I've been trying in several articles in many ways to make the analogy between the 1980 period and now. Sometimes the analogy is parallel and sometimes opposite. In 1979, the UK shocked the world by making Margaret Thatcher Prime Minister on a hard-right platform. The US followed as soon as it could, electing someone who had given "The Speech" for the hardest-right candidate in many a decade, Barry Goldwater, an alleged warmongering cowboy, Ronald Reagan. As with Thatcher-Reagan and the sudden change of political leadership at the top, so with Brexit followed by the victory of a tough guy-nationalist as president-elect.
Not to be a political analyst, but really, politics is now almost everything when looking at prices of financial assets. That's because the politicians, mostly the president and his team, have controlled the Federal Reserve ever since the Great Depression, or at least have worked hand in glove with it.
So when the people choose a new president from a new party, as with JFK in 1960 who won a squeaker on the promise to "get the country [the economy] moving again," or Reagan with his anti-malaise program to free the economy to get it moving again, I believe that investors need to look carefully at governmental and Fed policy but not take the "trend is your friend approach." There can just be too many whipsaws as administrations and possibly Fed policies change.
That said, the market and Fed similarities are surprisingly similar between the years leading up to the 1980 election and this election, though the trends in the USD, interest rates and gold are different. Let's explore them to see if it makes sense to then extrapolate what's next for stock prices in the first part of Donald Trump's (first?) term.
Most stock prices were strong even as the economy suffered "malaise" as Carter's term moved along
Jimmy Carter took office in January 1977, after which the stock market, which was generally measured in those days by the DJIA (NYSEARCA:DIA), entered a prolonged, dragged-out non-recessionary bear market. This lasted until February 1978 as measured by the S&P 500 (NYSEARCA:SPY), which is now the main index people follow, and which did not enter a bear market, just a correction, bottoming around 87. In any case, 1979 saw pre-recessionary action, then a sharp and brief recession hit in 1980. The '500' was strong throughout that period, rising to 118 in February 1980. It then dropped to 100 in April, then entered a surprising bull market, rising to what I believe was a then-record 128 by August. It hit 135 in mid-October, then had a sell-off, all presumably in expectation of President Carter's re-election. Then came the surprise Reagan victory. This could have upended the rally, but instead, the market took off anew, hitting a fresh record of 140, and hovered until year-end well into the new high territory of the 130s.
Then the Volcker tightening led to the Great Recession of its time, the long 1981-2 recession that was considered "necessary" in that "tight money" was considered therapeutic. The '500' dropped to 103 by mid-August before soaring - unbelievably - above 170 by June 1983. This far surpassed the prior records. The percentage rise off the bottom was similar to that off the Great Recession March 2009 bottom, but there was one major difference.
The difference was that the 1980 recession and subsequent 1981-2 Great Recession did not even cause a 30% bear market. Whereas, stocks were so expensive in 2007 that a similar recession caused nearly a 60% sell-off, which, if you do the math, is something like two 1981-2 bear markets back to back on a percentage basis, followed by an ordinary bear market.
This is where we have been. Let's see what faces Donald Trump and, therefore, us as he pursues a Reagan 2.0 program with, once again, a Democrat as Fed Chair.
The parallel between Fed trends then and now
As the linked table of Fed funds rate and inflation changes going back to the 1970s shows, the Fed began reversing its very loose policy in April 1978, before Paul Volcker joined the FOMC. Though irregular, the Fed tightened and finally got ahead of inflation by early 1980, loosened, then put the screws on as Q4 1980 moved along. By then, the "Reagan revolution" was beginning. For the first time in memory, the Fed, led by the Democrat Volcker, tightened and stayed tight for an extremely long time. By the time the Great Recession of 1981-2 (Volcker's term for the 2007-9 recession) was well underway, inflation had fallen sharply well into single digits, but the Fed raised rates 3 points in April 1982 to 15%. This is as inflation had been falling from 9% in 1981 to 4% in 1982.
Now, we have a different regime of what's tight and loose. In the QE era, "money printing" or QE is loose without changing the Fed funds rate. So just as the Fed was maximally loose cyclically in H1 1978, the Fed was maximally loose when it was completing full-bore QE 3 in December 2013, "printing" $85 B in new money that month. The entirety of the $85 B per month phase of QE 3, covering each of the 12 months of 2013, correlated with a steep, barely-varying ramp of stock prices. The "tightening" was relative and mild at first, just as the initial Fed tightening in 1978 was mild and ineffective. But just as the Fed "got there" by 1980 and especially 1981-2, it may continue on and be much tighter in 2017 than the market thinks. The setup is similar cyclically, and if anything, the politics provide more incentive now than it did for Mr. Volcker. Republicans are now poised to control the White House, Congress, and the Supreme Court; Dr. Yellen, a liberal and loyal Democrat, may find this an opportune time to tilt toward as tight a policy as the economics of the time may justify. Since I think that, indeed, much higher short-term interest rates can easily be justified, I present this as the base case: a Fed that completes the swing from maximally dovish in 2013 to as hawkish as the times permit next year. Then Janet Yellen will presumably leave the FOMC and President Trump will appoint a Republican successor. If my base case of what happens is correct, the economy will be slowed by Fed actions beginning with the expected 25 basis point increase to be announced on December 14.
