keep a man poor in any line ot business. Traders in their attempt to foresee price changes evi- dently look at the wrong things. Unlike the expert ball player, golfer, or money maker, they do not keep their eye on the ball. The conclusion appears evident that what the untrained man tends to do as a matter of course, that is, what seems to him the obvious thing to do, does not result in a profit. Keener 14 Forces insight, a more penetrating view of what causes price changes, in brief a developed financial skill, are essential in securing profits. And these qualifications the wise person will cultivate before, rather than after, he enters the market. This is the problem here set for solution. In succeeding chapters and Texts the forces which make prices are clearly analyzed, thus enabling the subscriber with increased profit to himself, to gauge them in advance. CHAPTER II MARKET MO\'ES The Swing of Prices The reader who turns to the financial page of his newspaper finds there a table of figures, frequently two columns wide, which extends a full page or more in length. This table, in part only, is here reproduced. NEW YORK STOCK EXCHANGE TUESDAY, DEC. 31, 1918 1918 1917 1916 Day's sales 933,594 Holiday 920,961 Year's sales 143,378,095 184,536,371 232,342,807 Closing Bid Ask. Sales First High Low Last Net Chge. 76M 100^ 7434 32 31M 44^ 75 SlVs 1291^ 95 41^ 26 76% 100% 75 32M 31K 44^ 753^ 51% 129% 12,450 7,300 11,200 7,400 23,600 16,380 4,900 8,400 6,000 95^111.000 41% 11,200 26%1 10,700 Am. Smelt. & Ref. . Am. Tel. & Tel. . . . Baldwin Locomotive Int. Nickel Kennecott Copper . Pennsylvania R. R. Rep. Iron & Steel . . Studebaker Co Union Pacific U. S. Steel VVestingii. E. M. & d Willys-Overland . . . 75H 99% 73H 32H 31J^ 43K 74% 50 129% 94 41% 25 77 101 75^ 32% 323^ 44% 75% 51J^ 130% 95% 41% 26% 75^ 99% 731^ 31% 315^ 43^ 74 50 1285^ 93H 40% 25 761^ 100 74K 32% 31% 44^ 75% 51 129% 95 41% 26% +VA + % + 1K + 'A + Vb +1% +1 +1% + % +1M +1% Three Types of Moves Those who watch the ticker realize that the four prices given in the newspaper's table, that is, first, high, low, and last prices 16 Forces of the day, reveal in only a limited way the exceedingly numerous fluctuations which occur. Upon the floor of the Exchange, market history is written in terms of eighths and quarters of a point. This fuller account of a stock's price changes will now be shown on a diagram, which taken in connection with the two JiiLuary 1,1915 by Mootba to January 1. 1917 Jauuary 1, tu KePruary l.iaiT g¥=E ^Ld^i=Fa 86 M % \ H 8G % |« ■ Jan uary 14 1916 '1 1 c 1 i 1 1 1 j 1 n 1 1 1 ! 1 1 1 : 1 1 Figure 3: Three Types of Moves in Steel Common Daily fluctuations are bullish, the secondary swing is bearish, while the primary swing is bullish. other parts of the figure presents a matter of considerable importance. U. S. Steel the morning of January 14, 1916, It advanced to f , then f , then |. opened 1600 shares at 85 1. Market Moves 17 Figure 3 C presents every mo\'e, or change in price, which occurred during that day. The fluctuations themselves were part of a broader mo\'e- ment which is termed a secondary swing (see B in Figure 3). Steel's record for that January 14th session is indicated by the heavier block on the second part of the diagram. Though Steel on January 14, was going up, its move in the secondary swing was downward. This secondary swing, in turn, which in the present instance covered approximately a calendar month, was part of a still broader range of prices, termed a primary move (see A in Figure 3). Steel's secondary swing, shown in B, has in the diagram of the primary move been indicated by a heavier block. While Steel's position in the secondary swing was bearish, its position in the primary swing was bullish. Studies of other stocks could be made which would show moves very much similar to these presented in Figure 3. Dow's Law The changes in prices just cited have been described by the late Charles H. Dow, a founder of the Wall Street Journal and a trader of rare insight, in a way which has since been termed Dow's law of market movements. This is his description : "The course of prices over a long period of time resembles the course of a winding river which doubles on itself again and again, so that in traveling from one point to another, distant perhaps twenty miles in a straight line, it will actually traverse a distance of fifty or sixty miles in making those twenty, and will often travel for some miles in a direction opposite to that of its ultimate or true course. Furthermore, the course is full of eddies which keep the straws on its surface twisting and turning back and forth all the time. "The ultimate or true course of the river is called the primary movement of prices and it expresses the gradual adjustment ot prices to investment values resulting from the operations of 18 F r ce s in\estors — viz., those who buy stocks for income rather than for speculation. By value is meant the relation of the earning capacity and dividend yield of a company's stock to the general value of money, so measured by interest rates. The secondary movements or swings are likened to the river's doublings and twistings, and are due mainly to the operations of margin specu- lators. The surface eddies are the daily fluctuations which reflect mainly the activities of the floor traders who operate in the Exchange. Sometimes the surface eddy doubled on the actual flow of the current, and sometimes the actual flow of the current doubled on the river's true course. Traders' operations are always intimately correlated to and interwoven with those of the margin speculators and those of the margin speculators with those of the investor, the whole forming the continuous current of the river." A Little Scene in the Broker's Office What connection has this study of moves with the average trader's wrong methods shown in Figure 2, and with a person's own plans to deal profitably in securities? The answer to this question can be presented with some little realism in the follow- ing instance, the like of which occurs in many a broker's office. Assume that January 14th, when U. S. Steel was fluctuating around 85|, Mr. Average Man had dropped into his broker's office "just to see how the market opens." Stocks are firm. Steel appears upon the tape— 1600: 85|, 1000: 85|, 2200: 85f. "Steel looks good this morning," suggests the customers' man. "There's one thing you can depend upon," sagely observes a graybeard seated for the day near the ticker. "Those who sold their stocks on news of this Mexican situation will have to climb for them in a few days. That's certain." He was com- fortably long of stocks. Steel appears upon the tape: 85| — a half-point up already from last night's close. "Buy me a 100 Steel at | quick," says Market Moves 19 Mr. Average Man. He gets it at f much to his surprise and when a few minutes later it touches \ a chilly feeling creeps over him. His confidence revives as Steel from that point mounts again, and when in due time it touches 86 he leaves the office quite satisfied with himself. Why did he purchase Steel? Was it for a turn of a point or two? Or because he believed a secondary swing upward was taking place? Or was he thinking ahead in terms of the long pull? The diagram shows full well the dangers ahead for the man who merely bought, without having in mind a clear idea of why. Perspective The chances are fifty to one that the average man in Wall Street under circumstances such as have been stated thinks only "Steel is going up." No doubt at the time Steel is going up. But what sort of a move is on? Is this the sort of move that fits into his trading, or speculative investment, or investment plan? These are questions which this average man ought to think over before he puts in his order, although as a rule it is after, if at all, that he giv^es them serious consideration. Con- sequently he lacks perspective, buys or sells without foresight, flounders, and commits the stupid blunders which work such havoc with his profit and loss record. These errors are all the more irritating because in large part so unnecessary. The stock market with respect to its moves is a sort of wheel within wheel affair composed of an outer rim which mo\es with broad regularity, inner gears which upon occasion run in re\'erse direction, and in the center a small, active balance wheel which continuously turns this way and that. Tr\-ing to watch all these wheels at the same time, without noticing how dilTcrent are their respective mo\'emcnts, will likely lea\'e a person dizzy — in prime condition to commit the errors cited in the pre- ceding chapter. But tlu> knowledge that market mo\os consist of three classes and that while these three ma>' pn^ceed together 20 Forces they very commonly go in opposite directions, provides those interested in the market a distinctly useful point of view. It simplifies their problem and renders it more definite. With this simplified and more definite problem in mind, you can the better keep your eye upon the particular forces which, in what- ever of these three kinds of moves has been selected, there operate to make prices. But what constitute the market forces themselves? Where can they be located? These are