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PRESIDENT GEORGE BUSH HAS HIT the campaign trail to tout his stewardship of the economy. With the numbers showing robust economic growth, his record should be an easy sell. Surprisingly, it isn't.
The president must have been shocked to the tips of his cowboy boots last week by a Washington Post-ABC News poll: Some 59% of the respondents said Democrat front-runner John Kerry of Massachusetts has a better vision for the economy. Kerry, a politician with the stern mien of a schoolmaster, is connecting with both Democrats and independents by arguing that Bush's economy is half empty, not half full.
Kerry's warnings about the possible consequences of a ballooning budget deficit have resonated with voters who witnessed a new Gilded Age as former President Clinton helped bring the budget into balance. Kerry has convinced the voters that Bush's relentless tax cutting, not the recession, is the cause of the sea of red ink. Kerry also has struck a nerve by thundering about the dearth of new job creation and the outsourcing of existing work to low-wage Asian countries.
Wall Street, in contrast to Main Street, is pretty much divided on the two candidates. The general thinking is that Bush would be good for stocks, with his tax cuts stimulating economic growth, while Kerry would be beneficial to bonds, because his focus on reducing the deficit could keep interest rates down.
Sen. John F. Kerry could be a plus for bonds, in a break from his party's past.
That analysis, if correct, suggests a dramatic reversal of the historic roles of the Democratic and Republican parties. Recent studies show that Democrats traditionally have been far better for stocks and Republicans better for bonds. Over the past 61 years, Merrill Lynch found, stocks averaged a 12-month total return of 13.6% when Democrats were in the Oval Office, versus 11.7% under Republicans. Bonds returned an annual 9.5% under Republicans, versus 2.8% under Democrats.
Bush already has proved to be a friend of stock investors. His multiyear tax cuts -- especially the reduction in the top rates on dividends and capital gains -- helped fuel a bull market last year that generated about a trillion dollars in market capital. Investors who had all but given up on the market after the tech wreck and the 9/11 attacks saw their portfolios climb back close to where they were when Bush came into office; the recent selloff has erased only some of the gains.
Going forward, Bush would make his existing tax cuts permanent, eliminating the uncertainly about tax rates that is confounding some long-range investment planning. Right now, cuts in income-tax rates, the capital-gains tax and the dividend tax are set to expire at staggered dates through 2011.
Kerry's proposed hikes have many economists fretting. His plan is to raise taxes on the "wealthy," but that group may not be as rich as you think. Kerry adviser Roger Altman tells Barron's the higher taxes would hit single filers making $143,500 and joint-filers making $174,700, a broader increase than Kerry previously has indicated.
"We know from history that a tax increase will slow the economy," says David Malpass, chief global economist for Bear Stearns. "If you tax labor and capital more, then you get less from them. Kerry would tax the economy's most productive labor." Milton Friedman, Nobel Prize-winning economist, adds that Kerry's plan would only spur more government spending, swelling the deficit.
This isn't to say that the financial community is uniformly anti-Kerry. Far from it. Kerry has some top economists in his cheering section, including Nobel laureate Paul Samuelson of MIT. Samuelson believes that Bush's tax cuts will damage the country in the long run because of projected shortfalls in the Social Security and Medicare systems. The government should run an austere budget that pays down the debt to offset the lack of saving by individuals and industry, he says.
When push comes to shove, the investment community doesn't seem wild about either candidate. It's a bit like shopping for a used car: You have to settle for flaws if you are going to take one off of the lot. In fact, Merrill Lynch is issuing reports on the benefits of "gridlock" in Washington. This would occur if Kerry were president and the Republicans controlled the House or Senate or both. Neither side would be able to steamroll the other. Sanity often prevails in an environment that demands compromise.
Malpass of Bear Stearns tends to agree, recalling that the combination of a Democratic President Clinton and a Republican House caused the Clinton economic boom, not Clinton's tax increase. "I think the tax hike early in the Clinton administration actually did slow the economy," he says. "It led to a changeover [to GOP control] in the House of Representatives; and then there was talk [by the GOP] of tax and spending cuts. The heart of the economic expansion started at this point."