Ramifications of Fed tightening; updating past analyses
Just going back to my calls from November-December 2015, I turned pretty bearish then when it became clear that the Fed was going to raise rates at its December 2015 meeting. I spoke well of both long-term Treasury bonds (NYSEARCA:TLT) and, for the first time ever, high yield (i.e., junk) bonds (NYSEARCA:HYG). Both did very well through the Brexit vote in June. I then turned very cautious to negative on bonds and bought the sell-off in growth/cyclical stocks. All of a sudden, I found myself owning and trading the following, all of which I wrote individual articles on or included in Q3. In alphabetical order, these included (prices as of Thursday's close):
- Boeing (NYSE:BA) on July 11, was $132, now $152
- Delta (NYSE:DAL) on July 20, was $40, now $48
- Gentex (NASDAQ:GNTX) on July 25, was $17.62, now $19.00
- Palladium (NYSEARCA:PALL) on June 30, was $58, now $72
- Southwest Airlines (NYSE:LUV) on July 20, was $43, now $47
- Thor Industries (NYSE:THO) on July 20, was $74, now $103.
I also specified in a June 30 article that I was leaving long-term bonds as a trade and moving to cash, as per the title A Top In Bonds? Back To Cash, Buying Palladium And The U.K.
I think the above calls worked out well, so well that I reverse them all. I now own none of the above stocks or the PALL ETF, and while I never sold all my TLT (I have a permanent portfolio that I don't write about), on a trading basis I have now recommended it or the equivalent to a family member. So in concept, I'm long Treasuries again for an oversold trade. But I'm not all in.
There was a second set of stocks that I mentioned as being interesting in one of my contrarian articles, from September 19:
I don't think there were a lot of financial writers focusing in detail on how to position for a Trump victory. But I said then that I thought it was a roughly 50-50 race, which ended up being more or less spot on. I spoke favorably of biotechs as obvious winners from a Trump victory, oilfield services stocks and named a few, defense contractors and steel stocks including Nucor (NYSE:NUE) and Steel Dynamics (NASDAQ:STLD). Of the above, I traded STLD twice and bought and sold a number of biotechs above and beyond my core positions, including Regeneron (NASDAQ:REGN) and Gilead (NASDAQ:GILD).
Again, for the record, I'm out of all the Trump trade positions; the core biotech positions remain mostly unchanged.
The point of structuring this section of the article in this fashion is that if I'm correct that it's at least prudent and possibly spot on to position for a more hawkish Fed than the market expects, cyclicals are the wrong place to be after this strong run-up in so many of these names.
If it's time to fade the cyclicals, where "should" money go?
Now let me briefly go back to the other theme that I have used along with forays into the cyclical upswing spurred by cheap oil and cheap money to see how that call has done and whether it may still be "working."
That call came in an August 15 article, Examining The Bull Markets In Gold, Stocks And Bonds; Is Cash Still Trash?, where I argued that cash was likely no longer trash and could reasonably be overweighted. Because this is more along the lines of what I'm thinking, as explained further in the next section, here are some quotes from the article. First, from a section titled:
Summarizing the case for shorter duration
...So my view is that of the 3 major markets I've been following since beginning to write on the Internet nearly 8 years ago [i.e., gold, stocks, bonds], none are attractive right now except perhaps in the ultra-long view.
That was a huge change for me, though as noted, I have done a lot of swing trading in this time period, happily with nice profits repeatedly.
I went on to say (emphasis added by me in this article, not the original):
Once interest rates rise - if they do - years of bond price appreciation can vanish almost overnight. Or, an outright deflationary depression can destroy dividend payouts and profits. Treasury yields may even sink a little lower, but the SPY could drop from a P/E of 25X to 8X. If interest rates rise with rapid inflation and something link the 1974 or 1979-82 scenario, or even the much milder 1966 non-recessionary bear market, then we have the scenario familiar to us grizzled veterans of nowhere to hide except in inflation hedges.
Whereas, if you stay shorter-term, you can only get hurt badly if the whole thing collapses. Which is not going to happen.
And I ended with a final section with the following title which included the following near-final sentence:
Conclusion - how and why cash can beat higher yielding stocks and bonds over a 10-year period; tortoise versus the (slow) hare
... It may be that in an appropriate time frame, one that cannot be defined or predicted, shunning duration and accepting lower yields may be similarly looked at as having been the best way to achieve alpha over a multi-asset basket for patient investors.