also essential questions, to whose answer several chapters will now be devoted. CHAPTER III PRICE MOVES FROM THE INSIDE Demand and Supply "Why do prices go up or down?" The question was put by a customer to his broker, a man of long experience in whom age evidently had bred conservatism. "Prices of stocks go up," the broker declared after a due pause, "when there are more buyers than sellers at a given price level, and go down when there are more sellers than buyers." Demand and supply, in other words, was the idea he intended to convey by this apparently safe platitude — which incidentally^ in the way he stated it, was inaccurate. It is true, of course, that the conditions of demand and supply change continuously, which in turn brings about bids, and offers at new levels, either higher or lower; but this con- ception, while of some use, does not really explain very much. We must get behind demand and supply merely as terms, to- the forces, which, by creating new conditions in the minds of buyers and sellers, make the market price. The Market Dynamic in Nature What we wish to convey by the above statements is that price making is always a dynamic process, in which buyers press for lower terms and sellers seek for higher. Consequently, markets are in a state of i\ux, with quotations always in process of change. It is the tendency of human nature, however, to think in static terms, which means nothing more than that people readily form habits which it requires effort on their part to break and that in consequence they are inclined to believe existing conditions will continue as they are. 22 F o r c e s When the market is dull and depressed, those interested in stocks find it hard to see in such conditions the prelude to a period of activity and higher prices. When prices are near the top and the reports on all sides say the country was never before so prosperous, they assume confidently that, while other booms have not lasted, this one, due to circumstances unlike those of preceding booms, is here to stay. This conflict between dynamic markets and static mental tendencies has worsted more followers of the Exchange than a few. Board Room "Rust" These static mental tendencies usually grip closely the person whom those at a distance from the market are in the habit of envying on account of what they consider his exceptional ad- vantages, viz. the office habitue. Very commonly this daily scanner of ticker tape and board is found seated listlessly before the latter, a blase individual who watches the hurrying board boy change the quotations here and there. What do these quotations mean to him? The United States Steel Corporation has long since shriveled into a mere bit of cardboard, size 2x4. Its belching furnaces, ore docks, thousands of employes, wonderful new plants, taxes, unfilled orders or net profits do not disturb his thought because, the victim of what has been very well termed board room "rust," his mind has become too warped to admit them. Union Pacific with its mag- nificent roadbeds and low costs per ton mile, Anaconda with its chain of mines and smelters, International Mercantile Marine with its famous liners, and Bethlehem Steel, the child of Schwab's brain — it is all the same ; shorn of every feature of their real selves, these great properties are to him but automa- tons condemned for five hours daily to strut upon the market stage. The account of price changes which these board room "rusters," behind clouds of smoke, pass freely among themselves are quite in keeping. Price Moves fro m the I u s i d e U S - .. M 5 3 9. '-I ■J} a a £ "" — 1 "5 '? ? ^ '£4^ i (f) 5 bo — M ill ^23 2- S. c; j2 .2 rt u op . = U < CO cd j: -r ^ o He--' ^ 1/ u £i S t; -S 5 o-° .a a" ^ -3 ! i ^1 24 F o r c e s "I hear they are going to put up Corn this time for sure." "Can is tipped up for a rise." "Insiders are picking up Reading on every decHne." "Lipper bought 7,000 Steel; Pynchon is selling Crucible." "I have it straight that the back dividends on Marine will be cleared away at this week's meeting" — ^which being inter- preted likely means that a good friend of his knows a man whose father-in-law had it from the assistant to one of the directors to "watch Marine, there's going to be something doing in it!" "The Big Interests Are Buying" The inexperienced trader is, in fact, hard put to it for e.x- planations of what is taking place. When the market sells olif on good news, advances on bad news or breaks out of its rut into sudden strength or weakness without any cause, so far as he can tell, he becomes pretty well tangled in his thinking. Since an explanation he must have, he discovers a mysterious "they" who control the m.arket; prices go off because "they" put them down; prices advance if "they" put them up. With increasing experience, this trader after a time has rendered his "they" somewhat more definite in the person of some powerful operator or operators. Years since when the market went up, Commodore \"anderbilt was declared to be the buyer; when it went down Daniel Drew was the seller. Later, the name Jay Gould w^as breathed every time a market move needed explanation. Still later it was E. H. Harriman, then Daniel G. Reid, more recently still Charles Schwab or the Gary- Morgan "crowd" or Jesse Livermore. In cases of doubt "the big interests" are made to do service. Had these operators actually put through all the transactions with which they were credited, the Bank of England could not have financed them nor the big Exchange room itself hold all their securities. Surface Effects vs. Underlying Causes What has been said indicates pretty clearly that the majority of persons interested in the stock market keep their eye upon the Price M ov e s f r m the Inside 25 surface effects, instead of underlying causes. They often thereby are captivated and dazzled and bewildered — but seldom profited. The statement of the problem indicates the method for its correct solution. "They" as an ail-sufficient explanation, needs to be supplemented by the willingness to search for causes; over-worked remarks about what "the big interests" are doing should give way to the idea of market forces. One must get behind the quotations to the forces which make them. The Exchange floor ought to be regarded simply for what it is, the scene of incessant struggles between bulls and bears or in other words, between forces which make for higher prices and forces which make for lower. It may be the tussle is temporarily a deadlock which, when broken after a time, results in a lively day on the Exchange, a two-million or so turnover with pos- sibly three points average advance or decline. Then a period of quiesence may ensue, a sort of lull between storms. How- ever long particular conditions exist, forces as they wax or wane, make the market. The study of these forces supplies the essential foundation upon which success in the market, year after year, depends. Persons interested in the market ma>' very well regard such study as constituting the alphabet of their business; and those who, in their present preoccupation with tips, "inside" infor- mation, the news, etc., have not yet appreciated its value are deceiving themselves with Wall Street's skillful camouflage. With respect to our own operations, whether these be in\-est- ment, speculation, speculati\e iinestment, or the tiiiancing of enterprises, are we read>' to pierce through this surtace cam- ouflage and act upon sound conclusions? Every niovement in i)rices is due to certain forces. The presence of these forces should not be denied simply because you do not see them. Neither tips, nor a \'ague sense of wontler. nor idle gossip should prevent you from seeking out these torce^ which make the market. These forces, once recognized and the manner of their opera- tion learned, rendi'r \<)u a real insider, one iclio knoics. CHAPTER IV TWENTY YEARS IN THE STOCK MARKET Broad View of the Market Those who want to lay a solid foundation upon which they later can deal with success, realize the importance of gaining at the outset a broad view of the market. This broad view enables them to see how the market's forces operate in setting prices; and because several years' operations upon the Exchange are surveyed, it provides them a sound perspective. Having acquired perspective, the average person, with whom inexperi- ence is a serious drawback, is in a position to derive a decided gain; while he cannot buy and sell in these markets of the past, he can study them and, his experience in this v.'ay much ex- panded, enter the present market with surer touch. For this purpose, that the reader acquire market perspective and see what forces have operated to produce price changes in the past, we have summarized within a few pages the events of twenty years. Needless to say, the account which follows is much condensed; the limits of space are such that countless details have been stripped away and only the broad outlines presented. The Stock Market in Profile The broad outlines of market history let us picture first graphically. For this purpose a considerable number of repre- sentative stocks, both rails and industrials, have been averaged in price and these averages in turn plotted on graph paper. Figure 5 accordingly shows the main swings of the market. A preliminary survey of this chart shows that stock-market Twenty Years in the Stock Market 27 prices tend to move in cycles with minor fluctuations during the big upswings and downturns of each cycle. The first cycle began in 1900 and ended in 1903. The upswing lasted two years and the decline about twelve months. The principal irregularities were a minor reaction in 1901 during the upward movement and a tcmporar\' ralK' in Januar\-, 1903 after the decline had set in. 1: Ul Wl IW. 1!)U.