NASDAQ HITS 1000
Led by Microsoft, Intel and other gee-whiz stocks, the NASDAQ hit 1000 yesterday, up nearly 40% since December 8, its recent low. The usual gaggle of cash-flow noodniks on Wall Street tell us that these dizzy advances are being "fueled" by cash "from a vast pool of money" in pension funds, company stock buy-backs and individual stock buying, according to The Wall Street Journal's "Abreast of the Market" column on Monday. Our old friend Byron Wien, chief market strategist atMorgan Stanley, worries "that people will plain run out of money to put in the market." In Sunday's New York Times Magazine, Michael Lewis also marvels at the flood of greenbacks that are coming out of this vast pool: "The most recent official explanation for the miracle boom is that the economy is weak, and interest rates are falling. This sounds plausible, except that a couple of years back the official story was that the market was rising because the economy was strong. In any case, I don't buy the official explanation. I believe that the stock market is rising because mutual fund managers like [Jeff] Vinik [who runs the Magellan Fund] cannot afford to stop buying stocks."
Wrong. The value of pieces of paper known as "stocks" do not rise or fall because of the ebb and flow in a pool of other pieces of paper known as "dollars." I first realized the fallacy of the cashflow argument 25 years ago, when I pondered Johnny Carson's question on his Tonight show: "Where does all the money go when the stock market crashes?" It simply vanishes, just as one-third of the nation's money supply (along with one-third of the banks) vanished in the years following the Crash of 1929. Lewis is closer to the mark when he quotes John Maynard Keynes, who played the market with great success in the 1930s and who once described the art of investing as "anticipating what average opinion expects average opinion to be."
The equity market in general is also up smartly since the December 8 benchmark, but with not nearly the zip shown by the premiere, low capitalization stocks that comprise the NASDAQ. One might argue that Microsoft and Intel properly belong on the higher-cap NYSE, but the NASDAQ arena represents youth as well as size. It seems clear to me the boom on NASDAQ is directly related to anticipation of a lower capital gains tax not only coming out of the 104th Congress this year, but also being signed into law. The bond market is wobbling because of confusion surrounding the Fed's intentions, but NASDAQ marches on as long as the politics of capital gains grows more positive. This will continue as long as the market sees that it is in President Clinton's political interest to sign rather than veto legislation containing the capgains cut the GOP will send him.
At the moment, the likelihood of a veto still seems extremely high from the perspective of our best sources on Capitol Hill. If this turns out to be the case, we would expect a major sell-off on Wall Street, with NASDAQ leading the way. The sell-off today is almost certainly a market correction along these lines, having nothing to do with shifting expectations surrounding monetary policy. Whenever it appears that President Clinton stands a better chance of being re-elected by working co-operatively with the Republican Congress, the likelihood increases that we will see a budget reconciliation signed instead of vetoed later this year. It has to be this year, not next, in order to effect the promise of House Ways & Means Chairman Bill Archer, who insists a lower capgains rate be retroactive to January 1.
There are two principal variables at work here, because the Republicans are also playing presidential politics. The President, advised by Dickie Morris, has been playing the social and economic conservative, always just a bit to the left of the GOP center of gravity. The plan is to get the voters used to the idea of a conservative Congress controlled by the GOP, which the White House more or less concedes in the '96 elections, and a slightly more liberal Democratic President in the Oval Office. The Democrats, who are always pretty good at this sort of tactic, wind up in control. This is because the conservative ideologues always want to be somewhere to the right of the Democratic agenda. Clinton can thus afford to play hardball to his heart's content on the welfare and regulatory reforms, for example, to demonstrate to his primary constituency that he deserves to be re-elected. He can dangle his signature over capgains, but the price he will extract will be painful to the budget conservatives. If they demand deeper cuts than he will accept, he will veto the whole shebang and down will go our retroactive capgains cut.
The positive side for the GOP is that if it is willing to co-operate in order to get capgains, the President will have no choice but to co-operate as well. Otherwise, Dickie Morris will tell Clinton that the voters will blame him for the market slide, economic weakness in 1996, and legislative gridlock. He will be a lame duck, almost a dead duck. Senate Majority Leader Bob Dole can pull this off, but he may have to resign as Majority Leader, turning the reins over to Minority Whip Trent Lott. As it stands, every Dole gesture of co-operation with Clinton gets him grief from the conservative ideologues in general, Sen. Phil Gramm in particular. Lott would probably have enough maneuverability to work this out with Clinton. Dole, though, might wonder if it would be better for his last political shot at the White House to remain in control of the legislation and take a veto, even invite one. The variables in this political chess game seem almost infinite, but the outcome still seems positive — if only because there seems so little chance for the President's re-election if the game ends in gridlock and he gets the blame.
As we surmised, the Fed's conduct of open market operations since dropping the funds rate one-quarter point on July 6 has maintained an extremely tight rein to keep funds from trading below the new target. The New York domestic open market desk remained out of the market all last week, and is now widely expected to shift to a drain mode when the next two-week reserve maintenance period begins Thursday. There is even talk of an outright sale of bills from the Fed's portfolio, an operation that the Fed has not conducted since 1990. Although the funds rate targeting procedure again is creating some very counterintuitive operating conditions (draining liquidity while dropping rates, just as last year they were adding liquidity while raising them) the lower rates combined with tighter dollar liquidity looks like a winner. The Bank of Japan, meanwhile, has been on a fairly steady (for them) liquidity injection run since announcing the shift in policy on June 7. The combination of a less stingy BoJ and more miserly Fed should be positive for continued strengthening of the dollar/yen rate.