I also repeated and updated the above article on cash, the first I had written with that point of view in almost eight years of writing on the Internet, in a September article.
Finally, I also mentioned in a separate article that, as might be obvious from associating a Trump win with a positive view of cyclical industrial stocks, that this victory would be bad for bonds.
Before going on, I like to keep track of how a major macro call is going. So comparing today's prices on the three major asset classes discussed above from August 15 to today, we have:
- SPY - $219 then, $219 now
- TLT - $139 then, $119 now
- Gold (NYSEARCA:GLD) - $128 then, $112 now.
Based on my own investing and writing in the eight years I've been blogging and writing, including for Seeking Alpha nearly the past four years, I would weight the above at 40%, 40% and 20%, respectively. Based on that, then indeed my strategy of trading cyclicals on the post-Brexit dip in late June and July, focusing on cash by mid-August, then trading the Trump victory trades of cyclicals plus biotechs through the election has been in tune with the times.
Next, I want to extend those themes both in the short term and longer term.
Gundlach speaks - and again makes sense
Jeff Gundlach, who has replaced Bill Gross as the new "bond king," actually is a multi-market maven. While I'm certain that he does not have anyone in his organization tracking my calls, he and I have been in sync for some months. As this article shows, on June 30, I wrote that I was taking profits in my long-term bond trading positions and going to cash or near-cash such as with a very short-term bond ETF (NYSEARCA:SHY). As this cut-and-paste from a current Reuters article shows, Mr. Gundlach announced that same tactic a week later. The bond king announces his latest thinking:
"The dollar is going to go down, yields have peaked and will move sideways, stocks have peaked as well and gold is going to go up in the short term."
Gundlach, known on Wall Street as the "Bond King," went "maximum negative" on Treasuries on July 6 when the yield on the benchmark 10-year Treasury note hit 1.32 percent.
Gundlach began purchasing Treasuries last week and agency mortgage-backed securities on Tuesday, as yields have risen, he said.
"I am less defensive now on Treasuries and I am less negative on the 10-year Treasury note at a 2.35 percent yield than we were at 1.35 percent yield," he said. "Bank of America's dividend yield is 1.39 percent while the 3-year Treasury yield is 1.45 percent. I mean, really?"
Now, at his DoubleLine firm, he has a whole organization of analysts and traders to execute these short-term trades. It's not clear to me that with oil prices now flat and in parts of the out-years, actually going into backwardation, gold makes for an exciting trade. If one believes in having some physical gold for general reasons, that's always a different topic from what I'm addressing, such as trading profits or income with good stability of principal. At least Treasuries are cheaper (higher yielding) than they fell to soon after Lehman collapsed in September 2008, whereas gold, which was still below $1,000 per ounce a year after Lehman fell, is above that level and far above the $700/oz low it reached in the post-Lehman panic.
For my part, I'm not seeing anything too exciting, though indeed Treasuries are both technically vastly oversold and fundamentally, the 10-year T-bond now exceeds the yield on the SPY and the S&P 500 by 30-40 basis points. These two metrics, the stock yield and the 10-year yield, have been cycling around each other since Lehman fell. Perhaps that will continue, but as always, some relationships that have been working may simply stop working.
So I think that TLT or shorter T-bonds could be interesting and reasonably safe trading buys here, with the fallback position of just holding them if the trade is mistimed. But I don't think they are ideal investments right now. I want to see what the Fed does - and says - and how inflation plays out.
The ramifications of a potential Fed tightening cycle continuing into 2017 could be adverse for all financial assets, though if the Fed makes cash attractive again, then the USD could be more attractive even if the rest of the world moves away from their incessant active QE programs that are destroying their currencies and making the USD appear strong on a relative basis.
The November Employment Situation report supports a cautious view
There were no important revisions to September or October, and the establishment survey reported job growth of 178,000 for November, spot on with the average for all of 2016 and for the prior couple of months. Employment growth, however, is well down from that of 2015 of 229,000.
Consistent with a general slowdown in the pace of economic expansion at least through mid-November, when the survey was taken, was that the two diffusion measurements the establishment survey takes were down as well (p. 5 of the PDF). Both the broad total private all-industry diffusion index and the smaller manufacturing index were well down from one year ago as well as down month on month. The manufacturing index was 47, thus not expansionary.
Average hourly earnings are now measured at up only 2.5% yoy.
Now let me add one more bit of information and sum up, fleshing out the bullet points and the supporting information presented in the body of the article.
Bubble-era late-cycle investing - more difficult than almost anything else in the markets
Since at least the autumn of 1998, when Alan Greenspan's Fed went aggressively after a reinflation of the stock market bubble, the US has moved from one bubble to another. There was a recrudescence of the 1970s style hard asset bubble, but this time, it was made far worse due to bubble finance. The result: a bankrupt banking system, only saved by institution of bailouts. A necessary part of the bipartisan saving of the banks and their bondholders was aggressive QE. This pumped cash into banks, relieving them of their suddenly-overpriced Treasury and mortgage bonds, allowing them to buy suddenly-depressed stocks and junk bonds.