Bush and Kerry share a number of imperfections that disturb the investment crowd. Bush doesn't seem to have much of an economic plan beyond extending his the tax cuts, says Kim Wallace, chief political analyst for Lehman Brothers. Kerry has myriad proposals but to date he has given few details, other analysts complain.
President George W. Bush is seen as the stock market's candidate.
Another similarity: While both candidates promise to reduce the deficit, neither appears willing to take tough action to curtail government spending. Kerry pledges to halve the deficit in four years, in part by raising the top two marginal tax rates. But this could be at odds with other campaign pledges that, according to some budget experts, actually would boost spending by $165 billion or more. States, for example, would get $50 billion in aid from Kerry.
Bush, for his part, promises to reduce the budget deficit from about 4% of gross domestic product to less than 2% in five years. He also promises to hold the line on government spending. But Bush has been promising for years to rein in the government's discretionary spending. Instead, it has risen about 6% a year during his term, well in excess of the rate of inflation. And that doesn't even include the cost of the war in Iraq.
"Neither one of them fixes the deficit," says David Kotok of money-management firm Cumberland Advisors. A Goldman Sachs report says that Bush's deficit-reduction plan "looks politically unrealistic" while Kerry's plan "is not set forth in a comprehensive way." Samuelson warns that an out-of-control deficit might result in a significant dollar depreciation, which would raise interest rates and the cost of imported goods.
Maintaining free trade is another concern among many economists. Bush talks like a free trader, but the Street will not forget how quickly he acted in March 2002 to impose tariffs on foreign steel to protect domestic producers. That caused a furor among auto and appliance manufacturers, who were forced to pay higher prices for the metal.
Kerry talks like a protectionist -- but as a senator he's voted for every major free-trade treaty since he backed the North American Free Trade Agreement in 1993. He pledges tougher enforcement of those treaties, not any revocation, a campaign spokesman told Barron's. But Wall Street hears a different, isolationist message. In a speech in Detroit last October, Kerry said, "China, Japan, Korea, Europe, others use illegal practices and tariffs to keep American products from getting a fair shake.'' He then threatened retaliation.
"I fear protectionism and worry that Kerry might be more prone to it," says Kotok. The rhetoric alone might spook foreign investors to dump the dollar if it heats up, says Malpass.
The centerpiece of Kerry's economic proposal is to raise taxes on the rich, just as Clinton did. Altman, who was deputy Treasury Secretary under Clinton, defined the rich as people taxed at the top two marginal rates. Previously, Kerry described the rich as people earning $200,000 or more, but the rates Altman describes would affect individual filers making $56,500 less.
"The Clinton years marked one of the greatest periods of economic prosperity in history," says Altman, one of the Clinton administration's most vocal balanced-budget advocates. He resigned after a flap with Republicans in Congress during the Whitewater scandal. "Kerry will take the rates back to where they were when Clinton left office," Altman says. The tax rate for the second-highest income bracket would go from 33% back to 36%. The top bracket would be taxed at 39.6%, up from 36%.
These hikes get a mixed reaction. Monetarists like Milton Friedman are appalled. "Kerry's plan is a disaster," he says. He says the government has grown too large and too harmful and that the only way to shrink it is to cut taxes.
W. Lee Hoskins of the Pacific Research Institute, a free-market think tank, concurs. "Kerry, by supporting tax increases, is supporting a high level of federal spending and its concomitant negative impact on economic growth," he says. "Slower growth means a weak dollar, a flat stock market and a bond market waiting on the Fed."
Altman says a tax increase is needed because programs such as Social Security and Medicare cannot be salvaged unless the country's fiscal house is in order. "Getting off of the ruinous deficit track is the best way to protect Social Security," he says. "Alan Greenspan says keep the tax cuts and cut Social Security. Our answer is a little different -- roll back the tax cuts."
Samuelson says he sees no negative effect on the economy if the rich, the beneficiaries of most of the Bush cuts, are forced to pay more -- so long as there is an offset such as a cut in the payroll taxes, which all workers pay. Dimitri Papadimitriou, president of the nonprofit Levy Economics Institute of Bard College, agrees. He suggests that a boost in capital-gains and dividend taxes be used to finance cuts in payroll taxes. The Bush campaign, for its part, says that dividend and capital-gains cuts benefit business by lowering the cost of capital and that rolling them back would have dire consequences for growth and job formation.
