How the Past May Predict the Future

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Since the election, I have been asked many times as to our projections for the stock market with a Trump presidency. In our recent Weekly Updates, we focused on economic fundamentals that support validity to the stock market rally. The confidence by business owners and consumers continues to rise since last summer as the economic activity has been slowly improving.

The National Federation of Independent Business reported in the middle of January:

“Small business owners’ optimism increased in December following the presidential election. The index jumped up 7.4 points to 105.8, the highest level since 2004, mostly due to a major jump in the number of small business owners expecting better business conditions, which rose from 12 percent in November to 50 percent in December.”

The University of Michigan Consumer Sentiment Report released same week indicated that consumer confidence had reached a twelve-year high about the future:

“The Current Conditions Index rose 0.6 points to reach its highest level since 2004, and the Expectations Index fell 0.6 points which was lower than only the 2015 peak during the past dozen years. The post-election surge in optimism was accompanied by an unprecedented degree of both positive and negative concerns about the incoming administration spontaneously mentioned when asked about economic news.”

As mentioned, investors have improved economic fundamentals to validate the stock market rally. The awakening of “Animal spirits” among entrepreneurial business leaders can have a significant influence on the growth of the US economy. A lot is riding on President Trump delivering on his campaign promises and his ability to negotiate with Congress to pass legislation that is reasonably close to the hopes of both business owners and consumers.

Now to the question of the future of the stock market. In 1980, Americans voted Ronald Reagan into office after 16 years of similar economic stagnation and stock market volatility. From 1966 to 1980, the S&P 500 had a annualized compounded return of 2.50% excluding dividends. During this period the S&P 500 stock index had two major 40% corrections and two 20%+ corrections. Finally, in October 1978 investors rallied the index steadily to new all-time highs going into the election even though economic conditions continued to erode during President Carter’s administration.

SPX 1967-1981

Not surprising to those who follow our Updates is our finding similar patterns with the S&P 500 50 years later. Since 2000, the annualized compounded return is 2.57% excluding dividends. During this period the S&P 500 had two significant corrections of declines 35% (2000 – 2003) and 48% (2007 – 2009), and unlike the two 25%+ secondary declines in the 1970’s, the S&P 500 experienced four short-lived but dramatic declines since it bottomed in March 2009. A notable similarity is during both periods the S&P 500 rallied to new all-time highs before and shortly after the Reagan and Trump elections.

spx 2000-2016

Many remember the 18-year bull market that began in 1982 that resulted in the development of society changing innovation including the internet, cell phones, micro-computers, and Starbucks (no more Denny’s coffee for me). During these 18-years the S&P 500 rallied more than 1000%, a historical annualized averaged return of 15.5% excluding dividends.

spx 1982-2000

It is now the hope of investors that the stagnation and volatility of the past 16 years that included historical market declines and recessions are behind us. Like our recent rally, investors in 1980 drove up the S&P 500 index 7% from the election to when President Reagan’s inauguration. As with President Trump, President Reagan promised to repeal or ease regulations and reduce tax rates. He was quick to deliver on his promises with the passage of the Economic Recovery Tax Act (ERTA) in August 1981 dropping the top tax rate from 70% to 50% and slashing estate taxes.

Unfortunately, Reagan’s policies did not immediately result in increased business profits and tax revenue. The impact of a significant decline in federal revenue ballooned the deficit and sent already high-interest rates into the stratosphere. By December 19, 1981, the Prime Lending rate soared to 21.5% as the Federal Reserve attempted to stem double-digit inflation.

Investors lost confidence in these new policies, and the index corrected 24% from its April 1981 to the fall of 1982. Eventually, the S&P 500 bottomed shortly before the passage of another major tax legislation, the Tax Equity and Fiscal Responsibility Act (TEFRA). This follow-up legislation reversed or relaxed many tax-related provisions of ERTA along with business growth incentives such as Investment Tax Credits that allowed individuals and companies to reduce their taxes equal to the amount spent on qualified activities or developments. Sellers became buyers and the index rallied into the holidays and began the 18-year bull market.

spx 1980-1982

What Does This Mean to Me?

President Reagan and Congress had to pass two significant tax-related legislations within 13 months before getting the right balance of tax reductions and economic stimulus. Legislations ERTA and TEFRA reversed the 40-year trend of high tax rates, and the process challenged investors to navigate through the changes. President Trump is embarking on equally controversial legislation including revising the Federal tax code, health care, and foreign trade policy that may result in similar market volatility over the next couple of years. Investors are hopeful new tax laws will produce sustainable long-term economic growth and another 18-year stock market rally. However, the path was bumpy during President Reagan’s first term and maybe just as challenging this time around. Investors will need to pay attention to proposed fiscal policy, and if the new legislation is favorable for long-term growth. We do believe the past 17 years of low annualized returns of the index are over and may precede a cycle of steady appreciation. We will view market declines as buying opportunities for companies and industries with above average perceived growth potential.

Let us know your thoughts and concerns. We welcome the opportunity to assist you with your investment goals!

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