Why It's Not 1982 Again, Part 2

Includes: LLY, VZ
by: William M. Wright

Why It's Not 1982 Again Part 1 gave you two great articles on why economists often are wrong in their forecasts both going into and coming out of a recession. Most of the free world can agree that has happened before.

But here comes my disagreement. Both James Grant (a student of financial history and Bear turned Bull) and Michael Mussa (Ex-IMF Chief Economist) conclude the traditional economist weakness in understating a recent trend change will (or could be) similar to what happened in 1982-83.

Yes, I feel those were two excellent articles, but with one common comparison flaw. They both use the 1982 Ronald Reagan economy and bull market beginning to make their case, but ignore what happened in 2002 after a much smaller recession officially ended in 2001.

Both point to how economists were too pessimistic in their growth forecasts and correctly point out how the actual recovery starting in 1983 had six quarters of outstanding GDP growth (5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%).

Yes, that my friends was the mother of all V-shaped GDP recoveries. Before you ask "How likely is it that will happen in 2010?" ask this question, "How is 2009-2010 similar to 1982-1983?" Now skip the remark, "Obama is no Reagan." We'll come back to this question.

Both men make an excellent point about economic forecast missing the economy's potential. But even rosy eyed Ex-Chief Economist Mussa is only forecasting 3.3% GDP for the USA next year. I can believe that's a possibility. That's not the irrational part. The irrational exuberance is the wishful and whimsical implication this could be the 1982-83 market déjà vu too.

Yes, there is no question we are seeing lots of green shoots in 2009 driven in large part by government spending, bank-bailouts and the knowledge that FASB 157 rules are back to pre-2007 levels for the largest segment of the S&P 500. So, those waiting for those 1981 average market P/Es of 7 missed the boat. F.Y.I. you can buy Lilly (NYSE:LLY) with a a 6% dividend and forward P/E of 7 right now.

But the notion this is 1982 again and the next 6 quarters of economic growth will be like the mother of all V-shaped recoveries is beyond my imagination.

Ask yourself these questions and I'll give you my view on each:

1. How can 3.3% 2010 GDP growth lead to six quarters of quarterly growth like the time period they reference above?

I see no way, but someone else may see a path to that math. Can an economist or math major help me understand this dream?

2. Why do they ignore what happened in 2002 when the market declined for three straight quarters back to the 2001 lows, after the recession official ended in 2001? Why ignore that recent reality for the very distant past?

In 2002, unemployment kept rising and peaked around June of 2003 at 6.3%, almost 9 months after the NBER declared the recession over. The 2001 recession was more a business capital expenditure recession as consumer spending and big debt accumulation was still in high gear after 9/11 thanks to the Fed's 1% rates.

Now even if the unemployment rate just stays level around 9.7% it would be logical to conclude consumer spending (and the easy money from banks) will not be close to the 2003 time period. And history has shown businesses do not start expanding and hiring until they see their consumers buying again.

Yes, we are having an inventory restocking pick-up, just like we did in late 2001-early 2002. Investors know this Q3 GDP will be a big fat bounce. Q4 should be good, but do not tell me the market rise will result in lots more spending in Q4. Why? Because more people were employed last December and the market had made it up to around 9,200 in Q4, 2008.

So, this causes me to conclude 2010 will not be 1982-83 again. The economy will be more like 2002 or 2004 again, only weaker. So I think we should look at that stock market time period. For some it was good and for others it was poor.

3. Is America's 2009 economy composition similar to 1982-83?

Absolutely not. This economy is nothing like the 1973-83 stagflation economy. Back then Treasury Secretary Paul Volcker (smoking those illegal Cuban cigars) needed to crush inflation with the highest interest rates in American history. (I wish this was 1982 so my savings would be earning 9-12% in my MMFs instead of 0.25%.)

If you are under 40 you may have no feel for real runaway inflation. And if you think mortgage rates are a little high, take a look at what the 1979 to 1981 Bank Prime Rate was in America. Now you know why we lived in those little houses. Notice how in 1981 the banks started lowering the Prime Rate (as a result of the Federal Reserve lowering the discount rates) from 20% to 11% in 1983. Yes, I said 20%. Now if the prime rate was 14-20% think about the sub-prime rates?

This move alone pushed stocks higher as the value of each dollar of revenue or profit became more valuable in a lower inflation and interest rate environment. This phenomenon, you know, is called P/E expansion. You can see the proof from 1982 to 1999 as the average Standard & Poor Stock P/E rose from 7 to 32 as inflation and interest rates declined and the economy became more robust.