( I'.IUI VMl' I'JUU 1!)U; I'JUS I'JU'J lUlO I'Jll I'll.' l'J13 I'JH I'JlJ I'JIO I'Jl" !J13 lUl'J Figure 5: The Stock Market in Profile The market's broad swings since the first of January, 1900, are here shown graphically. Dow-Jones averages were used previous to the closing of tlie Exchange in 1914, and the New York Times averages since. The important question for the investor is to know what were the underlying influences causing prices to advance two years and decline twelve months, for the big opportunities for accumulating profits cited at the beginning of this present Text lie in taking advantage of the long-pull moves of the cycle. Let us then study this cycle of 1900-1903 and attempt to separate the chaff from the wheat. B\' chaff wc mean the factors which 28 F r c e s cause only the ripples which appear on the general tide of prices. Cycle 1900-1903 The factors of primary importance during this cycle in de- termining the trend of prices are grouped below, classified into two groups — favorable or unfavorable. Let us first note that the ad\ance during the two years 1900-1902 amounted to about $50 in the railway shares on the average and about $20 in the industrials. The important factors which influenced Wall Street during these two years were as follows: Stock Market Influences, 1900-1902 Favorable Factors 1. Large exports of Boer War. This meant profits to American ex- porters and easy money conditions in Wall Street so long as Europe sent gold in payment for American mer- chandise. 2. The adoption of the gold standard by Congress in 1900, defi- nitely removing the uncertainty which had prevailed while Mr. Bryan was engaged in his free silver campaigns. 3. The formation of large corpor- ate combinations, such as the United States Steel Corporation and also rail- way mergers bringing vast railway mileage under Wall Street control. 4. The rapid increase in the gold production in the Klondike and South Africa, which provided the banks with abundant reserves. 5. The struggle for control of Northern Pacific, causing the stock to go to $1,000 per share. 6. Good crops, except a short corn crop in 1901. Unfavorable Factors 1. Bryan's nomination in 1900. 2. Strikes at the steel mills and anthracite coal mines. 3. Drouth in 1901 affecting the crops, especially corn. 4. The Galveston flood. 5. The assassination of President McKinley. 6. The Boxer troubles in China. 7. The panic among investors after J\Iay 9, 1901, when the North- ern Pacific corner collapsed. 8. Disappointment regarding earnings of industrial combinations in 1902, causing dividend reductions. 9. Failure of attempt to peg copper prices at end of 1901. 10. Beginning of Northern Secu- rities suit to stop railway mergers in 1902. 11. Ending of the Boer War in 1902, meaning a loss of export trade and necessity of exporting gold to Europe. Twenty Years in the Stock Market 29 The lesson to be drawn from above table of events is that the business world is complex. The inexperienced investor is likely to imagine that a single factor upon which he has his eye will prove the dominating influence. He is not able to balance all of the factors in the situation and judge correctly which factors will prove to dominate the market. For instance, the assassination of President McKinley or the Galveston flood occupied so much space in the newspapers temporarily that untrained investors in many cases doubtless forgot such fundamental considerations as the volume of business arising froni the export trade during the Boer War, the crops, and the vigorous and efficient efforts of nearly one hundred millions of people to produce profits from the internal developnient of the United States. Upon sober reflection, of course, it is e\ident that the wealth destroyed by the Galveston flood could have little influence upon the profits of a majority of business enterprises, and that the assassination of President McKinley would not interfere with the transportation of merchandise or the manufacture of steel. Labor troubles, also, could not impair profits greatly unless they resulted in a complete stoppage of business for many months, but experience shows that the necessity of earning a living forces capital and labor to get together in some fashion without a long stoppage of industry. But the question remains. "What caused prices to advance during 1900-1902?" The fact that they did advance show^s that the favorable factors more than offset the unfavorable influences. The most fundamental factors were the easy money rates in Wall Street during 1900-1901, the export demand for American goods, and the fact, also, that selling prices generalK' adxanced faster than wages during these years, resulting in abnornialK- large commercial profits. Let us now consider the events which caused the markt'd decline in 1903. 30 Forces Stock Market Influences, 1903 Favorable Factors Unfavorable Factors 1. Fair crops. 1. Large gold exports, causing 2. Active merchandising. tight money in Wall Street. 3. Fairly settled social condi- 2. Congestion of unsalable se- tions. curities in Wall Street, when banking funds were depleted. 3. Decision in Northern Securi- ties case unfavorable to Wall Street control of railways. 4. Receivership for shipping com- bination. 5. Labor troubles. 6. Depression in steel industry. The dominating factors in the dechne of 1903 were the tight money situation arising from gold exports, which checked lend- ing on securities, and the decision in the Northern Securities case, which affected market sentiment and made investors lose faith in the ability of Wall Street financiers to maintain values created through high finance. Cycle 1904-1908 Let us now consider the cycle 1904-1908. This cycle like the preceding one exhibits an advance of about two years and a decline of about twelve months. From the autumn of 1904 until the autumn of 1906 there was an advance of about $40 per share in railroad stocks and an increase of about $55 per share in the industrials. The market did not advance during the first half of 1904 on account of a poor winter wheat crop and the outbreak of the Russo-Japanese War. Before the end of the year, however, it was found that other crops were good and that the sale of supplies to Japan would add to the prosperity of many corpora- tions. By the summer of 1904, also, capital had become ex- tremely abundant in Europe and the L^nited States. Among the more important factors which entered into Wall Twenty Years in the Stock Market 31 Street discussion during the two-year ad\-ance of this c\cle were the following: Stock Market Influences Favorable Factors 1904 1. Government states the Northern Security decision does not mean that the Attorney General is "running amuck." 2. Exportation of gold subsides; money becomes easy. 3. Democrats nominate Alton B. Parker; Roosevelt's election as- sured. 4. Good corn crop. 5. Exports to Japan. 1905 6. Iron market advances. 7. Railways order equipment. 8. Rumors of combinations. 9. Dividends increased, notably on Steel Common, Union Pacific, Southern Pacific and Pennsylvania. 1906 10. Large crops; railway traffic heavy. Unfavorable Factors 1904 1. Poor winter wheat. 2. Financial uncertainty upon outbreak of Russo-Japanese War. 3. Russia and Japan sign treaty in autumn 1905. 4. In December, 1905, money market tight in sympathy with European prices; call money rates 125 per cent. 1906 5. Hepburn railway rate bill enacted.' Congress becomes gener- ally hostile to corporations. 6. San Francisco earthquake causes insurance companies to sell bonds to secure indemnity funds. 7. Capital scarce in Europe, Bank of England rate 6 per cent. By the end of 1906, the fiivorablc influence of large crops and extraordinary business profits was fully offset h\- the unfa\oral)le effect of high interest rates, reflecting an rxhaustion of cai^ilal. The world over, there were symptoms of a crisis. In Japan, Chile, Egypt, London, New York, and, in fact, in all parts of the world high prices had caused such an extension of bank loans that the bankers could little afford to risk further assistance to commercial expansion. Borrowers were making hea\y with- drawals of gold from the banks in order to pa\ the debts con- tracted on the basis of high prices. The bankers began to discriminate against stock exchange borrowers in order to assist 32 F r c e s merchants to carry on their operations. The result was a slump on the stock exchange late in 1906, which continued in 1907 until November, except for an occasional rally of a few points in the spring and in July. Railroad stocks declined fully $50 a share and industrials nearly as much. At the time, a good many speculators thought the decline was due mainly to the hostility of President Roosevelt and Congress toward corporations, but even though this may have dampened market sentiment, the fundamental cause was an exhaustion of capital. Among the factors prominent as market forces during this memorable year of 1907 were the following: Stock Market Influences, 1907 Favorable Factors 1. Trade supported by large crops of 1906 and good corn crop of 1907. Unfavorable Factors 1. Abnormally high operating expenses impair profits. 