Kudlow: Back to the Future
08/15/2003 12:00 am EST
Few financial experts are as popular--or as busy--as Larry Kudlow. He is CEO of Kudlow & Co., co-host of Kudlow & Cramer, a regular guest on numerous other CNBC shows, a panelist on The McLaughlin Group, a syndicated columnist, a contributing editor forNational Review, and author of American Abundance. We're thrilled he found the time to speak at The Atlantic City Money Show.
"I am still a cock-eyed optimist. We've just been through a dreary three years--which interrupted an unbelievable 20-year bull market. Right now, long term bull market prosperity is resuming. No matter what pessimism you hear on the airwaves, I don't buy it. I will argue that the best way to accumulate wealth is through the stock market. I hope you're in the market now. If you are not in the market, you should get in the market. And I hope you can have a longer term view. We will see a renewal of the prosperous times that typify this country. What does it take to have a prosperous country? Here are a few guidelines:
"First of all, you need a capitalist market system--what I call entrepreneurial market capitalism. We have it and almost no other country in the world does, which is why our performance is better than any one else's in the world. Second, you can't function without the rule of law. People in enterprises like MCI, Worldcom, Tyco, etc. have to be punished. They have to face the consequences. In addition, we need price stability. We need low tax rates for incentives. We need honest government regulations. We need a stable and reliable currency. We need rapid advances in science and technology. Nobody does this better than we do.
"Finally, we need safety and security. It's always been a hallmark of ours and because of actions taken by the government and the armed forces over the past two years, we are seeing a reestablishment of safety and security. We may get periodic shocks, but it doesn't stop what is the greatest system in the world. The bears like to be bears and gloom-and-doomers like gloom and doom--but I don't believe a world of it. Right now, we are succeeding in the war on terrorism, we are succeeding in Iraq, we are succeeding in Afghanistan, and Saddam Hussein's time is fast approaching. We have made enormous progress in our effort to export free speech, free elections, and free enterprise. These are good things. Sometimes they are tough to accomplish and things are not perfect. But we are doing what we set out to do and that's why I say security here at home is returning.
"Meanwhile, corporate corruption is being prosecuted, we've had the largest reduction in tax rates in nearly 20 years and the concerns over deflation in recent years have been solved as the overvalued dollar has come down relative to gold and commodities. That's what we needed. All of that looks pretty good to me. Inside the economy, the greatest strength is coming from increased productivity. This shows how efficient we are and shows how the great technology advances and investments continue to pay off. And we are now seeing very good gains in profits, in no small measure because of this productivity. Profits are now rising faster than the consensus of experts had thought. Profits are up about 30% from their low. So all of this is beginning to work very nicely.
"The dividend tax has been cut from 40% to 15% which is a revolutionary event. Instead of keeping 60 cents on each new dividend dollar, you can keep 85 cents. Now, corporations are declaring increasing dividends by the hundreds. And some 75 companies have instituted new dividends. Dividends will be the new stock market metric, in my opinion, for the next 10 or 20 years. In effect, we are now going back to the future. Dividends used to be a very important anchor of investing. It is estimated that over 40% of the total return from the stock market in the 20th century came from dividends. But because the tax situation was wrong--with dividend rates much higher than capital gains rates--people stopped paying out dividends and started reaching for capital gains. It's now time to start paying out dividends, and it's time for investors to start investing in dividends. Overall, the tax reform on dividends is a very positive development.
"We've also had a tax cut on capital gains from 20% to 15%. That means that risk taking, entrepreneurship, and venture capital--which dried up in the last three years--is on the rise again. We're waiting for business capital spending to pick up and we are seeing some healthy signs that help is on the way. Order backlogs are up for six straight months. We've just about come to the end of the job slump and the unemployment rate has peaked. We're also going to see a big expansion of tax-free savings accounts. Americans don't save enough in part because it's taxed so many times. Think about it: you get taxed once as wages through payroll tax. You get taxed a second time if you get dividends. You're taxed again on any capital gains. And you are taxed again if you have an estate or an inheritance to pass along. It makes no sense to me. Why would we tax corporate profits at all. All we've done is create a tremendous mishmash of tax rates and loopholes--and a system that is easily abused. It would be much better to end taxes on corporate profits altogether and tax companies on sales revenues. I think this is the kind of reform that is coming down the pike.
"Let me say, if you look at the barriers to prosperity and growth, we are now either eliminating or reducing many--if not all--of them. First, the issue of safety from terrorist attacks. Second deflation concerns. Third, corporate corruption. Fourth, lousy corporate governance. Fifth, marginal tax rates on capital. These are tremendous breakthroughs and that's why I am so optimistic now. These barriers are coming down and I expect much better news in the next several years. What the recent rise in the stock market tells me is that investor confidence is returning and that economic recovery is on the way. In the long run, over the past 55 years, the stock market has grown, on average, about 7% to 10% a year. That includes 10 bear markets. So we take our licks, but in the long run those 'blips' hardly show up. The last two recoveries, one was seven years long and the other was 10 years long. In fact, we have had 20 years of prosperity that have been briefly interrupted. My point today is that this interruption in prosperity is now over and the traditional, normal prosperity wave is resuming.
"Relative to Treasury yields, the stock market is some 30% undervalued. That's just my view. The S&P 500 is now around 960. My target is about 1250 in a year or so. The Dow is about 9000, but if it's 30% undervalued, then my target for the next year would be 11,700. Over the march of time, as the American economy does what it does--namely to grow--then in the next five years we should see a 20,000 Dow and in the next 10 years, we should see a 30,000 Dow. That's why I say that long term investing is the best way to create wealth. Take a look at history. The US has been and remains the greatest nation on the planet--the greatest nation in world history. The US has the economic freedom to produce and deliver the goods. We are blessed. Be optimistic. Keep the faith. Faith is always the very best spirit."
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