A Bull Market Scenario
Jude Wanniski
July 26, 1978


Executive Summary: What will it take to get the Dow Jones Industrial Average to a level of 3000 or 4000 by the early 1980s? In the conventional view, the question itself is an astonishing one. With the DJIA struggling to stay near 800 here in mid-July, the idea of a colossal bull market during the next several years has been unthinkable. A waste of time to even contemplate. It isn't.

A Bull Market Scenario

Begin by considering the possibility that the bull market has begun, that it began in April when the New York Stock Exchange turned 65 million shares and closed up 15 points. If we can only conceive of a path that would lead to a DJI of 3000 by, say, 1982, that attainment becomes a possibility. Even if the future diverges from that imagined path, the exercise would be worthwhile. In understanding the path, investors would have a higher degree of confidence in their investment decisions as they observe actual events either speed movement along the path, or slow movement along the path, or throw the market off the path altogether. Even those investors who reject the path as being wholly unrealistic will benefit by bearing it in mind.

The bull-market scenario I will elaborate here is not an ideal in my mind. It is, in the political/economic model from which it flows, a probability—a small but significant probability that the DJI will go to 4000 in five or six years, say 20%. And a high probability, perhaps 60%, that it will go to 3000 in that period. The probabilities are based not on wishful crystal—ball gazing, although the forecaster can never rid himself entirely of such tendencies. They are based on a calculation of political forces in the United States and around the world. This is, after all, a political analysis. Yet there is not the slightest doubt in my mind that the stock market is driven, in aggregate, by political forces.

When something has happened before, it is easier to imagine it happening again. So I make this point. A fourfold rise in the DJI during a brief span of years would not be unprecedented. In the opening days of 1921 the DJI was at 72. On Septembers, 1929, it was at 381. More than a fivefold rise in seven and a half years. The rise was in real, non-inflated terms, which is what I posit. The time is ripening for a parallel unfolding of political forces in the period ahead. As in the 1920's, we can expect a gradual, then accelerating dismantling of the government barriers between effort and reward. An era of incentives. The most important of these barriers are the now unnecessarily high federal tax rates on capital gains, personal incomes, and gifts and estates. Also a diminution of federal regulatory barriers to commerce. And a sharp reduction in the commercial costs that arise from doing business with an inconvertible dollar. My thesis is that these barriers will fall in series, not simply like a row of dominoes, but rather as logically as the play in an end game of chess—after one player has gained such thorough dominance of the board that only gross error on his part can deny him the future.

Think of the political forces that bear on the stock market as you would of a chess game: the "White" and the "Black". There is an array of forces attempting to drive the market down; an array of forces attempting to drive it up. The investor who does not confuse the White and the Black, and who further understands the relative weight of the pieces on the board, will be able to make marginally superior investment decisions to those of investors who are uncertain or oblivious. This is what counts.

The forces attempting to drive the market down are not doing so conspiratorially. The individuals involved, the Black pieces on the board, are merely the instruments of an incorrect strategy for the economy. In good faith, they are logically acting out an imperative that flows from erroneous, obsolete economic theory. Broadly speaking, we may call this theory "British", in that the British have been its chief practitioners in this century. It is both "Mercantilist" and "Malthusian" in its framework. It is Mercantilist in its assumption that an individual, a group of individuals, or a nation can only benefit at the expense of others. It is Malthusian in its assumption that economic growth can only come through exploitation of planetary resources, and that this is now impossible because global population growth has now overtaken the ability of mankind to exploit ever-scarcer planetary resources. Finally, it is neo-Keynesian, in the sense that Lord Keynes believed the day would come when the above assumptions would come into play. Then, the game made possible by his economic theory—stimulating the exploitation of natural resources through government deficits—would be up.

The Carter Administration is now possessed by these forces, and as a result stands as the chief roadblock to a major bull market.

I quickly say the Carter Administration is not entirely composed of Black pieces. Only that at the present moment the Black are in overwhelming control. Even in the chemistry of the President's mind there are White forces wrestling for dominance. We assume it unlikely that they will take control for more than an occasional moment, however.

The Carter Administration had been in control of the board and the market until early April, having driven it from roughly the 1000 level at inauguration to 750. Then, a totally unexpected move by the White pieces gained control of the center of the board. Representative William Steiger, Republican of Wisconsin, introduced an amendment to the Carter tax bill that would roll the capital gains tax rate back to its level of 1969, from roughly 50% at the top to 25%. Steiger informally surveyed the 37 members of the House Ways and Means Committee, of which he is a member. His determination that he had 19, possibly 20 votes for the amendment surprised him, and shocked the White House. The news totally upset the Administration's calculus for the economy. It took a few days for the White House to do new calculations that resulted in suspension of the Ways and Means Committee's tax-bill writing. The stock market did the same calculations with almost no delay. The result was the 65 million-share, 15-point rise of April 17th.

At the moment, the Steiger amendment remains in control of the board, braced by the Kemp-Roth bill that would reduce federal income-tax rates by a third over three years. In the almost totally improbable event that both Steiger and Kemp-Roth would pass the Congress and become law with the President's signature, I would expect (everything else being equal) a rise in the DJI to a level of 1200 to 1400 during the process and into next year, with a broader rise in the Over-the-Counter market reflecting the potency of the Steiger measure on young, expanding enterprises.

