Should Wall Street bulls break into a gallop if Republicans take the reins on both ends of Pennsylvania Avenue? Ought the markets care if Florida gave Al Gore a miracle comeback?
For the first time in memory, trading opened on the morning after Election Day with investors having no way to know who would next occupy the White House. Confronted with the most uncertain presidential ballot since 1876, the markets responded with a collective yawn. By mid-morning on Nov. 8 the Nasdaq was down about 1.3 percent — a slow day for that volatile index — while the Dow Jones Industrials and the Standard & Poor’s 500 benchmarks barely moved.
It is tempting to conclude that the choice of president does not matter to the stock market. This would be big news to Messrs. Gore and George W. Bush, both of whom were quick to claim paternity for the market success of the past two decades. Each, in fact, had a point.
Bush can fairly describe his tax-cutting agenda as the heir to that of Ronald Reagan, whose Economic Recovery Tax Act kicked in just as the modern bull market got started in 1982. Gore boasts of the federal budget surplus that grew out of a big tax increase that the Clinton administration pushed through Congress in 1993. Despite Republican predictions of doom, that tax hike did not stop the stock market from beginning an unprecedented five-year run of double-digit returns from 1995 through 1999.
Let’s get this straight: Ronald Reagan cut taxes, and the market went up. Bill Clinton raised taxes, and the market went up. Does a president, or at least a president’s tax policy, have anything whatsoever to do with how the market behaves?
Yes, but not nearly so much as presidential hopefuls might have us believe. Stock prices reflect what investors are willing to pay today for an expected stream of future cash flows. Taxes, and especially taxes on individuals rather than the corporations that are being traded, are only one variable in the formula for this value, and not a terribly important one at that.
Consider, first, that taxes represent half of federal fiscal policy; the other half is spending. Cut taxes and spending by an equal amount, and the fiscal impact on the economy is unchanged. Congress and the president together determine fiscal policy by their decisions on taxes and spending. It makes little sense to analyze one without considering the other.
Next, consider that fiscal policy works in conjunction with monetary policy, which is the level of interest rates that is guided by the Federal Reserve. Cut taxes too much, and the Fed may decide to cancel out some of the stimulus by raising interest rates so as to avoid feeding inflation. Create too much fiscal drag through a tax increase or spending cuts, and the Fed may promote easier credit to compensate.
Finally, an array of decisions in the private economy, and by governments abroad, probably plays a much bigger role in corporate profits than anything that happens inside the Beltway. Productive investments in new technology, the arrival or departure of labor due to demographic changes, better management techniques, and economic growth by our trading partners have more to do with the money-making potential of our enterprises than does a marginal movement in tax rates.
Often it is better to be lucky than smart. Falling oil prices probably helped offset an important chunk of the 1993 Clinton-Gore tax hike, by directly reducing costs and also by reducing inflationary expectations and, therefore, interest rates. On the other hand, Jimmy Carter had the misfortune to be up for re-election just as oil prices reached an all-time high. Nobody had to stay up late on that election night to find out how the story ended.
For a related article from the December 2000 issue of Sentinel, click below: