With confidence in the cellar, why are stocks through the roof?

August 19, 1993|By Michael Dresser | Michael Dresser,Staff Writer

Consumer confidence is in the tank, big companies continue to announce giant layoffs, polls show Americans think the economy is in rotten shape and they hate President Clinton's economic plan.

So Wall Street's throwing a party.

In the face of pervasive gloom on Main Streets across America, stock market indexes have been steadily climbing to record levels. The Dow Jones industrial average broke the 3,600 barrier yesterday for the first time, gaining 17.88 points to close at 3,604.86. The Nasdaq and American stock indexes also hit new highs yesterday.

What gives?

Mainly, interest rates.

With certificates of deposit paying in the neighborhood of 3 percent and yields on shorter-term U.S. Treasury securities at 25-year lows, the stock market and stock-purchasing mutual funds have become a refuge for beleaguered savers -- whether they have any confidence or not.

"Nobody with any sense would be putting any money into this market except that it's the only game in town," said Charles W. McMillion, an economist and president of MBG Information Services in Washington.

Mr. McMillion was the one of the most pessimistic of about a dozen financial industry specialists who were asked yesterday to explain the seeming anomaly of a weak economy and a thriving market. But each of them, from the most exuberant bull to the most gloomy bear, agreed that low interest rates were the driving force behind a steady surge to the stock market heights.

For some, such as Mr. McMillion, interest rates were the only significant factor in the rise. But other market watchers offered a variety of explanations ranging from the effects of the new budget bill to demographics to prospects of a rebound in consumer spending. In recent days, the market has been led by pharmaceutical stocks, relieved by indications from the Clinton administration that drug companies will not face government price controls.

The market's recent climb has led many forecasters to warn of an impending correction (meaning a sharp drop), but other market veterans see no reason the market can't hold its gains and add several hundred points more. And while many still believe the Clinton economic program will be a drag on the overall economy, it contains several elements that could make stocks even more enticing.

So far, the Clinton package has at least done no harm to stocks, which have risen about 30 points since the plan squeaked through Congress Aug. 6.

"What the market is implicitly saying is . . . we're looking for better times," said Bill Paternotte, managing director of Alex. Brown & Sons in Baltimore. "It has given tacit approval to Clinton's economic plan."

If Mr. Paternotte is right, the markets are at odds with the public. A Time/CNN poll taken in the wake of the budget vote showed that 49 percent of Americans said Congress should not have passed the Clinton plan, while only 41 percent said it should. Meanwhile, the University of Michigan's respected survey of consumer confidence showed that in early August, 80 percent of Americans expect the economy to get worse, up from 69 percent in July.

New tax bill spurs market

Nevertheless, if interest rates continue to scrape bottom, the new tax bill could continue to spur the market, if only in marginal ways. But that effect will come largely through a negative incentive.

By raising the marginal income tax rates on the wealthy Americans who can afford to buy stock, President Clinton and Congress have widened the differential between the taxation on earned income and capital gains to its highest level since the early 1980s.

The likely effect is to flush even more money out of bank deposits and other fully taxable investments and into markets where investors can find shelter. The stock market, where sales gains are taxed at the 28 percent capital gains rate rather than up to 39.6 for the wealthiest taxpayers, is one such haven.

Even if high-income taxpayers don't rush out and buy IBM shares directly, the bill has other incentives that will tend to increase the demand for stocks.

For those two-income families whose taxable income exceeds $140,000, the level at which their taxes jump to 36 percent from 31 percent, one of the most attractive shelters will be increased payments into tax-deferred retirement accounts, said Gary C. Pokrant, a certified public accountant with Reznick Fedder & Silverman in Bethesda.

The tax bill also makes it more likely that taxpayers close to the cut-off point will hold on to the stocks they have, said Richard E. Cripps, director of equity marketing at Legg Mason Inc. in Baltimore. For example, he said, a couple whose income is just below $140,000 and owns stock that has appreciated $20,000 would fare better if they held on to the stock a year so it could be counted as a long-term gain, which wouldn't push them over the line.

Mr. Cripps said there are additional factors that are pushing stocks upward, including the aging of the baby boom generation.

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