This isn't likely to happen, however, President Carter threatens to veto a bill containing Steiger. He would surely veto a bill containing Kemp-Roth. What seems probable during the summer months—with always the congressional elections of November looming on the horizon-is passage of a modified version of Steiger in the House and a complete rollback of capital gains to 1969 in the Senate. There, a companion bill sponsored by Sen. Clifford Hansen of Wyoming has attracted more than 60 co-sponsors. Senator Russell Long, chairman of Senate Finance, (in my opinion the most capable U.S. Senator), can win the Senate version in conference with the House if he chooses to select that route. If he believed there could be sufficient pressure brought on the White House to sign the resultant legislation, he would do so. Otherwise, while he could get a veto override of the President in the Senate, chances are small he would see sufficient strength in the House for a veto override. President Carter would have to be persuaded that a veto of Steiger, sustained, would mean Democratic losses in November. This will be difficult, because the President now believes the exact opposite. He believes a rollback of capital gains will be a Republican liability in that it "favors the rich". He is wrong. The voters will sense the potency of Steiger as an instrument of real economic expansion. The outcome will hinge on Republican timidity or forcefulness in pressing the issue in October.

The time for Kemp-Roth legislation to reduce marginal income-tax rates, and its progeny that may take the top income-tax rate down to 25% by the latter 1980's as Representative Kemp intends, has not arrived. Because it could not possibly survive a Carter veto, even those congressional forces who desire it would not press it into a bill that would go to the White House if this meant endangering Steiger, the all-important cut in the capital-gains tax rate.

Where does this leave us? Either a modified Steiger enacted, taking the DJI to perhaps 950. A full Steiger enacted, with perhaps a DJI at 1100 or so. Or a sustained veto of Steiger, and a DJI tending to drop below 800. I say "tending" because it is here assumed that the Republican Party would truly make hay over a Carter veto and make major gains in November. As the stock market senses this probability, it would push against the downward tendency. It would see a high probability that a political shock to President Carter and congressional Democrats in November would both weaken their resistance to tax measures a la Steiger and Kemp-Roth and provide a cushion of votes in both the Senate and House for veto overrides.

The market must necessarily be wary of the ability of the White pieces to hold and extend their position on the board. My bullishness is entirely based on the estimate that this will be done, that time is now on the side of the White against the Black. The White pieces not only represent youth, growth and dynamism. They have identified each other as such and are broadcasting and fortifying their strength as a coming dominant political force. Each week adds doubly to this strength. As the young grow stronger, the old grow weaker. This is not a contest of individuals, I hasten to add, but a contest of ideas. As in the 1920's, when the same kind of development took place, the Black pieces will not give up without a heroic struggle. They will force the Whites to prove themselves with muscle again and again. So, in the market, when the upward surges come, they will come swiftly, briskly, in 50-point, 60-point and 100-point movements during a space of days as one key 'Black' piece after another is toppled.

On the way to a DJI of 3000 or more, the biggest surges would almost have to come in 1980 as the Republicans and Democrats duel for the White House, with the market anticipating a renascent GOP victory large enough to give it effective control of Congress as well. The easiest task for the dominant GOP, into the 1980's, would be to peel down the explicit tax rates. A more difficult task will be to unwind the regulatory excesses now built into the economy, difficult because of interminable debates over which regulations are excessive and which are not. Voters will be wary of giving the GOP too great a mandate, fearing wholesale dismantling of the regulatory superstructure, the good with the bad.

In a march toward 4000 DJI, the last 1000 will require not only deftness in whittling away at regulatory excesses. It will require similar movements on both the tax and regulatory fronts among the major western industrial nations and in the Third World. The United States can only go so far as an expansive force before it must lift or see lifted a major portion of the rest of the world economy. Unilateral expansion in the family of nations invites friction too, as the Japanese have discovered. Here too, my bullishness rests on awareness that incipient movements along the lines of Steiger and Kemp-Roth are emerging in Britain, Germany, Sweden, France and in the Third World. Exciting experiments with incentive tax systems in Puerto Rico will be watched closely throughout the developing world.

Finally, the unwinding of unnecessarily high barriers to commerce caused by the impact of global inflation on progressive tax systems must be accompanied by a return to an international monetary system with a convertible key currency—almost certainly a gold-convertible dollar. The only way inflation can be stopped is through dollar convertibility. A gold standard. Any standard. Only when the U. S. Government's monetary authority is forced to give up something of value when its citizens come to the Treasury with surplus money, demanding something of value, can the flood of cheapening dollars be stanched. This will be a most difficult job. Almost the entire American economics profession—Keynesian and monetarist—is committed to theories that require dollar inconvertibility. But just as the Republican Party is now moving away from its traditional economic theorists in the area of taxes, Republican politicians will gain confidence in moving away from the same theorists on issues of money and convertibility. Younger economists —those under 35—are already abandoning the obviously unworkable ideas of their elders. By the early or mid-1980's these younger economists will have matured further and will dominate in political influence—as the grey beards gradually leave the scene. Inflation will be conquered in the 1980's as it always has been—with gold.

Just as the long contraction of the period 1966-1978 contained within it the seeds of expansion, so too does the expansion now beginning contain within it the seeds of contraction. There is no way of telling how long the expansion posited here will last. History suggests, though, that a 50-year run is not inconceivable. When Great Britain emerged from adolescence in 1815, at the conclusion of the Napoleonic Wars, it began an expansion that lasted to roughly 1875—a run of 60 years. A 60-year bull market.

The United States is now throwing off the tattered ideas of its adolescence—as the premiere nation of the world, a position it inherited from Britain only in 1945. It will lead a global expansion not by exporting to the world those economic ideas that poisoned and debilitated the British Empire, but by rediscovering the ideas that built the United States of America.