On March 30, The Wall Street Journal’s front page contained a huge graph of the market’s rise since 1990, highlighting key historical events that have influenced the Dow’s bumpy ride. These events included the Mexico peso devaluation in December 1994, Alan Greenspan’s “irrational exuberance” speech in December 1996, and Bill Clinton’s presidential election in November 1992.
Arguably the single most momentous event impacting the trajectory of the market in the 1990s is not even mentioned in this or any story we read about Dow 10,000. That event was the election on Nov. 8, 1994, that gave Republicans control of the Congress for the first time in 40 years. On that date, the Dow was at 3,850. In less than five years, the Dow has nearly tripled in value. In just five years, nearly $10 trillion of new financial wealth has been created.
The White House boasts of a Clinton bull market, but the evidence argues persuasively that the market rally began its steep ascent in November 1994, not November 1992. Consider the market indicators presented below:
In Bill Clinton’s first two years with a Democratic-controlled Congress, the Dow gained 600 points and averaged an 8.5 annual rate of return. Not bad. But from November 1994 through today, the era of the GOP Congress, the Dow has gained 6,150 points and averaged a 24 percent annual rate of return. Interest rates rose in Mr. Clinton’s first two years, but have fallen since the elections of 1994.
What explains the market’s love affair with a Republican Congress? Partly it is that Republicans — for all their foulups and disappointments — have passed some very economically beneficial legislation over the past five years. The most important of all from the perspective of providing adrenaline for the financial markets was the capital-gains tax rate cut from 28 percent to 20 percent. This has substantially increased the after-tax rate of return on individual investments in the United States. The rate cut also has had a favorable unlocking effect, thus allowing investors to sell stock holdings in fading 20th century industries like steel and energy, and reinvest the gains in 21st century high-tech stocks.
Other bullish legislative victories by the Republicans have included the achievement of the first balanced budget in 30 years (though the GOP has been far too timid on cutting the budget for our tastes), the expansion of Roth IRAs, which have turned out to be popular savings vehicles for middle-income workers, and the historic welfare reform bill of 1996.
History teaches us there are five policy mistakes that can end a bull market. First is an inflationary monetary policy. Second is a tax increase. Third is protectionism. Fourth is a huge expansion of the federal budget. And fifth is unsound government interventions in the private market place, such as wage and price controls or the Hillary health care plan. From the late 1960s through 1981, the United States violated every single one of these policy rules, and consequently we had a horrendous 15 year bear market. In 1982, the Dow bottomed out at 850. As the Reagan tax, budget and monetary policies took hold, the market began its now 17-year surge.
Today’s policy regime is profoundly benign. Inflation is nonexistent. Republicans are likely to cut taxes, not raise them. Both Mr. Clinton and Republicans in Congress want to expand free trade, not curtail it. The budget is actually shrinking as a share of GDP — again not as fast as it should be falling, but the direction is favorable. And last but not least, no particularly harmful governmental intrusions in the marketplace have seen the light of day on the GOP Congress’ watch, though the health care area is worrisome.
Critics of this Congress and the last one have lambasted the GOP for its “do nothing” agenda. There is, of course, still much unfinished business in Washington, starting with moving toward a private IRA-type system for Social Security, cutting the fat out of the bloated federal budget, and fixing the incomprehensible tax system. But with the markets rising by 20 percent a year, unemployment at its lowest in two decades, the budget in surplus, the inflation rate closing in on zero, and real incomes rising, there is something to be said for a Congress that simply avoids doing monumentally stupid things. It’s when Congress gets active in passing laws that the markets get jittery.
Perhaps the real message for Washington of Dow 10,000 is that we could do a lot worse than two years of gridlock in Washington ‑and, alas, we probably will.