The twenty-year bear market.

The Twenty-Year Bear Market

WALL STREET is not quite sure whether the current backing and filling is a short-term bull market within a long-term bear market, or vice versa. For perspective on long-term market trends:

Table : AVERAGE DAILY CLOSE OF

Table : S & P 500 STOCK INDEX

Table : (1941-43 = 10)

Adjusted for inflation, the stock market peaked in the mid Sixties. The recent stock-market boom actually reflects lesser heights than those of the 1963-67 period (the highest individual year was 1968, when the index reached 45.62). Steady erosion had pushed the index down to a post-1968 low in 1982 (19.94), and even five years of the late, great bull market produced only a 40.59 average (in 1987). The index finished the year at 34.96 after bottoming out at 31.82 on October 19.

Historically the market moves south when capital-gains-tax rates move north. The 1948-1967 rise in equity prices coincided with a 25 per cent tax rate on capital gains, moderate compared to the 90 per cent rate on ordinary income during much of that period. Starting with the Tax Reform Act of 1969 and culminating with the Tax Reform Act of 1976, Congress progressively raised the maximum tax rate on capital gains from 25 per cent to 49.1 per cent. In 1978 rates were cut to 28 per cent, and then to 20 per cent via the 1981 Reagan tax cut.

The 40 per cent increase in the top capital-gains-tax rate that took effect January 1, 1987, ended nearly a decade of rate reductions and what was mistakenly regarded as one of the greatest bull markets in history. For many investors, these rates more than doubled: a married couple with taxable income of $40,000 had a capital-gains-tax rate of 13.2 per cent under the old law, but now faces a rate of 28 per cent.

In a perverse way the initial impact of these tax changes was positive, because many investors liquidated their positions in late 1986 in anticipation of the rate increase, and those who didn't were reluctant to sell at the higher tax rates. These factors held down the supply of stock for sale in the first part of 1987, propping up prices.

Also, foreign investors were induced to buy U.S. equities when the dollar declined, but gradually became unnerved when it appeared that the dollar's fall would be longer and deeper than anticipated.

Taxes are only one of many factors influencing equity prices, but there can be little doubt that the 1986 changes were a setback to the stability of the stock market and to long-term investing.