WALL STREET: Tailspin & Recovery

Not since President Eisenhower’s heart attack in September 1955 had the stock market taken such a blow. After setting new highs each, week for three weeks in a row, the market started down at the week’s opening. While the ticker ran late for more than two hours of the 5½ hours of trading, 1,040 of the 1,287 issues traded suffered losses ranging from 5 to 42 points. It was the second largest number of issues traded in one day in stock exchange history (largest: 1,290 issues on Jan. 5, 1955). At day’s end the market closed off 14.68 on the Dow-Jones industrial average, and $6.7 billion was wiped from the paper value of stocks on the exchange.

The decline extended into the next day, but its pace slowed considerably. The sell-off did not alarm most market experts, who chalked it up to a long-awaited technical correction after the long climb. They were confident that the market would turn about quickly—and they were right.

Just as sharply as it had fallen, the market rebounded at midweek, gained back about 50% of its losses for the week. Steel, which had suffered heavy losses in the dip, sprang back at more bullish estimates of steel production in the weeks ahead. Better October earnings for railroads snapped back railroad stocks. Pennsylvania reported $4,026,319 in October earnings, highest for any month this year and more than twice last October’s earnings; New York Central had its best month since December 1956, with earnings of $4,674,110. At week’s end the market was almost back where it started.

The week’s sharp dip highlighted one of the bull market’s chief problems, a shortening supply of stocks. This has made the market so thin that prices move widely up and down on comparatively small sales. To many a market specialist, much of the blame for the thin markets can be laid on the capital gains tax.

Harsh Penalty? On a long-term stock profit, an investor must pay a capital gains tax of up to 25%. This means that if he sells, and pays the tax, he lessens his borrowing power by the amount of the tax and thus has less to invest, unless he can find another stock that will go up enough to make up for the tax loss. With shares already selling at record highs, finding such a stock is difficult. Result: investors are locked into their stocks, thus keeping shares off the market, and forcing up prices.

What further bothers market specialists about the tax is that it prevents people from being guided by what they really think is a good investment, tends to make the market a less realistic mirror of business conditions. “With capital gains,” says Walter Maynard, senior partner of Shearson, Hammill & Co., “you are betting the certainty of a 25% loss v. a problematical gain. And with that certainty of a loss, investors will refrain from making a sale even while admitting that the price of a security is high enough for them to get out.”

To make the market more liquid, many market specialists advocate lowering or repealing the tax. Says New York Stock Exchange President Keith Funston: “The capital gains tax is one of the harshest penalties on success this country has ever devised.” Others would be content to win the same advantage for investors that Congress extended to homeowners, who do not have to pay a capital gains tax on the profit in selling a house if they reinvest the money in a new home within a year. Both groups argue that a reduction would not only loosen the market but bring the Government more than it now gets in capital gains taxes, since investors would be encouraged to take profits more frequently, thus paying more tax in the end.

Unhealthy Bias? Though Wall Street is solidly lined up against the tax, some tax experts resolutely oppose any reduction. They would, in fact, like to increase the capital gains tax to lessen the gap between it and regular income tax. Said Robert Eisner, economics professor at Northwestern University, in a Tax Institute symposium published this fall: “Our treatment of capital gains gives the entire tax system a very heavy, and possibly unhealthy, bias in favor of investment. Our relatively easy tax treatment of capital gains has diverted the funds of the wealthy to acquisition of capital assets. Far from drying up venture capital, it has made it readily available. If anything, capital gains taxes might well be increased and, particularly, extended to so-called ‘unrealized’ capital gains, thus eliminating the much discussed ‘lock-in’ problem.”