the extremely weak stock market of 1974 was generated by three strong depressants. In the aftermath of Watergate, economic policy turned extremely restrictive and consumer confidence collapsed. Slow real money growth cut share prices by 7 percent from their fundamental EPV. Two other factors cut prices by 16 percent each--a lack of confidence and the understatement of corporate net worth through traditional accounting measures. The composite tax rate on equity was in fact approximately four points below its 1955 numéraire value and thus contributed modest positive support relative to the 1955 position.
The final regression specification suggests significant roles for (1) current cyclic conditions, (2) economic fundamentals, and (3) illusion in the pricing of shares. Not surprisingly, consumer confidence and stimulative monetary policy support market prices. On the other hand, investors appear to weigh "true" economic prospects and "foggy" accounting measures of corporate net worth approximately equally, as witnessed by the 0.5 coefficient of the ratio of book to replacement value in the last regression. This ratio was virtually stable from 1955 through 1968, but by 1978 had fallen to 65 percent of its 1968 value, implying a depressive impact on the stock market of approximately 20 percent. The substantial role of illusion operating through the inflation distortion of corporate net worth, and perhaps through exaggerated responses to tax increases, is clearly shown in figure 10. The era of escalating inflation ushered in by the fiscal stimulus of the Vietnam War coincides with a sharp departure of share prices from their arguable equilibrium values.
The suggestion of a strong inflation illusion is certainly not unique to this study. As the weak stock market performance of the 1970s has become clear, quite a few authors have remarked on the negative impact of inflation.27. Recently, Malkiel and Modigliani-Cohn28. debated whether this correlation is due to increasing risk or to illusion.____________________