We're Entering a New Reagan Boom--NOT!
Trump first dazzled American pop culture with his gaudy hotel logo and celebrity interviews in the 1980s. In fact, the Donald still looks like a slightly older version of an ‘80s yuppie—a me-first “master of the universe” sporting everything but the power suspenders. So is it so far-fetched to think that he might overhaul today’s economy by turning back to that 1980s magic?
Many policy pundits are hailing the idea, so much so that you might think that the “Again” in “Make America Great Again” is a direct reference to the Gipper’s success in slaying inflation, downing the USSR, and building a 600-ship navy. Even notable leaders of the original “supply side” revolution are remaking their appearance in (or near) the Trump coterie: Art Laffer, Larry Kudlow, Stephen Moore.
To be sure, there are intriguing analogies. Reagan, like Trump, entered office at a downbeat moment in U.S. history, when record shares of Americans said the nation was “on the wrong track.” Reagan, like Trump, was a confidence-exuding, larger-than-life personality not known for his precise grasp of facts. Reagan, like Trump, was a friend of Main Street who bore a withering agenda of regulatory cutbacks and tax cuts dear to the heart of most business owners. And Reagan, like Trump, strove to implement an economic agenda championing huge fiscal expansion in an environment of monetary tightening.
By all accounts, today’s #TrumpTrade is largely driven by these last two features of Trump’s agenda: Huge tax cuts, huge regulatory reductions, huge fiscal stimulus, and a pivot away from low-rate, weak-dollar monetarism.
I’ll pass on the question of how “great” the ‘80s really were. Clearly, even the architects of the Reagan Revolution—George Gilder versus David Stockman, for instance—differ greatly on what it did and did not accomplish. Let me also pass on the question of all the reasons the #TrumpTrade could—and I think will—end in tears. I covered those reasons in an earlier post. And, in a joint post we will make with the Macro Sector in a few days, we will outline them again along with suggestions for how you can profit from its failure.
Just remember: The greater the #TrumpTrade enthusiasm, the cheaper it will be to reap big gains when it goes down.
OK, so let’s get back to my main argument. How is the outlook for President-elect Trump late in 2016 not like the outlook for President-elect Reagan late in 1980? Here are a few thoughts:
Back in the early ‘80s, we had large cohorts of youth (Boomers and first-wave Xers) starting their careers and a small 60something generation (Silent) about to retire. That was great for economic growth: The exploding size of the working-age population was guaranteed to kickstart GDP growth, while the deceleration in the number of retirees would keep Social Security and Medicare outlays (especially by the late 1980s and 1990s) in check.
Today, the situation is reversed. In 2016, the late-wave Millennial cohorts entering their 20s are shrinking and the yearly number of Boomer retirees is about to hits its apogee. Fun fact: In every five-year period from 2015 through the end of the century, the YOY growth in the U.S. population age 20-65 will shrink to a small fraction of what it was in any five-period from 1945 to 2015. What does Census project for the growth rate during the first Trump term: 0.2% per year. What was it during the first Reagan term: 1.6% per year. That’s an extra 1.4% of free annual GDP growth—simply due to the presence of new warm bodies!
Back in 1980, most women wanted careers for the first time and most young adults did not get along with their Archie Bunker parents. As a consequence, the employment rate of young women surged, further accelerating the Reagan boom. And the share of young adults (age 25-34) living with their parents plunged to an all-time low in 1980. (It remained low even during the severe 1982-83 recession.) Result: The growth in market employment was supercharged even faster than the working-age population.
Today, again, the situation is reversed. Since 2000, the share of all women either in the labor force or employed has been declining at an accelerating rate. And, since 1980, the share of young adults (age 25-34) living with their parents has roughly doubled, from 11% to 23%. Combine this workforce withdrawal with the rise of the disinflationary sharing economy and you can bet that a growing share of economic transactions will no longer be happening in the marketplace—and hence, no longer counting toward GDP.
Back in the fall of 1980, the economy was rocked by stagflation: It was just emerging from the Carter recession (Q1-2, 1980) and was only five years removed from the severe Ford recession (1974-75), Inflation was raging well into the double digits. Unemployment was nearly 8%. Buffeted by this macro turbulence, productivity tumbled in the year before the election. Market volatility was high.
In the fall of 2016, the outlook is again quite different. We are seven full years removed since the last recession. Inflation is stuck below 2%. The official unemployment is just under 5%—though the share of working-age Americans not looking for work remains high. As was true in 1980, labor productivity (as measured by the 5-year CAGR) has fallen beneath 1%. But back then, this was a recent and recession-related development. Today, it is a longer-term structural trend unrelated to recession. And volatility? 2016 has been one of the most placid years on record.
Only sunbathers who put on tanning oil during the eye of a hurricane will regard this as positive for the #TrumpTrade.
Back in 1980, total federal debt was near its all-time post-Depression low (31% of GDP) and total nonfinancial debt was similarly subdued (140% of GDP). There was, in short, a lot of unused debt capacity—and Reagan used it. By 1992, the Reagan-Bush administrations had pushed those two numbers up to 61% (roughly doubling the size of the national debt) and 185%, respectively.
Today, after two later debt-fueled presidencies (GW Bush and Obama), those figures have been pushed up further. Total federal debt is now at 105% of GDP, a level only exceeded at the height of World War II; and total nonfinancial debt is now at 245%, a level with no precedent. Reagan, in other words, started out at a moment of historically light debt—and Trump is starting out at a moment of historically heavy debt. Can Trump safely add lots more debt on top of what we already have? Carmen Reinhart and Ken Rogoff wrote a famous book in 2011 saying he can’t. No one knows for sure. All we know is that we’ve never been here before.
