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I put a new impeller in the motor and ran on the water and no overheating. Motor ran fine with strong tell tale discharge.
So, water must not exit the block and out of the exhaust housing/lower unit passage until it warms up sufficiently to allow the thermostat to open and then escape once it's able to run through the water cover discharge path.
Thanks Kbait. I was wondering why other later models with functioning thermostats that were not stuck open would still show water discharging down the exhaust together with the tell tale, when just running a hose connected to the copper water tube (so leg off and not running).
I think it could be because they have a spring attached to the thermostat and with increased water pressure it forces the spring to compress and allow water to discharge.
With this 1979 model there is no spring and that will not allow water to discharge through the exhaust housing testing this way.