Well, we finally got the tax cut! The effect of a lower tax on dividends, capital gains and personal taxes should be good for the stock market. The Administration certainly did all it could to provide a floor under the markets and give capital an opportunity to go to work to achieve higher after-tax returns. If that capital is free to move and not hampered by a liquidity squeeze, we should be enjoying higher stock prices by the end of the year. A growing economy, increased revenues, and talk of a smaller deficit would follow by election 2004.
This all sounds great, right? But, there’s always a catch to any positive scenario. That catch might be a liquidity problem resulting from an overly tight Federal Reserve posture. Alan Greenspan simply must provide enough fuel for the economy to operate efficiently, thereby freeing up stored capital for investment. If the desired liquidity is insufficient, we can expect that capital to remain on the sidelines waiting for a rainy day. It’s really that simple.
We’re now in the hands of the maestro (Alan Greenspan), and we have no clue as to how he may operate. Frankly, we have become less confident in his stewardship over the last three years. In our piece written in December 1999, we cautioned about this stewardship and the need for a steady hand at the Federal Reserve Board. Our view back then focused on the critical role held by Greenspan as a liquidity squeeze would “prick the bubble” in the market place.
Looking back at the last 3½ years, we now know the rest of the story. Alan Greenspan has been chasing a deflationary wave, barely providing enough liquidity to keep us afloat. He has now admitted to a concern about deflation and, hopefully, this view will cause him to err on the side of ease. With this assumption in mind, we are adopting a more positive portfolio structure for most of our clients. We have increased exposure to equities and cut bonds to a market-weighted position. We’re more positive than we have been in four years. We will, however, not change our conservative nature and watch every Federal Reserve move as the scenario unfolds. As the economy gains traction, operating profits and higher disposable income will help reduce the critical nature of Federal Reserve policy. We must bear in mind that the rest of the world is facing a deflationary dilemma. This is precisely why the currency fluctuations have featured a weaker dollar. We will continue to advise you as their policy unfolds, but for now…it feels good to have the tax cuts in place.