Irritating as that was, the unending US and global QE has taken bubbles to a new level. As I documented before noting the excessive boom in gold this summer, and just focusing on stocks and bonds, a metric I devised to combine stock valuations with Treasury bond valuations sank to the highest level - meaning, the lowest return to investors - ever in US history going back to about 1871. That's 1871, not a typo.
The only comparable period involved another period of QE, the post-crash 1930s just before the "depression within a depression" of 1937-8. That pre-bear market period is the only one I can find where very high stock valuations coincided with very low Treasury bond interest rates. The upshot was initially horrible for stocks and good for bonds as deflation returned. Then the advent of World War II ruined bonds.
So this parallel suggests keeping extra dry powder to see if some asset prices become more attractive.
Then there's the more recent Reagan/Volcker-Trump/Yellen parallel. The times were opposite in some ways; rising rates and depressed stock and bond valuations then versus 35 years of falling rates and high stock and bond valuations nowadays.
With that secular difference something I've discussed before, what surprised me when going back to the Fed actions and stock market data was the similarity between then and now.
These similarities are, first, of a Fed spending the second half of a president's term chasing the inflation that prior Fed actions had encouraged. Both then and now, the stagflation of the time, and the necessity of the Fed tightening (1979-80) and de facto tightening ("removing accommodation" 2014-ongoing) probably helped move enough voters to take a chance on a new president who promised to cut taxes and slash regulations while increasing jobs.
The second similarity involves stock price action. Even though the stodgy DJIA went sideways to down, most stocks rose from 1978 with the monetary steroids until Fed action in 1980-2 brought their valuations down to secular lows.
I expect that as I said last December in a bearish article, no recession will be needed for stock prices to retreat. Janet Yellen began complaining about certain stock prices in July 2014. She and the Fed have repeated their observation more generally that stock valuations are above normal.
As with the Volcker Fed and Ronald Reagan's election, so too with Chair Yellen. There is now no political force to stop her from pushing the FOMC to move to the tighter-end of the policy spectrum, finally just beginning to reward savers for putting up with near-ZIRP for eight years and still, as shown above, not even coming close to rewarding them the way the Volcker Fed finally rewarded savers after they saw their bank deposits lose most of their value from 1966 through 1979 - while paying taxes on the interest, as well.
As with Reagan, so with Trump? Reagan deregulated energy, and oil prices plunged. Donald Trump is clearly channeling Reagan here. The victor: the consumer, and holders of fixed income who benefit from lower energy prices; also, industrial consumers of energy (the broad economy). The Trump corporate tax cut, if implemented as he lays out, would benefit a number of industries. I'm not sure it's possible for an investor to achieve alpha here, now that he appears highly likely to actually prevail in the Electoral College and therefore become president. The smart money will have figured all these particular ramifications out long before I could.
Thus my strategic focus remains on the Fed rather than extrapolating trend lines. Until mid-year this year, and increasingly as I thought that Donald Trump had a much underrated chance of winning, I have taken the "under" on Fed action. That left me thinking that compared to cash yielding far too little, at least a bond gave a yield, so it would be better than cash. Thus cash was trash, and relative attractiveness of equities or gold (and other inflation hedges) was to be measured not against cash but against high-quality bonds such as Treasuries. Now I cannot say that. With valuations of stocks and long-term bonds both still historically high, either or both could normalize and impose large unrealized losses on investors who were heavily exposed to these long duration assets. At least in Reagan's time, valuations favored the long-term holder, even though tactically, cash in December 1980 was the best asset for some months to come. Now, we have the 1937 example of stretched stock and bond valuations to consider, making a large bet on duration yet riskier and trickier unless one commits now for many years ahead.
There are some investment positives in my view. One is the continuing flexibility and creativity of the US economy and its leadership position in so many growth industries. Within all that, as in 1980 and during the stock bubble of 1999-2000, individual sectors and individual stocks may rotate to become unduly out of favor. There are, in my view, some attractive individual stocks in different sectors. I have begun highlighting some of them in recent articles and plan to do more of the same. The investment focus could either be for swing trading or long-term investing, depending on how trading and business conditions dictate; but my goal is they all such picks have enough strengths that they could be "anti-fragile" and withstand Fed tightening, recession, inflation/deflation, etc.
Some of the names I've just begun building positions in are known to all, and others are much more obscure. I would hope that these names work out as well as the mostly cyclical names I wrote about in June through October, as discussed above.
Thanks for reading and sharing any comments you may have.
Disclosure: I am/we are long TLT,GILD,REGN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.