2. Commerce Commission in- vestigates Harriman railway lines. 3. Bond syndicates unable to sell new security issues because of exhaustion of capital. 4. Continuation of trust prose- cutions. 5. State authorities active in regulating railways; clash with Fed- eral authorities. 6. Judge Landis fines Standard Oil §29,000,000. 7. Copper trade slumps. 8. Knickerbocker Trust Com- pany fails. Bull Market of 1908-1909 After the panic had passed, it was found that the properties built up during the preceding period of prosperity were physically' intact; that in 1908 the crops were growing as usual, and that as a result of the crisis wages were low and materials cheap. Owing to the general halt of business during the latter part of 1907 and Twenty Years in the Stock Market 3>i the early part of 1908, capital rapidly accumulated, not onl\' in the United States but in England and on the Continent. By the summer of 1908 conditions were ripe for an advance, and during 1908-1909 stock price fully reco\ered the losses of the preceding panic. Rails ad\anced S50 a share and indus- trials nearly as much. The following were prominent market influences: Stock Market Influences, 1908-1909 Favorable Factors Unfavorable Factors 1. Low wages and cheap ma- 1. Railroad receiverships, terials. 2. Anti-trust suit against Xew 2. Accumulation of capital caus- Haven road. ing decline in money rates. 3. President Taft recommends 3. Freight rates increased. tax on corporation incomes. 4. Increase in tariff duties in 4. Harriman, leading market 1909 considered favorable. general, becomes ill. 5. Expansion in iron and steel 5. Europe begins to resell Ameri- industrj-. can stocks bought during panic of 1907. Reaction in 1910 At the beginning of 1910 speculators in Wall Street were wvy much confused. Capital was still fairly plentiful in London and Paris and the railroad promoters in the I'nited States who were accustomed to borrow heavily in Europe had big plans for the future. Nevertheless, the chart on page 27 shows that stocks declined about S25 a share on the a\erage during the first seven months of 1910. The Interstate Commerce Commission rendered a decision, the tendency of which was to undermine confidence in railway securities, and for \arious reasons investors in England and Holland sold back American securities which they had pur- chased during the panic of 1907. It is estimated that this re- selling from Europe amounted to ;?150,000,(H)0. The reason for such selling was partly the restrictive political acts at Wash- ington regarding the railways and partly the fact that European investors began to find attractive investment opportunities in 34 Forces other parts of the world at this time. An important consider- ation, also, was that they had bought stocks during the panic because they were cheap and in anticipation of making a profit, and the wild ball market in Wall Street in 1909 gave them the expected opportunity to sell at a big profit. That is, they sold because prices were high. The following table summarizes the events considered im- portant market influences during this year. Stock Market Influences, 1910 Favorable Factors Unfavorable Factors 1. Fair crops. 1. President Taft recommends 2. President's annual message in increased powers for Commerce Corn- December reassuring. mission. 2. Collapse of Hocking Coal and Iron Pool. 3. Anti-Trust agitation. 4. Money situation tightens. 5. Commerce Commission makes sweeping reductions of railway rates. Irregularity 1911-1914 The three years following 1910 were unfavorable to the ■development of a normal stock-market cycle. In 1911 and again in 1912 speculators courageously ad- vanced prices, but in each year the bull movement collapsed. In July and August, 1911, speculators were thrown into con- fusion. They would talk about the short corn crop one day and the prosecution of the steel trust the next day as a cause of the market's weakness. The fact was, however, that the un- settlement of the financial markets in Europe caused by the Moroccan dispute was the dominating influence. The Kaiser threatened to employ violence in dealing with France, and Lloyd George intimated that any move against France would prejudice British interests in Africa and that Great Britain might be ex- pected to take a hand in any war that de\eloped. Many Twenty Years in the Stock Market 35 bankers withdrew funds from Switzerland and Berlin, and British speculators sold stocks heavily in Wall Street. This fact now has come to be regarded as the dominating influence, although at the time Wall Street actually thought other con- siderations were more important. The following table shows the market factors which governed Wall Street activities during 1911: Stock Market Influences, 1911 Favorable Factors Unfavorable Factors 1. Easy money conditions. 1. Commerce Commission sus- 2. Supreme Court announces Pends rate increases. "rule of reason" in dissolving Stand- 2. New York Central reduces ard Oil and American Tobacco div-idends. trusts. 3. Standard Oil and .\mcrican 3. Orders for steel increase to- Tobacco dissolved. ward end of the year. 4. Moroccan crisis causes panic in Europe and dumping of .\merican securities on New York market. 5. Attorney-General begins suit against U. S. Steel Corporation. In l'>12, on the basis of good crops and a rapidK' growing demand for steel, not only for industrial purposes in the United States but for exportation abroad, the stock market adv'anced. As in the preceding year, howev^er, the advance was brought to a halt by political conditions in Europe. About the first of October the Balkan states made war against Turke\' and there was danger that the big powers would be drawn in. The Balkan War continued into the year 1913 and the settlement b\' the Treaty of Bucharest was so indecisi\e that it left Austria and Germany at daggers' points with Russia and iur allies in Western Elurope. It was only a question of time until war would break out, and a stream of stocks flowed steadily into W'.iil Street from the boxes of well-informed capital- ists abroad during the first half of 1914. N'e\ertheless, Wall Street became optimistic and looked for better things in 1914, 36 Forces and American optimism had a strong foundation in large grain- crops and a record cotton crop. But just as an autumn bull market was expected to begin, the Great War broke out. The following table reviews the events of the three years, 1912-14: Stock Market Influences 1912-1914 Favorable Factors 1. Record corn crop in 1912. 2. Large exports of steel. 3. Large crops in 1914. 4. Congress passes Federal Re- :serve Act. Unfavorable Factors 1. Democratic Congress decides on investigation of "money trust." 2. Flood in Mississippi River. 3. Balkan War in autumn of 1912 causes Europe to sell American stock. 4. Republican party splits. Wil- son and Democratic Congress elected, making tariff reductions certain. 5. Union-Southern Pacific mer- ger dissolved by Supreme Court, December, 1912. 6. President Wilson's speeches after election antagonistic to big business men. 7. Revolution in Mexico early in 1913; Taft withholds action, leav- ing problem to Wilson. 8. Democrats in Congress at- tack profits and wealth. 9. Poor corn crop in 1913. 10. Settlement of Balkan War leaves Austria and Russia at daggers' points. 11. New Haven Road suspends dividends. 12. Commerce Com'n suspends proposed freight increases in 1914. 13. Great War breaks out in Europe. 14. Stock market flooded with foreign holdings; Stock Exchange closed. Twenty Years in the Stock Market 37 War Boom The Stock Exchange remained closed from the end of July until December. During this period Wall Street bankers were busily engaged in making remittances of gold to England to pay the debts of certain railways and cities, including New York, which matured during those months. Finally the debts were largely settled and Charles M. Schwab returned from his inter- view with Lord Kitchener with large contracts for war supplies. About this time, also, France and England had depleted their stocks of commodities and urgently needed war supplies of all kinds. Then followed two years of "war order" prosperity, industrial stocks advancing S35 a share on the average during 1914—1916. The rails recovered only about $20 a share from the war panic, remaining heavy on account of continual selling from England. The following table gives the leading events of 1915-1916: Stock Market Influences, 191 Favorable Factors 1. Charles M. .Schwab obtains large orders for war supplies from England. Orders for other com- panies follow. 2. Wages and prices low follow- ing panic of 1914. 3. Large exports of food stufTs at high prices. 4. Money conditions become e.