In our last market commentary, A Night To Remember, we offered the view that a new bull market for stocks was “right around the corner.”
Since that post election communication, there have been several trial balloons hoisted by the Administration about different types of tax cuts. Frankly, they are all positive for the stock market, but the real George W. Bush program is still under wraps and we don’t expect to see it before the State of the Union Address in January. Until something formal is forthcoming, we can only search for clues and hints from the Administration.
The best clues found so far surround the budget process. Vacancies created by the resignations of both heads of the Congressional Budget Office and the Joint Economic Committee on taxation tell us that there may be a move afoot to do away with the static analysis that has plagued tax-cutting pro-growth legislation in the past. This is the very source of the rhetoric, “How much will these tax cuts cost?” that only looks at the specific revenue loss created by a tax cut, without any consideration given to the positive effect of the reinvestment of these tax savings back into the economy. It was static analysis that called for huge deficits resulting from the last capital gains tax cut. Instead, tax revenues from the tax cuts increased so dramatically that our entire budget ended in a surplus position.
Replacing static scoring with a dynamic process will pave the way for a pro-growth tax cutting agenda. Interestingly, the heads of both budget committees in the Congress are pro-growth, supply-side advocates. The table seems to be set to enjoy a pro-growth feast. Let’s keep our fingers crossed and watch closely to see who is appointed to fill the vacancies.
Meanwhile, the market rally is not waiting for a final rendering as beaten down issues rally vigorously from deeply over-sold territory. News of improving consumer sentiment along with decent corporate earnings is helping drive the market. These easy comparisons will likely give way to some stock market consolidation in the very near term due to the sharp run-up in some stocks. We remain quite positive for the longer term, however, and plan to buy on dips whenever the stock market goes through those predictable doubting sessions. The fundamental story is quite compelling.
As the stock market gains strength, one can expect the bond market to decline as money moves from bonds to stocks. For clients concerned with performance, we have cut back bond positions substantially and shortened the duration of existing holdings to avoid some of the negative return aspect of bonds. For clients who need the safety of a “hedge” or the income, we advise holding bonds through this period of adjustment. Without inflation the real rates of return on high-quality Treasuries are still quite positive. After all, the right kind of tax cut can increase the after-tax return on bonds as well. It is still important to have balance in one’s overall financial structure, and for our clients needing this balance, we advocate holding on to Treasuries.
Best wishes to you and your loved ones for a happy and healthy holiday season…