The Stock Market

By August 12, 1982, the Dow Jones average of 30 industrial stocks had slid from 822 to 777. On the 13th it climbed to 788, on the 16th to 792. On Tuesday, August 17, the market suddenly leaped upward by a then-all-time record of 38.81 points (with a near-record 93 million shares traded). The next morning, the rally continued with 37 million shares traded in one hour as the Dow soared by another 18 points.

Wednesday and Thursday were roller-coaster days: a sharp rally followed by profit taking and an all-time record 133 million shares traded

on Wednesday; a rally, fall (over rumors about banks and Mexican debt), and finally a nine-point gain on Thursday. On Friday, after the tax bill passed, the Dow leaped ahead by nearly thirty-one points.^[2]

The stock market frenzy continued during the following week, with 550 million shares—a daily average of 17 million more than the previous record—traded. The rally continued until it finally leveled off in April 1983, with the Dow hovering around 1200.^[3]

What did it all mean, and who deserved the credit? With the November election approaching, would the stock market rally support what Time called a "strong new hope that Reaganomics might work to pull the American economy out of stagnation"?^[4] As a matter of logic, both questions depended on whether whatever caused the stock market upswing was part of Reaganomics. As a matter of electoral politics, Reaganomics might be seen as whatever happened during the Reagan administration, whether Reagan was responsible or not. However, logic and politics were not the same.

Secretary of the Treasury Donald Regan declared, "The market forces are beginning to believe our resolve in redirecting the economy. Perhaps it took something like the tax bill to convince people that we're serious about fiscal responsibility." By his account, there was no difference between the tax bill and Reaganomics, which was finally paying its expected dividends. Others thought that the administration was a late convert to "fiscal responsibility."^[5] If Reaganomics represented supply-side economics, then the tax bill reversed policy, as Jack Kemp claimed, and the market rally could not be credited to the original policy's wisdom. A third possibility was that the rally had less to do with the tax bill, whether Reaganomics or not, than with monetary policy and hence "Volckernomics."

We lean toward the third position, but we can never know what the markets are thinking because markets do not think. The overall trend of a market results from uncoordinated individual hunches and guesses. Individuals consider not only the economy but also many other things: How will companies perform financially, and thus what will be the dividend or capital appreciation on investment? What else could people do with their money, comparing the return on equities to, say, Treasury bills? And, hardest of all, what will other actors do? Consequently, political interpretations of stock market behavior are more important for their effects than for their validity.

Conceivably, the stock market rallied at this time because the economy was such a disaster. Why were investors suddenly willing to pay more for stocks (and therefore, in percentage terms, receive smaller dividends) than they had before? The most obvious explanation in August 1982 was an expected decline in return on other investments due to a drop

in interest rates. Lower interest rates might mean greater corporate profitability. Stocks and old bonds would become more attractive as alternatives to new bonds and savings of various sorts.

Let us go back to Wall Street the week the rally began and reconsider the reporting of Time's enthusiastic correspondents.

The first hint that something extraordinary was about to unfold came on Monday morning. The First Boston investment firm announced that Albert Wojnilower, its chief economist, had revised his economic forecast. After warning for months that the huge federal budget deficit could send interest rates shooting back up again, Wojnilower now admitted that the cost of money would probably continue to decline over the next year. On Tuesday morning, rumors whirled through Wall Street that Henry Kaufman, chief economist of the Salomon Bros. investment house, had also changed his mind on interest rates. Word that these two gurus, known on the Street as Dr. Doom and Dr. Gloom, had reversed themselves electrified the stock exchange…. Because few portfolio managers were willing to risk missing a major market rally, a buying panic quickly built up.^[6]

Newsweek told a similar story. Lower interest rates could mean that recovery and higher profits were on the way. But Kaufman forecast lower rates because the economy was so sluggish that demand for credit would be weak. Kaufman was right. Capital investment, the engine of recovery according to supply-side doctrine, did not begin to increase until summer 1983. Businesses were hunkered down to wait out the recession. Throughout the first half of 1982, as businesses had scaled back on capital investment, analysts had looked to the second installment of the income tax cut to spur consumer demand and economic recovery.^[7] As the magic date approached, however, no surges occurred in either demand or supply.^[8] The demand side of high interest rates was diminishing. The governors of the Federal Reserve joined Dr. Doom and Dr. Gloom in observing that trend. They, however, saw a particular kind of gloom and doom in the trends—a debt problem far worse than the federal deficit. As the demand for money slowed, the Fed decided to increase the supply.