To understand the giant Reagan stock market rally of the 1980s, you need to start with one crucial fact: It began at the end of a long bear market (during the late ‘60s and ‘70s) that had pushed equity valuations down to extraordinary lows.
In August of 1982, when the rally began, Shiller’s cyclically adjusted P/E (CAPE) was 6.6—among the lowest CAPE values ever measured. Today, Shiller’s CAPE stands at 27.2—among the highest ever measured. Note: The mean CAPE since 1870 is 16.7. Given that the CAPE shows strong statistical mean reversion, the odds of a strong upward trend in equity prices starting at 6.7 (beneath the 5th percentile) are very high. Similarly, the odds of a boom starting at 27.2 (above the 95th percentile) are very low. Even conceding some drawbacks in the CAPE measure, it’s fair to say that a Trump boom pushing equities ever higher into 2017 is a very risky valuation bet.
Further considerations? Well, the Reagan rally benefited from two further market tail winds. One was steadily falling interest rates (both nominal and real) after the initial “Volcker” recession. Since 1920, the 10-year correlation of monthly returns on stocks and bonds has been positive about 70% of the time. (The main exceptions have been deflationary periods of underemployment—which, presumably, would not be the case once Trumponomics gains traction.) The second tail wind was low initial corporate earnings as a percent of revenues or national income—which again mean reverted over time and gave extra upward thrust to the S&P boom.
Guess what two trends we are not likely to see in the first two years of Trump’s Presidency? Any success scenario for the Trump economy would require interest rates to rise steadily throughout his term. And as for S&P profit shares, both domestic and foreign, these linger way above their historical means. They are likely to shrink, not grow, especially under the pressure of full employment.
In 1980, Reagan won by championing free-market individualism and by his determination to cut back on practically every type of federal spending (“government is the problem”) except defense. A new generation of risk-taking, anti-establishment voters (Boomers) who chaffed at the strength of America’s middle class surged late to his banner and ensured his victory.
In 2016, something different is going on. Trump won by telling supporters that Obama-Clinton-Wall Street was not looking out for them and was not doing enough for them. He berated the Democratic Party for not having the courage to nominate a real populist (Bernie Sanders). There is no part of government he has any real interest in cutting (except for “Penny Plan” nonsense foisted on him by the powerless GOP rump).
On the other hand, there are huge powers of government Trump wants to restrengthen—building infrastructure, “fair” trade, bringing back jobs from abroad, and so on. Why? Because America is too enfeebled and the public too endangered to survive weak national leadership. For Trump, it is not morning in America—but more like midnight in America. Today’s new generation of risk-averse voters (Millennials) are worried that America’s middle class will disappear before they have a chance to join it. Trump has them on his radar screen. The elders of the GOP, who still try to talk like Reagan, do not.
Reagan’s bashing of statism was best epitomized in the famous remark he made in Berlin in 1987: “Mr. Gorbachev, tear down this wall!’ Guess what? Thirty years later, Trump attracted voters by talking not about tearing walls down, but about building them up. And it’s not just Trump. “New authoritarian” leaders across Europe and Asia are also rebuilding walls and redrafting industrial policies to protect their citizens. We’re in the midst of a social and generational trend shift encompassing much of the world.
To be sure, the new President-elect has been showcasing a potent deregulatory agenda, for the energy and financial sectors in particular. Yet these moves are motivated less by free-market ideology than by America-first corporatism. My evidence? Just look at Trump’s leading intellectual strategists, such as they are, and compare them to Reagan’s: Dan DiMicco, Peter Navarro, and Steve Bannon on the one hand versus Ed Meese, Bill Niskanen, Marty Feldstein, and Marty Anderson on the other. I rest my case.
To recap, be careful of the Trump-Reagan parallel.
Back in the 1980s, investors looked forward to demographic and marketplace trends that favored strong economic growth. They waited for a cyclical reprieve from an unusually stormy macro environment (the 1970s). They knew the economy could, if need be, rack up plenty of new debt. They could see that equity valuations and profit margins were at record lows—which means they would likely mean revert. They expected that, if inflation could be tamed, falling interest rates would further fuel price growth. And they could sense that the American public was moving toward an embrace of marketplace individualism and its associated risks.
Today, it’s fair to say, that investors can look forward to none of the above.
One final thought about the Reagan-Trump parallel. Even if you feel that the likeness is persuasive—and that Donald is indeed the second coming of Ronald—keep in mind that Reagan’s election did not spark the Reagan boom. The economy and the markets had to go through a brutal recession and bear market first.
Yes, the initial market response to Reagan’s election was positive: The S&P surged by 8.5% between election day and the end of November. But then it started sinking, losing all of its gain by inauguration day (January 20, 1981), and plunging still further over the next 18 months—until it reached a secular low on August 12, 1982. By then, the S&P was 21% below what it had been on election day and 28% below what it had been at the end of November. The inflation-adjusted decline was even worse.
So if a replay of Reagan is your best-case scenario, don’t succumb to complacency. You could still be in for a teeth-clenching roller coaster all the same.
(Click here to read Howe's piece, "President-Elect Trump: Why Did It Happen? What Does It Mean For Markets?")
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This is an excerpt from an institutional research note written by Hedgeye Demography Sector head Neil Howe. To read Howe's institutional research email firstname.lastname@example.org.