Early in the year, we had the rosiest scenario of all the relevant economic and market forecasters. "Confidently Bullish" is how we put it in our January 20 FYI. Alan Reynolds' economic assumptions were that 1) inflation was not going into a spiral, the PPI numbers of January and February notwithstanding, and 2) real growth would soften in the second and third quarters and strengthen in the fourth. My political assumptions were that 1) the Fed was on the beam and would stay there, easing when the gold price got closer to $350 and the dollar bumped up against the G-7 range, and 2) the Bush administration would succeed in getting a cut in the capital-gains tax out of Congress. We saw a DJIA around 2800 without a capgains taxcut, 3200 or so with a good capgains package.
The consensus view, early on, was that inflation was going to be a big problem and the Fed would have to strangle it with higher interest rates. By late spring, the consensus — including some erstwhile supply-siders — shifted to a recession forecast. The DJIA's record high of 2734.64 yesterday has been accompanied by a shift in the consensus to a no-inflation, no-recession outlook (although some of our friends with monetarist leanings still predict one or both for 1990).
We're now nervously bullish, most of our early '89 optimism now capitalized in the market. The Fed eased when we thought it would, steadying the dollar against foreign exchange and gold. And OMB Director Richard Darman, a modern Svengali, seems about to pull a decent capgains package out of his hat. All well and good.
But we're now more anxious, precisely because everything's going so good. If the consensus sees there isn't going to be a recession, if stronger real growth numbers start popping up, the Fed could tilt toward deflation. The vacancy on the Board of Governors makes us nervous for this reason. We're pulling for Florida State's Jim Gwartney, to strengthen the hands of the price-rule contingent. Who knows what the Bush White House will come up with on this, its first go at a Fed seat?
Suppose Darman doesn't get his capgains cut, his magic failing him? There is now less pressure on the Democrats to capitulate on capgains because the stock market is so strong and the consensus has decided there ain't gonna be a recession in '90, an election year!! The White House economic team, out basking in the sun, may return after Labor Day to find a Congress more open to the anti-capgains ideological arguments of the Democratic leadership. We hope not, but it has happened before that the stock market climbed on the prospect of a tax cut designed to get the economy moving, then sank as Congress decided the economy was already moving and didn't need the cut.
If things go awry on any of these counts, we would expect to see a moderate correction. At the moment, our antennae are picking up only positive vibes, reason enough for us to be nervous. Now that we're getting Wall Street and Mexico under control, I'm off to Moscow September 2-to-9, at the invitation of the Soviet state bank, to advise them on ruble convertibility, supply-side and such. I'll also urge the immediate creation of a Moscow stock exchange, to sop up all those surplus rubles they're worried about. On the day it opens, I predict the DJIA will be at 3500. Give or take a ruble.