When the US stock markets closed last Thursday, traders called it the “Trifecta Day.” Thursday was the first day since December 1999 that all three major indices closed at record highs. The DJIA closed at 18,613, NASDAQ at 5228.4, and S&P 500 at 2185.79. All indices are also positive in returns YTD.
Investors both celebrated the historic day while wondering if the 16 years that followed the last record will be an indication of the future. Below is a graph of the long winding arduous road of the three indices from the past historical moment to last Thursday:
The cumulative return of the three indices ranges from 56% (NASDAQ) to 69% (DJIA) for the 16.5 years since December 1999. Let me clarify what the recovery in the indices means in annualized return. If you had stayed invested in an index fund (buy and hold) representing any of the three major indices your hard earned annualized return would be 2.81% (before taxes not including dividends). Clearly, many investors have not grown their investment portfolios 60% or gained 2.81% annually during the past 1½ decades. Many have done worse. We speak to many participants regarding their 401k accounts, and many have just got their retirement account back to their original principal balance of 2007 – including all the contributions added since 2007. In 2005 I had similar conversations with participants that were just breaching their previous high balance of 1999. In other words, they didn’t buy and hold through the significant volatility of the markets but sold at low points and then eventually rebalanced their account back into growth funds (typically years after the market recovered) resulting in negative annualized returns these past 16 years.
This is not the first time markets brutalized investors with high volatility and low returns over long sustained periods. Leapfrog past the boom years of 1982 to 2000 (13.9% annualized return for the DJIA) to the 16 years of 1966 to 1982. Key remembrances of this era include the oil embargo (beginning in 1973-74), US troops leaving Vietnam (1973), President Nixon impeachment and resignation (1974), gold prices soaring in twelve months begin January 1980 from $240/oz to $850/oz, the Iran hostage, 10%+ inflation, and the prime lending rate peaking at 21.5% (1981) – depressed yet?. Below is a chart of the DJIA during this period.
Needless to say, this was an equally difficult time for investors and if one had held a DJIA index fund – which was not available at the time – their annualized return would have been slightly above 0% (not including taxes and dividends).
What can we learn about these two eras and was there a “smoking gun” the caused similar market volatility? First, market volatility offers terrific short-term profits by selling at peak cycles and buying at low points. Since 2010 the DJIA has rallied over 200%. During volatile macro-cycles of 1966-1982 and like the present, all-time highs are warning signs and not buying opportunities. Secondly and most importantly, is there a smoking gun? Yes, that is economic policies employed by the government. This system was re-introduced (yes governments went back to this failed policy) by President Richard Nixon and is being repeated again. Here is how Barron’s has reported it:
“We are all Keynesians now, President Richard Nixon famously declared after his New Economic Plan was unveiled in 1971. The notion seems to be echoing now, with the two major parties’ presidential candidates calling for increased government spending, notably for infrastructure and projects…Led by Hilary Clinton and Donald Trump, both major political parties are turning again to public investment in infrastructure. Just like every other president since 1928 who faced a punk economy, the two candidates are promising to get the country moving again, get it growing more, get it building more, and get it borrowing more. ”
There is only one problem if “we are all Keynesians again”. The well is tapped dry. In the early 1970’s interest rates were in mid-single digit and the deficit was a mere 35% of our national gross domestic production (GDP). The Federal Reserve had room to lower rates as a stimulus and Presidents Nixon, Ford, and Carter had Federal Reserve and Federal government money to spend. Today interest rates are stuck at 0% (Janet Yellen will not approve negative interest rates) and the Federal deficit is an alarming 105% of GDP. For the next president to pass deficit spending budgets like the 1970’s, then Americans will watch the Federal debt increase 300% to over $60 Trillion or about $17,000 debt for every man, women, and child.
The cover of The Economist tells it all.
Their featured story in this liberal magazine details how the greatest historical Keynesian experiment since 2008 in both dollars (over $10 trillion) and percentage of GDP has resulted in the slowest economic recovery since 1949. As Einstein has been quoted “Insanity: doing the same thing over and over again and expecting different results.”
WHAT DOES THIS MEAN TO ME
If politicians implement in 2017 similar economic policies of the past, then investors only need to refer to that similar era to determine their investment strategy. Referring to past experiences during periods of similar Keynesian policies, when markets reached all-time highs it was time to sell and wait for the decline. As stated in July 11 issue of Weekly Update, fundamentals don’t always have a direct impact on market activity and despite poor economic conditions, stocks can still rally. However, as Warren Buffet was quoted, “fundamentals matter.” Should the new president and Congress embrace even more Keynesian fiscal policies by running the debt higher and maybe fire Ms. Yellen, doesn’t mean the stock market will crash. Initially, it may even rally more with fresh new stimulus dollars. However, history indicates that eventually, the market will correct the imbalance between value and fundamentals and that is when astute investors should be ready to move.
If you have any questions or comments about this Update or would like to review your investment portfolio, we would love to hear from you. There are asset classes that don’t correlate with the stock market and we welcome the opportunity to share what are those categories of investments. Give us a call or send an email and we will respond to your inquiry!