To: Students of Supply-Side University, web browsers
From: Jude Wanniski
Re: The financial market does not wait
When I saw Sen. Don Nickles, chairman of the Budget Committee, last week promise on the Senate floor that the Bush tax cut would add 10% or 15% or even 20% to the value of equities on Wall Street, I quickly e-mailed his top staffer to warn that the market had already advanced 5% because of the progress the legislation had made since mid-March. Wall Street does not wait until the last minute to “discount” a piece of news by capitalizing it into share prices. It is like a tote board at a racetrack, which incorporates all the opinions of the people at the track who are placing their bets. They do not all place their bets at the last minute and in fact the smartest bettors genuinely wait until the last minute as they watch the way the odds are developing.
Last Saturday, the New York Times carried a story in its first business page by a very competent reporter, Alex Berenson, who noted that the tax legislation that had passed Congress the previous day was greeted with indifference by Wall Street. I proceeded to write the following letter to the Times, which the newspaper chose not to print, probably because I was so far out of the ballpark. Polyconomics provided the only analysis of the market rally that began in mid-March to the progress of the tax bill. Those of you who experienced last week’s SSU lesson on 1929 are already aware of the fact that markets are incredibly efficient in absorbing the available news and using it to set prices, which change from day to day the way they do before and after the horses leave the gate.
In his May 24 report, "No Big Rush to Stocks After Cuts in Two Taxes," (May 24), Alex Berenson notes the ho-hum reaction of Wall Street to final passage of the Republican cuts in capital gains and dividend taxes. The first fruits, though, had already been gathered in the rally that began in mid-March, which coincided with the surprising progress being made on the legislation that seemed unlikely to include any reductions in the taxation of capital. The equity markets are up from their low point by 5% in these weeks. Some part of the rally may have reflected the quick end to the conflict in Iraq, but most of the $600 billion increase in the value of the nation's capital stock can be directly attributed to the lower taxation of capital worked out by Congress these past weeks. In that sense, the $350 billion in tax cuts over 10 years have already paid for themselves.
Chairman, Polyconomics, Inc.
I sent Alex Berenson a copy of the letter and he subsequently replied that he believed I was in error, because he had spoken to several of his best sources on Wall Street and they all assured him the market rally was the result of the war beginning in Iraq. Here is how I responded:
I sent you separately a client letter from April 2. It is no surprise that everyone you spoke to when the rally began told you it was the end of uncertainty on war in Iraq. I was baffled at the time how this could be true... The rally occurred as risks increased, not decreased. Then it suddenly dawned on me that the rally was due to the shocking surprise that the tax bill was actually making progress in the Senate. I got an excited call from an administration source early on March 21 tipping me off to what was happening in the Senate... which the lobbyists knew was developing for the previous two days. Roll Call had a story on it March 20. Most economists and financial commentators never believed a "little bitty" tax cut would cause any excitement at all on Wall Street. But this was a huge tax cut on capital!!
At the time, I paid almost no attention to the tax bill because I believed it would be stripped down to the social tax cuts, kiddie credits etc. It was also not clear that Bush would push for it with any seriousness, perhaps preferring the issue to the bill. You can be sure that I was absolutely alone after March 21 in advising my clients that it was the tax bill driving the market.
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To tell you the truth, it was one of my clients who e-mailed Poly on March 19 complaining that I was spending all my time trying to discount the effects of the war with Iraq into share prices and not spending any time at all looking at what was going on in Washington, as had been my practice for years. That’s what set me in motion, shaking the Washington tree and my sources there, which is what produced the news on the surprising progress being made by the tax bill. Historians will no doubt look back on this market rally and agree with conventional analysis, but we of course know better.