Wall Street's recent appearance on Washington's list of political demons is a source of embarrassment for conservative brokers and frustration for conservative politicians. Like most quarrels between natural allies, the problem has its root in a mutual misunderstanding.
The recent decline of stock prices is largely an impersonal and delayed reaction to high interest rates, but many administration officials have taken it as a personal rejection of them and their policies. A feeling of betrayal compounds the sense of rejection because it seems to come from the very conservative Wall Street Republicans who should be the president's most staunch supporters.
In fact no rejection or betrayal was intended in Wall Street even though both have been taken in Washington. The president himself is extraordinarily popular in the financial community. Approval for his strong stand on defense is surpassed only by astonishment at his success in budget cutting. Compared to what even the most optimistic conservative might have hoped for in January, the administration's budget cutting achievements are running at about 150 percent of expectations.
Wall Street's main worry is the size of the budget deficit, but then worry is endemic to men who manage m oney, particularly their own. The budget deficit is a legitimate concern, but if it disappeared tomorrow another concern would arise to take its place. Quite aside from any rational calculation of risk, most investors are simply worry-warts at heart.
The feelings of rejection and betrayal in Washington stem from a basic misunderstanding about what Wall Street is and, more to the point, is not. The Dow Jones Industrial Average is not a political popularity poll. Politicians who must face reelection naturally are concerned about their public approval, but that approval is not to be confused with the level of stock prices. Political egos looking for flattery are best off looking elsewhere.
Because power is concentrated in Washington, there is a tendency to think that power is concentrated in Wall Street in the hands of a few willful men who are out to frustrate the administration's economic program. Power was concentrated in the days of J. P. Morgan, but those are long past. The men who head Wall Street's major firms are polished, professional, articulate bureaucrats whose power to significantly move the stock market is remarkably small.
The absence of power to set stock prices is a natural consequence of the role played by Wall Street brokerage houses. They are not principals, but middlemen who merely match buy and sell orders. Brokerage firms offer investment advice to their clients, most of which either is ignored or is offset by conflicting advice from other firms. The rash brokerage firm which commits its own limited capital to a major bullish or bearish position faces the threat of swift extinction if it turns out to be wrong, hence the adage, "Don't fight the tape."
Wall Street is like a central telephone exchange which facilitates and encourages millions of conversations, but has little control over their content. The content of investment conversations flowing through Wall Street is controlled by millions of investors whose buy and sell orders determine stock prices. Wall Street is largely a conduit for the decisions of millions of investors, rather than a determinant of what those decision will be.
The power of Wall Street firms to set stock prices is cloaked in mystery (for good reason, since people often respect most what they understand least), but the situation is really no different from a real estate broker's power over local home prices. A great salesman may be able to raise the price of one particular house, but the overall level of home prices in the neighborhood is set by what people are willing and able to pay for them.
The exception to this comparison with real-estate buyers is that not all investors are created equal. Some are larger than others, particularly the huge pension funds and bank trust departments which account for a large portion of stock exchange activity. If there has been any collusion (consensus would be a more accurate term) by pension managers, it has been on the side of the administration. The cash position of pension funds is a relatively moderate 10 percent. That leaves 90 percent in stocks, bonds and other assets whose prices have declined sharply in recent months. Pension managers have been the victims of declining stock prices, not the instigators.
Outraged administration officials not only overestimated Wall Street's power to determine stock prices, they vastly overestimated Washington's power as well. Political events are only one of many forces pushing stock prices up and down. A countless number of economic and psychological factors, many of which turn out to be dead wrong when viewed from the pleasant perspective of hindsight, are equally powerful in moving stock prices. Declining stock prices occurred shortly after the president's tax program was passed, but assuming a cause-and-effect relationship between these two events requires hubris.
Amateur investors spend much of their time explaining stock price movements during the recent past. Professional investors seldom bother. They know from long experience that short-term market movements are often random, contrary, and inexplicable. Only over periods of two or more years do stock prices accurately reflect economic and political realities. Professional investors who have experienced the large up and down movements of stock prices also have learned an important rule of thumb which is vital to their financial and psychological health, a rule which applies to anyone whose feelings (as opposed to finances) are hurt by falling stock prices -- Don't take it personally.