\- tremely easy, discount rates 232 to 3 per cent. 5. Large gold imports from Eu- rope. 6. U. S. Steel wins anti-trust suit in lower court. 7. France and England sell S500,- 000,000 .Anglo-French notes, insur- ing further demand for war supplies. 8. Record wheat crop. 9. In 1916 exports continue large. 5-1916 Unfavorable Factors 1. Lusitania sunk in May, 1915. 2. Mexican problem continues. 3. Early in 1916 German sub- marine activity indicates U. S. may be drawn into the war. 4. Peace rumors and top-heavy prices adversely affect war-order stocks. 5. Carranza captures .American troops. 6. German U-53 raids .Atlantic Coast, autumn of 1916. 7. Crops in 1916 less favorable than in 1915. 8. .Market collapses in confusion during peace move by Germany. 9. President's Peace Note and Lansing's "verge of war" statement in December, 1916. 44746ii St. Paul's Daily News Figure 6: From Cause to Effect Metropolitan When business expands to enormous proixjrtions or when severe contraction ensues, the Stock Exchange becomes prominent since these commercial and financial conditions there focus. Wall Street, the mobilizer of capital, flourishes or languishes as its countless borrowers and lenders flourish or languish. Twenty Years in the Stock Market 39 America in the War The period of participation in the war by the United States was marked by a decline of $35 on the average when the war broke out and irregularity until the armistice was signed. Despite large profits, federal taxes prejudiced the position of the stockholder. Moreover, speculative demonstrations were frowned upon during war time. After the armistice was signed. however, the directors of most American corporations found themselves possessed with large "undiscounted" profits, which had accumulated during 1918, and as the Allies and the American government gradually settled the claims of these corporations for work done, numerous plans were proposed to capitalize the war profits by issuing stock dividends, or declaring distributions in cash or Liberty Bonds. The recovery from the low levels of the war period until the summer of 1919 amounted to about $35 a share in the industrial stocks. The rails reco\'ered only $15 on account of uncertainty as to how Congress would dispose of the railway problem. The following table summarizes thee\'entsof the years 1917- 1919: Stock Market Influences, 1917-1919 Favorable Factors Unfavorable Factors 1. Entrance into war by U. S. 1. Unrestricted submarine war- means large demand for war supplies. fare by Germany causes disaster to 2. Decline in rails halted by shipping and confuses market senti- Government guarantee of income on mcnt. December 26, 1917. 2. Federal war taxes cause un- 3. Guarantee of minimum price certainty regarding earnings. for wheat promises large crops and 3. Russian Imperial Govern- therefore heavj' volume of trade. ment overthrown March, 1917. 4. Weakening of German morale, 4. Federal price fixing initiated August, 1918, causes optimism. summer, 1917. 5. Following Armistice, Nov. 11, 5. (Operating expenses increased, 1918, corporation officials find them- railroads in sad plight. selves possessors of large undis- tributed surpluses; certainty of ex- tra dividends or stock dividends cause price advances, March to July, 1919. 40 Forces Stock Market Influences, 1917-1919 (continued) Favorable Factors Unfavorable Factors 6. War savings flow into the 6. Italian army suffers disaster. stock market during spring and sum- 7. Bolsheviks overthrow Keren- mer, 1919. sky government. 7. President Wilson refuses de- 8. Collapse of foreign exchanges mand to increase railway wages; indicates check to exports. Judge Gary refuses to confer with 9. Demands of railway employes radical labor agitators. and strike in steel industry dampens speculative enthusiasm. America After the War Immediately after the signing of the Armistice came the natural reaction from the speculative furore of the War. In early 1919, however, the pent-up demand for goods made itself felt and we entered into a period of inflation. This culminated in the Fall and early months of 1920. Then followed one of the most drastic readjustments that the country has ever experi- enced. The first industries to liquidate were the Silk, Textile, Woolen and Leather. These were directly followed by others until by the Fall of 1920 most industries were well into a period of liqui- dation. Raw producers were most adversely effected, particu- larly the farmer. Liquidation of food products continued until Wheat sold below $1.00 against a fixed price of $2.70 during the War, while Corn and Oats went below 50 cents. As the farmer afford-s 35% to 40% of the total purchasing power of the country this brought a most severe depression. Such de- pression continued through late 1920 and through 1921. In the year 1921 this resulted in a marked easing in money conditions due to the fact that the loans of the war period were being paid up and that business did not demand much new capital. The natural result of these increased funds was, first, the largest upward movement in bond prices in years, second, the use of funds in speculation. The stock market, discounting the natural improvement in business, following such a deflation, rose an average of 2>5 points from the lows of June-August, 1921, without any reaction of Twenty Years i7i the Stock Market 41 importance. Due to the varying effects of the deflation^ ho\ve\er, the advance was very uneven, equipment, construc- tion, food, and chain store stocks rising greatly, while tire and rubber, fertilizer, copper, oil and iron and steel stocks, due tO' the over-expansion of the war in these various industries, lagged perceptibly. Stock Market Influences 1920-1922 Favorable Factors 1. Good crops. 2. Improving money conditions. 3. Ending of the period of inflation which had brought such extravagance. 4. Republican President elected which was supposed to be favorable to business. 5. Export trade continued good in spite of readjustment. 6. Investment securities ad- vance rapidly in price. 7. Savings bank deposits in- crease. 8. Reserve in Federal Reserve Banks increase rapidly. 9. Loans and re-discounts in Federal Reserve Banks decline radi- cally. 10. Continuance of large gold im- ports. 11. Full tni|)l()yment at high wages toward end of 1922. Unfavorable Factors 1. Unparalleled decline in commodity prices. 2. Heavy inventory losses by most industrial companies. 3. Many industrial companies operating at large deficit. 4. Continued declines in foreign exchanges. 5. The failure of labor to liqui- date and to decline in price in propor- tion to commodity prices. 6. General unrest. 7. Continued high taxation. 8. Hands of Republican admin- istration tied by Congress. 9. Position of the Farmers becomes the worst in thirty years. 10. Purchasing power of nation declines rapidly. 11. Railroads fail to earn amount outlined for them in War legislation. 12. Failures are the greatest in years. 13. Unwise tariff legislation. 14. Great unemployment. 15. Unequal declines in various commodity prices lead to much uncertainty and dissatisfaction. What Next We Consider Thinking over the foregoing tables leads a man to iIr- essen- tial viewpoint, that prices arc made by forces, and that in seeking out these forces he works from cause to effect. 42 F r c e s There is another conclusion which he will draw, which is scarcely less valuable. These tables containing briefly summa- rized forces which have made prices, are composed of two columns, favorable and unfavorable. No situation has ever been so favorable that certain adverse factors did not at the same time exist, and never is a bearish situation without some bullish factors. What takes place with respect to prices depends upon which set of factors exerts stronger influence. The favorable factors decidedly in the ascendant, prices mount; the unfavor- able factors predominant, prices fall. The exchange floor at all times represents a tussle between forces which make for higher prices and forces which make for lower. This broad survey of forces which make prices will now be followed by a closer examination of how the process works. The first phases of this examination, called "From Gross to Dividends," takes us into the financial structure of the cor- poration itself. CHAPTER V FROM GROSS TO DnTDEXDS A Study in Corporation Finance The paragraphs in the preceding chapter contain a sound summary of items which were the principal forces setting prices during the past twenty years, and it is safe to say some of them will still be in harness making markets when the \-oungest subscriber has grown gray in financial wisdom. Let us now study further, in the attempt to see more clearly how these forces exert their influence in the market. This next step takes us into corporation finance. It will be a study of the gross income of corporations whose stocks are popularly known as "market leaders." The purpose is to show how the movements of these stocks are intimately related to fluctuations in that narrow slice of gross income known as the "balance available for dividends." The following eleven stocks during the year 1917 were traded into the extent of 80,000,000 shares. The transactions in them, in fact, comprised about four out of every ten shares bought and sold on the