The decline from 20% in 1981 to 11% in 1983 also generated those fantastic six quarters of high GDP growth as going into debt to buy things became more affordable. My pragmatic brain is saying even if we go from 0.5% to 0%, that isn't going to generate six quarters of consumer-led spending like 1983. So, again I'm back to 2010 looking more like 2002 again.

4. Why forget the recent American economic phenomenon known as Jobless Recovery?

How quickly they forget. One Seeking Alpha article simply said 2001-2002 is a poor comparison. He quickly rationalized there is no reason to believe 2010 will be a jobless recovery. Now how in-depth and rational is that thinking? Just read the fact based reports from respectable economist who talk about this new variable everywhere. Just go to any of the Federal Reserve Bank websites and read what their high price economists say. They all agree it was first seen after the 1990-91 recession which cost Bush Sr. his job. Doesn't anyone remember Clinton's "It's the economy stupid" slogan?

Since high priced economists talk in economic abstracts, let's explain this new economic "phenomenon" to these 35 year old PhDs using basic real life examples and history. Why did we have those big job recoveries back in the 70's and 80's but not today?

Let's go back in time. It's 1983 and you have a job and the cost of money just got cut from say 16% to 8%. Now think about buying a car, clothing or appliances in 1982-1983. The big three were all American. Communist Chinese products? No way. Vietnam is where we spent a fortune in American blood and money for the right to not buy communist made goods. Sure we bought Asian made products but in lower quantities than today. Why? Because we also made TVs, stereos, computers, washers and dryers in America. Today, most appliances and clothing (just to give two examples) are made outside America.

So, in 1982-83, as those lower interest rates increased sales, American factories employed more American workers, who in turn had more money to buy more stuff (of which a much higher percent was made in America and nothing was made in communist China or Vietnam). Surely some economist has quantified this impact in an economic equation and report.

As Peter Schiff would say, "Today, we spend more than we make and we consume what others abroad sell us -- is it any wonder we are broke and out of work?"

We have no convincing evidence leading us to believe this "jobless recovery phenomenon" has vanished from our shores. So, this is not 1982 again.

5. Does any well know economist agree with using the 1982-1983 economy and market to support this notion?

No (at least I couldn't find anyone). Janet L. Yellen, president of the Federal Reserve Bank of San Francisco (far more qualified than I) sees no comparison. In fact, in a one hour presentation to the San Francisco Bay CFA association on Sept. 15, she explains why not. He's my Cliffs Notes Report.

And Nobel Prize Economist Paul Krugman explains why there is no comparison using the same logic. The guy knows the differences.

A lot of what we think we know about recession and recovery comes from the experience of the 70s and 80s. But the recessions of that era were very different from the recessions since. Each of the slumps — 1969-70, 1973-75, and the double-dip slump from 1979 to 1982 — were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again.

... Post-moderation recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand. And that means that the Fed can't just cut interest rates and boost housing. This recession is very different than the early '80s.

The Bottom Line

Yes, this should be the biggest and steepest upward market surges since the 1930's. Call it whatever you wish, but this was no head fake. Suckers rally? No, the suckers were left behind to write all those articles explaining why the market was going to fall back to the March lows.

No, this is not the beginning of the 1982-87, Ronald Reagan, Bull market-style economy. It was a different time. As Novelist Tom Wolfe, wrote "You Can't Go Home Again."

No, I'm no Bull turned Bear, just a Bull (on tiptoes) who remembers the 2001-2002 market. Yes, I'm getting defensive.

Yes, this market has and can defy gravity and remain in Bull mode for the remainder of the year. Can we have a 5% pull-back before getting to those pre-Lehman Brother bankruptcy levels? Yes. But now everyone is into "buy the dip" mode. So, even with October coming up, I'll not worried about 2009. My worry is 2010.

Since many quality earnings stocks were left out of the rally, you can find many excellent dividend paying opportunities.

So, even though Ronald Reagan is not in office, I'll leave you with one powerful positive. There are $3.5 trillion dollars in MMFs earning only 1/4% interest. In 1982-83, MMFs and CDs got paid a fantastic rate of return for taking no risk. Today $3.5 trillion is almost nothing. It pays to take risk.

People cashing out of their big winners can still by quality stocks with low forward P/Es like Lilly (LLY) or Verizon (NYSE:VZ) paying 6% . I chose to do that today.

Disclosure: I purchased Verizon (VZ) and Lilly (LLY) today (9-23-09)