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The Pricing-in Is Right
The Bush tax-cuts have set the stock market on fire.


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Larry Kudlow

The red-hot Dow stock market index has run up to the 9,000 range, with no end in sight.

Just two weeks since the passage of President Bush’s tax cut — one that strengthens economic incentives by raising after-tax investment returns by over 40 percent — the bellwether Dow has gained more than 400 points.

Once again, liberal negativists are being proven wrong. They were wrong when the economy quickly lifted-off following the passage of the supply-side John F. Kennedy tax cut in the 1960s and the big Ronald Reagan tax-rate reductions in the 1980s. They were wrong again when a cut in the capital-gains tax rate powered technology investment in the second half of the 1990s.

And they are doomed to repeat their failed liberal thinking once more today.

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The current stock market rally represents an impressive showing of the immediate impact of pro-growth tax cuts — the same cuts that Democratic critics argued would provide no short-run benefits. All of the major indexes are up more than 20 percent since they began pricing-in the tax cut, and they are already recapitalizing American business.

Few people understand that the 11,000-odd publicly owned U.S. companies desperately needed a rising stock market to rebuild their credit quality and funding capabilities in order to expand operations, invest, produce more, and hire new workers. In the last three years, capital and wealth were destroyed in the stock market, a development that caused a credit crunch, corporate contraction, and a rise in unemployment. But the new tax cuts on personal incomes, investor dividends, capital gains, and business equipment expensing — along with a steady increase in the money supply and a waning of uncertainty — are combining to give investors plenty of reasons to buy shares and replenish business capital.

Yes, there are millions of small companies that are privately held, and therefore might seem to be outside this recapitalizing and refunding process. But the credit improvement that the big fish enjoy will work down to the smaller fish. When attitudes toward big business improve, everyone in the lending community is in a better frame of mind. The lending will be there for the smaller firms, and also for the highest-risk start-up ventures that were shut down in recent years.

Under the old law, $100 of corporate profit paid out as a dividend to successful earners netted only $40 of new investable capital, after tax. Today, under the new law, the next $100 of profit will generate an extra $55 of private-investment capital, after tax. The reduced government tax bite on investment income (including capital gains) leaves more new cash to be plowed back into the economy to produce new technology and equipment, new factories and office buildings, and new jobs at higher salaries.

In no uncertain terms, this stock market surge signals the beginning of true economic recovery. And the good news is only beginning to pile up.

Within the financial sector, the money supply is substantially rising — by roughly $120 billion since the war’s end. Inside the economy, prices of raw-material commodities are gradually climbing, profits are continuing upward, and productivity is gaining steadily. Both the manufacturing and service sectors are showing new life signs. Consumer confidence is returning.

Recessionary obstacles to growth — war uncertainties, energy spikes, unusually bad winter weather, confusing policy debates in Washington — are all coming down. An easier, not weaker, dollar and a recovering gold price suggest the end of deflationary pressures.

Slowly but surely the major stock indexes are pricing in every one of these favorable developments. So are the money markets, where interest-rate futures are predicting an end to deflation and a gradual return to normalcy. (Heavily traded euro-dollar futures contracts are pointing at a 1 percent rate-rise for both 2004 and 2005.)

This interest-rate outlook bodes well for stronger economic growth. After years of lackluster increases in gross domestic product, we could now be looking — roughly — at 4 percent annual growth of real GDP between now and the end of 2005. Corporate profits should rise 12 percent yearly.

Without any nasty external shocks to derail this forecast, the Dow Jones Industrial Average could reach 10,500 by the end of this year, 12,000 by the end of next year, and over 13,000 by the end of 2005.

You say it can’t happen? I say it can.

Has there ever been a period of strengthened national security, lower tax rates, and an expanding money supply that did not produce prosperity? Never. And when these policies are combined with unbelievable advances in science and technology, when they exist in a free-market capitalist system where every instinct is for more progress, prosperity, and freedom, and when they are leveraged through the economy by way of historic productivity increases — you have a mighty economic boiler that’s primed to burn.

Mr. Kudlow is CEO of Kudlow & Co.



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