Exchange: Anaconda Oopper Alining Company Baldwin Locomoti\c Works Bethlehem Steel Corporation Central Leather Company Mexican Petroleum Company Republic Iron and Steel Company The Studebakcr (Corporation L'nited Fruit U. S. Rubber U. S. Steel Utah Copper 44 Forces This list contains representives of the steels, motors, cop- pers, equipments, oils, and leathers. Hence in addition to its liigh turnover compared with the Exchange's total volume of business, it represents with fair accuracy Wall Street's diversified industrial interests. Let us now sketch the course of these eleven corporations' income from gross to dividends. We say sketch, because the •disposal of corporate income is to be considered fully in the texts studying The Financing of Enterprises, and our interest here is simply to get at market forces. Shares and Their Priority Claims These eleven companies in 1917 reported gross earnings of -over two billion five hundred million dollars ($2,500,000,000). Various persons lay claim to these gross earnings. Labor wants its pay envelope, the suppliers of raw materials submit their bills, and numerous other expense items must be satisfied. Most of the heavy demands of these persons and items are backed up by priorities, and very nearly 85 per cent of gross must be •disbursed to satisfy them. The bondholders comprise another group with a priority claim on gross income. Their claim — interest — is an impor- tant fixed charge against railway income, but, be it noted, in the case of those corporations here considered, interest removes but a narrow strip from gross income. Most industrial com- panies avoid issuing bonds, if possible. Next after the bond owners the preferred stockholders have a priority, although one less urgent in nature. Their slice equals 3 per cent, or more, of gross. The directors now, with approximately 88 per cent of the original gross no longer available for distribution, face the common stockholders. They do not vote the remaining 12 per cent of gross as common dividends, howe\-er. With conserva- tive intent, they set aside as "surplus" a fairly generous portion — and the thin stream of what still remains of gross dribbles into the common stockholder's purse. Fr om G r s s to Dividends 45 The relative magnitude of dividends on common stocks as compared with wages and other prior claims against gross income is suggested in the table below: Distribution of Gross Income Wages and materials .... Allowance for depreciation Interest and pfd. dividends Improvements, etc., out of surplus Dividends on common stocks $2,000,000,000 80.0% 125,000,000 5.0 75,000,000 3.0 200,000,000 8.0 100,000,000 4.0 Total gross income .... $2,500,000,000 100.0% Consider the corporation's gross income as flowing toward the common stockholder. Then note the process of distribu- tion, how the large proportion of the gross earnings consumed by expenses for wages and materials, and how small is the margin of dividends actually paid. Having presented the relation of gross to dividends in its general aspects, let us now study individual cases. Bethlehem Steel in 1918 had a gross income of $44S, ()()(), 000, yet the earnings on the common shares were only $11,000,000, or 2.5 per cent of gross, while the dividends actually paid to the common stockholders were only $4,458,000, or one per cent of gross. The United States Steel Corporation did a little better, showing earnings for Steel common equal to 6.42 per cent of gross, and dividends for the stock equivalent to 4.07 per cent of gross income. In view of the importance of the earnings of Slecl common to the man of independent judgment as a basis for his personal study of investment conditions, we are printing a table here showing a statistical history of the income and dividends on this stock since 1902. This table shows how the "balance for common" dropped from 554,000.000 in 1902 to $5,000,000 in 1904; rose to $79,000,000 in 1907, only to fall to $20,000,000 the next year; fell below zero in 1914, and rose to $246,000,000 two years later. Then, most extraordinary of all, ii"'f 'In- 46 F r c e s rapid decline from 1916, to only $10,000,000 in 1921. Surely this is a feast and famine record which suggests that there will always be opportunities for profitable speculation in following the trend of the steel business. U. S. Steel (000 omitted) Gross Income Bal. for Com. Com. Div. Pd. Year Amt. % of Gross Amt. % of Gross 1903 $536,573 $25,013 4.66% $12,708 2.36% 1904 444,405 5,048 1.12 000 .00 1905 585,332 43,365 7.35 000 .00 1906 696,757 72,909 10.47 10,166 1.46 1907 757,015 79,346 10.43 10,166 1.34 1908 482,308 20,509 4.25 10,166 2.11 1909 646,382 53,854 8.35 20,332 3.14 1910 703,961 62,187 8.80 25,415 3.60 1911 615,149 30,080 4.87 25,415 4.13 1912 745,506 29,020 3.89 25,415 3.40 1913 796,894 55,997 7.03 25,415 3.18 1914 558,415 (Def.) 1,723 —.30 *15,249 2.72 1915 726,684 50,614 6.96 6,354 0.86 1916 1,231,474 246,312 19.98 44,476 3.61 1917 1,683,963 198,999 11.81 91,494 5.43 1918 1,744,312 112,312 6.42 71,162 4.07 1919 1,448,557 51,380 3.54 25,415 1.75 1920 1,755,477 83,842 4.78 25,415 1.45 1921 986,750 10,311 1.04 25,415 2.57 1922 1,092,697 13,514 1.24 25,415 2.32 $17,706,425 81,283,961 7.25% av. 8490,511 2.77% av. ♦Paid out of surplus. Eliminating Bethlehem and U. S. Steel from the list of eleven companies grouped above, we find that the di\'idend& on the remaining nine will average about 5.5 per cent of gross and the total "balance for common" about 15 per cent. This is evidence that dividends average onlv one-third of the income 1915 1918 $380,500,000 $779,600,000 55,250,000 100,450,000 17.1^:^ 13% 820,700,000 $42,900,000 5.4% 5.5% F r m G r s s t D i V i d e n d s 47 actually earned by common shares. Note this point in the following table: Earnings, Nine Companies Gross income Earned on common shares . Earned, per cent of gross Dividends paid on common shares. Dividends paid, per cent of gross . The important suggestions derived from a study of the above tables are: 1. That dividends take a \er\' small proportion from the gross earnings of industrial enterprises, generally from 3 to 5 per cent of gross income. 2. That a very small increase in wages tends to wipe out dividends unless the gross income increases in pro- portion. And, 3. That, conversely, dividends can easily double or treble with a very slight gain in gross income, if the outlay for wages and materials does not gain in proportion. Dividends VS. Earnings as a Market Guide We have stated that the amount of earnings put back into the property for improvements by most industrial companies is more than double the amount paid as dixidcnds. Stock- holders must sacrifice present enjoyment of income for the purpose of expanding operating facilities. The income to which they are actualK' entitled is largely paid to workmen employed in increasing equipment. On the average, industrial companies pay dixidends of SI. 00 out of every three earned by common shares, the other S2.00 being spent for betterments or put aside to swell "surplus." The stockholders, of course, retain owner- ship of the income put back in the property, and the jirice of 48 Forces the stock usually reflects such investment in equipment. This is especially brought out by showing the fluctuations in the price of Steel common as compared with dividends and earnings per share. Whenever earnings are large, the stock rises in anticipation of heavy dividends. If the earnings double or treble, it is expected that dividends may double or treble, and the price of the stock leaps upward. But when the directors vote to appro- priate two-thirds of the earnings on the common stock to the improvement of plant, and distribute only one-third of the profits to the stockholders as dividends, the speculators are perplexed as to whether the stock should sell on the basis of book value of the plant, or in relation to the amount of cash dividends actually distributed. Investors know that an increase in profits means either larger dividends or an increased equity in the company's plant, and while the money market is calm, the stock rises. But when a panic comes and there is a premium on cash, investors begin to appraise property in terms of cash dividends, ignoring book values. The stock during a panic therefore falls to a close rela- tion with the cash dividends. The book value of "equity" in plant is largely ignored. After the panic has passed, however, it is once again recalled that large amounts of money have been invested in property, and the stock rises in anticipation of future earnings on this increased property. In the long run, the average price during a period of eight or ten \'ears bears a close relation to cash dividends paid. In the swings of the stock-market cycle, however, due considera- tion is given to the amount of earnings invested in capital equip- ment. Thus the stock market reflects a see-saw movement of prices, at one time rising in anticipation of the future income yield, but later falling to a level which gauges the actual cash dividends paid. Since the biggest possibilities in making money lie in buying during periods of depression and selling during periods of prosperity, it is more profitable to give greater attention to fluctu- ations in earnings on the stock than to the yield from actual From Gross to Dividends 49 dividends paid. This is demonstrated in the following chart, which shows how the price of Steel common has fluctuated with the percentage earned per share since 1902. Price movements, it is noted, precede dividend changes to a conspicuous extent. The question arises, how shall we forecast when the earnings are going to increase or de- crease? In answering this question there are two classes of factors to consider. First, the steel industr>''s internal ba- rometers, such as the "new orders booked" and the changes in the selling prices of steel products. Second, those fundamental factors which determine the big swings in orders and 1902-1921. Key— Graph ".A."