KERRY HASN'T YET DECIDED what to do about dividends and capital-gains rates, says Altman. But Altman's own opinion is that "returning dividends and capital-gains rates for the highest income taxpayers to pre-Bush levels should get the most serious consideration."
Table: What They Would Do
Many economists think that would be a mistake. Eliminating the "double taxation" of dividends has been a Holy Grail for economists for 50 years, says Robert Barbera, chief economist for Hoenig Research. "It's already had an enormous and demonstrably positive effect on the economy," he says. Bush cut the top dividend tax to 15% from as high as 39.6% under Clinton, and the capital gains tax to 15% from 28%.
The bottom line for investors? A study by Merrill Lynch analyst Richard Bernstein finds that investors can profit regardless of who wins the election. Bernstein writes that since 1943, with each party holding the White House about half the time, stocks have performed better under Democrats and bonds have done better under the GOP. The optimal portfolio mix under Democrats has been 67% equities and 33% bonds, he says. Under Republicans, it has been 36% equities and 64% bonds.
Canadian analyst Pierre Lussier of the Investment Information Provider did similar research but took it back to 1929. During that period, Democratic presidents oversaw real economic growth of 5.18%, versus 1.69% for Republicans. Inflation and long-term interest rates, on average, fell when a Republican was in the Oval Office and rose with a Democrat at the helm.
But Bush and Kerry might represent a role-reversal. Kerry in the short term would actually be better for bonds, argues Andy Laperriere, analyst with International Strategy and Investment. Hoskins says Bush would be positive for the stock market because his tax cuts will spur economic growth. "Bonds would sink as real interest rates rise because of increased investment opportunities," he explains, and the dollar would strengthen. This assumes, of course, that Bush can get spending under control.
And here's something to consider: If Kerry were to beat Bush, he might be unable to implement any major tax policy until at least 2006, when the Bush cuts begin to expire, points out George Friedman, chairman of Stratfor, an intelligence-gathering and forecasting service for companies and investors. That's because it often takes a year or more for legislation to work its way through Congress. By then, the economy is likely to look quite different, he notes, so it could be premature to make investment decisions based on the candidates' current positions.
In politics, as in markets, there's no such thing as a sure bet.
The president must have been shocked to the tips of his cowboy boots last week by a Washington Post-ABC News poll: Some 59% of the respondents said Democrat front-runner John Kerry of Massachusetts has a better vision for the economy. Kerry, a politician with the stern mien of a schoolmaster, is connecting with both Democrats and independents by arguing that Bush's economy is half empty, not half full.
Kerry's warnings about the possible consequences of a ballooning budget deficit have resonated with voters who witnessed a new Gilded Age as former President Clinton helped bring the budget into balance. Kerry has convinced the voters that Bush's relentless tax cutting, not the recession, is the cause of the sea of red ink. Kerry also has struck a nerve by thundering about the dearth of new job creation and the outsourcing of existing work to low-wage Asian countries.
Wall Street, in contrast to Main Street, is pretty much divided on the two candidates. The general thinking is that Bush would be good for stocks, with his tax cuts stimulating economic growth, while Kerry would be beneficial to bonds, because his focus on reducing the deficit could keep interest rates down.
Sen. John F. Kerry could be a plus for bonds, in a break from his party's past.
That analysis, if correct, suggests a dramatic reversal of the historic roles of the Democratic and Republican parties. Recent studies show that Democrats traditionally have been far better for stocks and Republicans better for bonds. Over the past 61 years, Merrill Lynch found, stocks averaged a 12-month total return of 13.6% when Democrats were in the Oval Office, versus 11.7% under Republicans. Bonds returned an annual 9.5% under Republicans, versus 2.8% under Democrats.
Bush already has proved to be a friend of stock investors. His multiyear tax cuts -- especially the reduction in the top rates on dividends and capital gains -- helped fuel a bull market last year that generated about a trillion dollars in market capital. Investors who had all but given up on the market after the tech wreck and the 9/11 attacks saw their portfolios climb back close to where they were when Bush came into office; the recent selloff has erased only some of the gains.
Going forward, Bush would make his existing tax cuts permanent, eliminating the uncertainly about tax rates that is confounding some long-range investment planning. Right now, cuts in income-tax rates, the capital-gains tax and the dividend tax are set to expire at staggered dates through 2011.
