by David S. Waddell
Surprise! Donald Trump won the Presidential election. Additionally, the Republicans swept Congress, creating a legislative freeway for conservatives. Fortunately for investors, the 13 prior congressional sessions dominated by Republicans (President, House, and Senate) since 1901 produced average annual returns of over 8 percent for the Dow Jones Industrial Average. The last time we had a red river flowing through Washington with major tax and trade reform afloat was 1980. Washington fatigue, after the poor political and economic performances of the 1970s, led to a populist revolt catapulting a previously Democratic outsider from California with a spotty acting career into the Oval Office. History may not repeat, but Donald does rhyme with Ronald.
By the end of the 1970s, politicized central bank policies, oil price shocks, and misguided price controls boosted consumer price inflation to over 14 percent in 1980. Jimmy Carter took to the microphone and delivered his “great malaise” speech, blaming America’s ills on Americans’ bad attitude. Ronald Reagan broadcasted his “Are you better off than you were four years ago?” message soon after promising smaller government, less regulation, lower taxes, and revived prosperity. To break the stagflation logjam, Reagan combined tight monetary policy with loose fiscal policy. Monetarily, the Federal Reserve raised interest rates to 20 percent by June of 1981, squelching inflation down to 3 percent by 1983. Fiscally, Reagan’s Economic Recovery Tax Act of 1981 reduced capital gains rates 28 percent, personal income tax rates 25 percent, and accelerated depreciation allowances to boost business investment. Once the cuts took full effect in 1983, growth surged. For the four years prior to tax reform, the economy averaged annual growth of .9 percent. Over the four years post, the economy grew 4.8 percent annualized. The stock market responded in kind. Spurred by high growth, low inflation, and stable interest rates, U.S. stocks rose 19.5 percent annualized between the years 1983 and 1986.
Over the last 50 years or so, the U.S. economy has averaged growth of 3 percent compared with the 2 percent we have experienced since the great recession. Quantifying the gap, we are now about $3 trillion below our long-run economic potential … a point not lost on the 2016 electorate. Trump’s popular cocktail of infrastructure spending, regulatory relief, offshore repatriation, and tax reform certainly qualifies as a bold attempt to break our current slow-growth “malaise.” Should these provisions pass, there is little doubt that they will increase economic RPMs as they did in the 1980s, but there are some meaningful environmental differences. Reagan’s playbook boosted the U.S. dollar nearly 50 percent between 1980 and 1985. Priced in U.S. dollars, food and energy prices collapsed, ending the energy panic and reducing consequential growth push inflation. Today, the U.S. relies far less on foreign fuel sources, lessening the deflationary impact of a stronger currency. Additionally, rising rates mean rising rents, an inversion of the reductions under Reagan. Therefore, while the Trump policies could substantially boost growth consistent with historical precedent, inflation may not prove as accommodative. Should inflation surprise, the Fed could overreact, threatening stock market valuations and growth forecasts. Given Trump’s preference for appointing tighter-fisted Fed governors, we may see more “hawkish” monetary habits.
Bottom Line: As long as long-term interest rates remain well above short-term interest rates, “Trumponomics” should levitate the economy and asset values, as intended. However, if inflation, interest rates, and the U.S. dollar start to vigorously wrestle each other for supremacy, flipping the yield curve upside down, Trump’s Reagan rhyme could become . . . cacophonic.
David S. Waddell is CEO of Waddell and Associates. He has appeared in The Wall Street Journal, Forbes, and Business Week, as well as other local,
national, and global resources. Visit waddellandassociates.com
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