— Prices Steel Common. mCtal priCCS. 1 nCV are Grapli"B" — Earnings per share. Graph "C" — Dividends, piainlv CrOpS politics and money conditions. Just how these fundamental factors in- fluence the l)u>ing policy of consumers and the selling policy of the steel companies will be analyzed later in the text on "Business C\-cles." At this point we will merely exhibit a chart which affords graphic evidence of the close relation of ''orders booked'' and money rates to the price of Steel common in the stock market. It will he noted that when unfilled orders increased in 1905, 1909, 1912, and 1915, there was a rapid increase in the price of the stock. When the otlicials of the corporation and keen observers in Wall Street noticed that orders were falling off in 1907, 1910, 191.^ and 191S. however, the price rapidly fell. m \fA \r.o I?;? i?ii i?i3 1715 m w m Kj \m m m \% m m m Figure 7: Steel Common Quarterly dividends, earnings and price fluctuations. 50 Forces This close relation of orders to prices was continued after the armistice in November, 1918. For a few months orders were low and prices heavy, but when orders increased in the spring of 1918, investors again became confident and Steel common advanced. 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914' 1915 I91fe 1917 1918 1919 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 2400 2J300 1600 1200 600 400 Figure 7: Stock Prices and Fundamentals The dose relation between money rates, orders booked by the Steel Corporation, and 'the price of Steel common here is graphically presented. CHAPTER VI LOOKING AHEAD The Sinews of Wall Street What the sinews of Wall Street really are begins to become more clear. While board room "rust" often obscures these sinews and while under skilful camouflage effects frequently are mistaken for causes, the preceding study has revealed the under- lying forces in a way which will prove useful. This in itself represents no small achievement, since market perspective and a knowledge of the real price-making forces very often are not gained in several years' experience. Meanwhile, the would-be financier bumps along, with a few ups and many downs, wonder- ing why it is he does not strike things better. Winning golfers like Travers and champion sluggers like Ty Cobb state their rule of success in this way: Keep >'Our eye on the ball. This rule also has a fruitful application in Wall Street. Questions Which Point the Right Way The common stockholder, standing expectantly at (he end of the liiu', ui)()ii surveying the sources of his income ii.ituralK- feels concerned in the various intermediate steps of this process from gross to dividends. Those steps affect his money re- ceipts; hence in concentrating up^m tluin he practices the Travers-Cobb achice to keep his eye on the ball. These intermediate steps, since they comprise everything which has to do with tlu' iiicoiiK--])ro(lucing capacity of a stock and the rates for mone\-, are necessaril\- \aried in nature. The summaries in the preceding chajiter present the most important of I lu-ni : How are the crops? Are the factories busy? .52 Forces Do the mines operate at capacity? Are railroads well supplied with traffic? What is the value of exports? of imports? the excess of exports over imports? What is the attitude of labor? the extent of unemployment? the brand of philosophy preached by agitators? Are politicians favorable to business? What is doing in Congress, the State Legislature and the courts on economic matters? Are money rates high or low? What is the condition of the New York banks? of the London and continental money markets? Which way is gold moving, and in what volume? What in general is the condition of business? Is it good or bad? Are business men buoyant or depressed? Do they favor a policy of expansion or of curtailment? How is this particular corporation affected by the preceding condi- tions? What are its earnings, gross and net? How high are its fixed charges? its preferred dividends? When distributing surplus, are the directors conservative or prodigal? The common stockholder, therefore, as he stands at the end •of the Hne, has in addition to his expectancy an inquiring mind and numerous questions. The Profit Maker's Point of View A certain point of view upon this common stockholder's part is here so essential, yet so generally disregarded, that we preface our discussion of it with a little story of two big profit makers. In the days when Andrew Carnegie was still "King of the Steel Makers" his lieutenant was one Charles M. Schwab. Carrying out certain constructive notions which shaped them- selves in his mind, Schwab planned the Homestead Steel Works, to cost $10,000,000, an enormous undertaking for that period. The first that Carnegie heard of it was when he arrived in Pitts- burgh from Scotland one morning and Schw'ab laid the plans before him. "Charlie," he gasped, "where would we ever sell the entire •output of such a plant?" "Look here, Mr. Carnegie, at these statistics showing the Looking Ahead 53 i» annual consumption of steel in this country, see in how few years the demand doubles." "Never in the world could we sell such an oul|)ut," responded Mr. Carnegie. "Charlie, put those plans right in your drawer and keep them there. Don't show them to anybod\-." The great general is first a great soldier, and Schwab was Carnegie's most loyal soldier. Without a word those plans were laid away and soon forgotten. Within two >'ears the cable came from Scotland: "I have borrowed the monc\- here. Build the Homestead." It took all the organization ability of Schwab to rush those works to completion in time to meet the rising American tlcmand for steel. In a few years the Homestead was but a small part of the Carnegie works, whose total annual net earnings were four times the construction cost of the Homestead. Today the entire Carnegie works arc but a minority in the United States Steel Corporation, while Schwab himself with char- acteristic vision has pushed Bethlehem Steel into a remarkable position second only to this great billion-dollar concern. Schwab and Carnegie looked ahead. Their plans were laid for future conditions and their rewards were due to foresight. "Keeping a little ahead of conditions," declares Schwab, "is one of the secrets of successful business; the trailer seklom goes very far." The Commercial and Financial Mainspring This incident of Carnegie and Schwai) introduces us to a matter of basic importance, whose e\er\-da>' realness is not usually appreciated. When a manufacturer conmiences to set the marki-tiug pi ice for his commodity, which cost to produce is fundamental — past cost, present cost, or costs which he aulicipatcs later will prevail? While it is true that in the case of staple articles which are continually being reproduced and whose costs do not vary a great deal from time to time, the figure o\'er which he ponders will be practicalK' the same if not identical with fxist 54 F r ce s records, it is even in this case and markedly so in other cases a new figure, the cost expected to prevail in the future rather than the cost experienced in the past, which acts upon the manufac- turer as a controlling motive when he comes to set his selling price. The future is his real touchstone. Should he consider the securing of additional capital, its present value to him is the discounted value of the expected income — again a calculation based upon things anticipated. This principle, however, is widely applicable. Upon what does the value of all economic goods depend? Upon the satis- factions which they atTord, that is, the agreeable sensations derived from them or the disagreeable sensations which their use enables us to avoid. These satisfactions are matters of the future. In purchasing a pair of shoes, a house, a motor car or an aeroplane, we bank upon this future, with all its chances and risks; and the price now paid equals the discounted value of the article's expected benefits. These expectations may be sur- passed later when the commodity is consumed or the benefits possibly will fall short of the estimate, but in either case it is expectation and not realization which gives these economic goods their current value. Calculations of the future are the mainspring of commerce and finance, the real basis of everyday buying and selling. Jay Gould's Statement Finance is the most highly flexible and elastic portion of the whole production process, and with it calculations of the future have an