Kerry's proposed hikes have many economists fretting. His plan is to raise taxes on the "wealthy," but that group may not be as rich as you think. Kerry adviser Roger Altman tells Barron's the higher taxes would hit single filers making $143,500 and joint-filers making $174,700, a broader increase than Kerry previously has indicated.
"We know from history that a tax increase will slow the economy," says David Malpass, chief global economist for Bear Stearns. "If you tax labor and capital more, then you get less from them. Kerry would tax the economy's most productive labor." Milton Friedman, Nobel Prize-winning economist, adds that Kerry's plan would only spur more government spending, swelling the deficit.
This isn't to say that the financial community is uniformly anti-Kerry. Far from it. Kerry has some top economists in his cheering section, including Nobel laureate Paul Samuelson of MIT. Samuelson believes that Bush's tax cuts will damage the country in the long run because of projected shortfalls in the Social Security and Medicare systems. The government should run an austere budget that pays down the debt to offset the lack of saving by individuals and industry, he says.
When push comes to shove, the investment community doesn't seem wild about either candidate. It's a bit like shopping for a used car: You have to settle for flaws if you are going to take one off of the lot. In fact, Merrill Lynch is issuing reports on the benefits of "gridlock" in Washington. This would occur if Kerry were president and the Republicans controlled the House or Senate or both. Neither side would be able to steamroll the other. Sanity often prevails in an environment that demands compromise.
Malpass of Bear Stearns tends to agree, recalling that the combination of a Democratic President Clinton and a Republican House caused the Clinton economic boom, not Clinton's tax increase. "I think the tax hike early in the Clinton administration actually did slow the economy," he says. "It led to a changeover [to GOP control] in the House of Representatives; and then there was talk [by the GOP] of tax and spending cuts. The heart of the economic expansion started at this point."
Bush and Kerry share a number of imperfections that disturb the investment crowd. Bush doesn't seem to have much of an economic plan beyond extending his the tax cuts, says Kim Wallace, chief political analyst for Lehman Brothers. Kerry has myriad proposals but to date he has given few details, other analysts complain.
President George W. Bush is seen as the stock market's candidate.
Another similarity: While both candidates promise to reduce the deficit, neither appears willing to take tough action to curtail government spending. Kerry pledges to halve the deficit in four years, in part by raising the top two marginal tax rates. But this could be at odds with other campaign pledges that, according to some budget experts, actually would boost spending by $165 billion or more. States, for example, would get $50 billion in aid from Kerry.
Bush, for his part, promises to reduce the budget deficit from about 4% of gross domestic product to less than 2% in five years. He also promises to hold the line on government spending. But Bush has been promising for years to rein in the government's discretionary spending. Instead, it has risen about 6% a year during his term, well in excess of the rate of inflation. And that doesn't even include the cost of the war in Iraq.
"Neither one of them fixes the deficit," says David Kotok of money-management firm Cumberland Advisors. A Goldman Sachs report says that Bush's deficit-reduction plan "looks politically unrealistic" while Kerry's plan "is not set forth in a comprehensive way." Samuelson warns that an out-of-control deficit might result in a significant dollar depreciation, which would raise interest rates and the cost of imported goods.
Maintaining free trade is another concern among many economists. Bush talks like a free trader, but the Street will not forget how quickly he acted in March 2002 to impose tariffs on foreign steel to protect domestic producers. That caused a furor among auto and appliance manufacturers, who were forced to pay higher prices for the metal.
Kerry talks like a protectionist -- but as a senator he's voted for every major free-trade treaty since he backed the North American Free Trade Agreement in 1993. He pledges tougher enforcement of those treaties, not any revocation, a campaign spokesman told Barron's. But Wall Street hears a different, isolationist message. In a speech in Detroit last October, Kerry said, "China, Japan, Korea, Europe, others use illegal practices and tariffs to keep American products from getting a fair shake.'' He then threatened retaliation.
"I fear protectionism and worry that Kerry might be more prone to it," says Kotok. The rhetoric alone might spook foreign investors to dump the dollar if it heats up, says Malpass.
The centerpiece of Kerry's economic proposal is to raise taxes on the rich, just as Clinton did. Altman, who was deputy Treasury Secretary under Clinton, defined the rich as people taxed at the top two marginal rates. Previously, Kerry described the rich as people earning $200,000 or more, but the rates Altman describes would affect individual filers making $56,500 less.
"The Clinton years marked one of the greatest periods of economic prosperity in history," says Altman, one of the Clinton administration's most vocal balanced-budget advocates. He resigned after a flap with Republicans in Congress during the Whitewater scandal. "Kerry will take the rates back to where they were when Clinton left office," Altman says. The tax rate for the second-highest income bracket would go from 33% back to 36%. The top bracket would be taxed at 39.6%, up from 36%.
These hikes get a mixed reaction. Monetarists like Milton Friedman are appalled. "Kerry's plan is a disaster," he says. He says the government has grown too large and too harmful and that the only way to shrink it is to cut taxes.
W. Lee Hoskins of the Pacific Research Institute, a free-market think tank, concurs. "Kerry, by supporting tax increases, is supporting a high level of federal spending and its concomitant negative impact on economic growth," he says. "Slower growth means a weak dollar, a flat stock market and a bond market waiting on the Fed."
Altman says a tax increase is needed because programs such as Social Security and Medicare cannot be salvaged unless the country's fiscal house is in order. "Getting off of the ruinous deficit track is the best way to protect Social Security," he says. "Alan Greenspan says keep the tax cuts and cut Social Security. Our answer is a little different -- roll back the tax cuts."
Samuelson says he sees no negative effect on the economy if the rich, the beneficiaries of most of the Bush cuts, are forced to pay more -- so long as there is an offset such as a cut in the payroll taxes, which all workers pay. Dimitri Papadimitriou, president of the nonprofit Levy Economics Institute of Bard College, agrees. He suggests that a boost in capital-gains and dividend taxes be used to finance cuts in payroll taxes. The Bush campaign, for its part, says that dividend and capital-gains cuts benefit business by lowering the cost of capital and that rolling them back would have dire consequences for growth and job formation.
KERRY HASN'T YET DECIDED what to do about dividends and capital-gains rates, says Altman. But Altman's own opinion is that "returning dividends and capital-gains rates for the highest income taxpayers to pre-Bush levels should get the most serious consideration."
Table: What They Would Do
Many economists think that would be a mistake. Eliminating the "double taxation" of dividends has been a Holy Grail for economists for 50 years, says Robert Barbera, chief economist for Hoenig Research. "It's already had an enormous and demonstrably positive effect on the economy," he says. Bush cut the top dividend tax to 15% from as high as 39.6% under Clinton, and the capital gains tax to 15% from 28%.
The bottom line for investors? A study by Merrill Lynch analyst Richard Bernstein finds that investors can profit regardless of who wins the election. Bernstein writes that since 1943, with each party holding the White House about half the time, stocks have performed better under Democrats and bonds have done better under the GOP. The optimal portfolio mix under Democrats has been 67% equities and 33% bonds, he says. Under Republicans, it has been 36% equities and 64% bonds.
Canadian analyst Pierre Lussier of the Investment Information Provider did similar research but took it back to 1929. During that period, Democratic presidents oversaw real economic growth of 5.18%, versus 1.69% for Republicans. Inflation and long-term interest rates, on average, fell when a Republican was in the Oval Office and rose with a Democrat at the helm.
But Bush and Kerry might represent a role-reversal. Kerry in the short term would actually be better for bonds, argues Andy Laperriere, analyst with International Strategy and Investment. Hoskins says Bush would be positive for the stock market because his tax cuts will spur economic growth. "Bonds would sink as real interest rates rise because of increased investment opportunities," he explains, and the dollar would strengthen. This assumes, of course, that Bush can get spending under control.
And here's something to consider: If Kerry were to beat Bush, he might be unable to implement any major tax policy until at least 2006, when the Bush cuts begin to expire, points out George Friedman, chairman of Stratfor, an intelligence-gathering and forecasting service for companies and investors. That's because it often takes a year or more for legislation to work its way through Congress. By then, the economy is likely to look quite different, he notes, so it could be premature to make investment decisions based on the candidates' current positions.
In politics, as in markets, there's no such thing as a sure bet.
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