unusual currency. Present worth of its wares, or securities, depend upon calculations of the benefits later to be derived in the form of interest pa^^ments and dividends; and calculations of the rate of interest by means of which these future values may be translated into present values through the process of discounting. Here, as elsewhere, the practical realness of the future again appears. The testimony of Jay Gould affords in this connection an interesting sidelight, in that it reveals the bent of the financier's Looking Ahead 5S mind. Mr. Gould was on the witness stand, under cross- examination concerning certain past events with respect to Union Pacific. "I consider the future of a road more important than its past." Q. "Yes, but what I want . . ." "The past was no criterion as to the Union Pacific Road." Q. "But don't you think that General Dodge and Mr. Humphreys . . . ?" "All my life," replied Mr. Gould, warming up, "all my life I have been dealing in railroads — that is, since I have been of age, and I have always considered their future and not their past. "That is the way I have made my money," he continued. "The ver>' first railroad I ever bought had a most deplorable past, but its future was fair. I paid ten cents on the dollar for its bonds, and finally sold the stock for $125. It was the future of the Union Pacific that drew me into it. I went into it to make money." The common stockholder, we may conclude, if he is to secure profits there at the end of the line from gross to dividends, con- cerns himself primarily with anticipated earnings of the cor- poration and anticipated money rates. With a fine disdain of the obvious, he mounts into some favored post of observation, armed with telescope, and faces fonvard. What's Ahead? Wall Street's leading money makers all keep an e>e upon coming events. When the outlook, as they see it, fa\ors a period of depression, they distribute stocks in anticipation of curtailed orders, factories running on half time, unemployment, poor earnings, and reduced dividends. When these latter conditions in due time become obvious, these same persons very likely are then accumulating stocks upon the prospect of business im- provement. Wall Street discounts coming events, and translates i(s forecasts of the future into actual concrete prices for securities. 56 F r c e s The "mystery" of why the stock market acts so and so, very commonly has here its explanation. The market moves upon prospects as far ahead as the best informed people can see, and its present prices are based upon estimates of future conditions. ticvP' lateA" ,;V^^^*^ \pa' ,tei' , M^*^^ VcvP^ ted' , .v»f^<^ \pate4* "Melons" Dividends "Lemons" /j{/c, '^afed. Unfilled Orders Net Earnings Manipulation Money Rates Tariffs Business Sentiment Crops Gross Earnings Mn f'c/pa fecf. Wages Business Failures 'Ant, '"'Pat ed. Politics Strikes Wars ■•^""■^'■Pated^ Taxes Figure 9: The Right Viewpoint The person who deals in securities raises continuously such questions as "Buy or sell, or hold my position? Which' stock?" Their correct answer calls for foresight, a looking ahead. A person cannot speculate upon the obvious. The so-called "insider" differs from the great majority of investors and traders in that he bases his commitments upon calculations of future economic conditions while the attention of the majority almost exclusively centers in prevailing conditions. "Why does the market not respond?" the outsider inquires in disgust when his stock sluggishly moves off the very day its statement of excellent earnings had appeared in all the news- papers. "It already has," thinks the insider; "what's ahead?" While all events cannot be discounted and many either are overdiscounted or underdiscounted (as will be considered later) the fact that in general, stock prices move ahead of present con- ditions and the certainty that they will discount everything obvious, is the most important, the simplest and the most disregarded of all speculative features. Riddance of this fault alone, under the methods outlined from Text to Text, will Look i n g A h c a d 5 7 possess you of a changed viewpoint which not onl\- wins profits in Wall Street but an^'^vhere in business. The Next Step Future business conditions, in the form of items wiiich affect the income-producing capacity of corporations and the cost of money, bear upon present stock prices through the medium of minds engaged in the attempt to forecast. The beliefs of persons with funds and their hopes and fears con- cerning the future are in the end what rule upon the Exchange floor, and, since values wax and wane as these beliefs change, it is essential to know the methods with which Wall Street manipu- lators play upon the mind. The subject opened up in Text III, "Manipulation and Market Leadership," is a very interesting one; and our survey of forces which make the market cannot be at all complete until we have delved into it. Garden City Press, Inc. Neivton, Mass. TEST QUESTIONS "FORCES WHICH MAKE PRICES" The Test Questions which are unstarred can be answered directly from the Text discussion. Vou will lind them helpful for purposes of review. The questions which are starred call for original thought, the ability to apply the knowledge gained from the Text to the solution of new problems. 1. What opportunies for profit does the stock market afford? Discuss the methods of a seasoned veteran outlined by Mr. Clews. *2. When inexpt-riencid and poorly informed persons were buying, as indicated on the chart. Page 11, WHO supplied the stocks? When they sold, WHO took over their stocks? What conclusion, which will increase your profits, do you draw from this? *3. Mention three specific errors revealed in the investi- gations made by Guyon and Gibson of brokerage accounts. How are you to avoid these errors? 4. Into what three types can you classify market moves? What is Dow's Law? 5. Describe what has been the course of the market during the past twenty years. Name specific forcc^ which ha\e operated to produce this course. *6. "The industrials have been booming. Isn't it about time for the rails to have their turn?" Note the diagram on Page 27. Do the rails necessarily mo\-e with the industrials? 7. Sketch clearly the course of corporation's revenue from gross to dividends. Which of those who share this income have priority claims? *8. 'This discussion of inflation, exchange rates, crops, etc.," writes a subscriber, "which I read in the jjapers impresses me as a mass of generalities. Why does the editor not confine himself to individual stocks? That is his real business." Is it, or is it not? What conclusions upon this point do you draw from the chart on Page 49, for instance? *9. Do Stocks go up or down at the time of j^residential elections? During wars? 10. "The annual statement issued, by the Steel Corporation seems to me to be most satisfactory. Why should the stock continue to sell off?" — L. D. H. How would you answer L. D. H.'s question? ANSWERS TO STARRED QUESTIONS "FORCES WHICH MAKE PRICES" *2. The experienced and better-informed. These are often referred to as "insiders" and professionals; and while they are not always right, they nevertheless secure very satisfactory results in general. The conclusion is: Reverse the methods followed by the public and thus act upon the methods of "insiders" and professionals. *3. Bought at the top. Sold at the bottom. Loaded more heavily at high prices than at low prices. *6. The industrials have been "booming" evidently because of their prosperity. And this increased business in turn calls for increased use of transportation, which normally is reflected in larger earnings and higher prices for rail securities. Moreover, for sentimental and other reasons within Wall Street, stocks often do move together. This common action does not always occur, however. The industrials, newly organized and their securities largely "undigested" made compara- tively little headway in 1900-1502, while the rails advanced sharply; and the rails, with their rates practically unchanged and operating costs mounting, advanced little in 1915-1916 while the industrials enjoyed an unusual bull move. The only sure way is to keep examining the forces which make prices. *8. These topics • — ■ inflation, exchange rates, crops, etc. — concern vitally business conditions as a whole, and hence the earnings of individual corporations. The charts on Pages 49-50 indicate that fundamentals and stock prices are closely correlated. Since the editor's real business is to present information which is helpful, he properly devotes considerable space to fundamentals. *9. These are old questions, which during every election and war are thrashed over in Wall Street. Elaborate deductions, often accompanied by numerous charts, are presented showing what the market has done, and hence what it should do this time. Considerable benefits can be derived from all this, provided conditions are similar. The war, a bull argument on industrials in 1916, turned into a bear argument in 1917, when the United States entered it. Whereas, orders were large in both cases, new factors, such as the excess profits tax, changed con- ditions decidedly. UNIVERSITY of CAUFOKWIa AT LOS ANGELES LIBRARY