Market & Economic Commentary| Fall 2017

By: Jim Scheinberg – November 3, 2017

The New Roaring Twenties?

For the sake of my theory, please afford me some poetic, or perhaps better said, chronologic-license and forgive the fact that we are a still a few years away from the 2020s. Though this period will likely never be known as the second coming of the prolific period of global growth that occurred nearly 100 years ago, to ignore the similarities may prove to be costly to those who doubt the strength of the era we are presently enjoying… and the potential aftermath that may follow.

Hindsight is 1920

Warren G. Harding was considered by many historians to be one of the most ineffective Presidents of modern era. He was elected in 1920 based on a nationalist “A return to normalcy” campaign which included a pledge to reject mem­bership in the League of Nations (now the UN). Protectionism would grow steadily for the next nine years culminating in the catastrophic Smoot–Hawley Tariffs passed in 1930, which many argue deepened the crash of ’29 into the Great Depression. Harding only received the nomination because the Republican field was greatly divided (with over 12 can­didates vying for the nomination). In fact, Harding garnered less than 10% of the vote on the first six ballots!

The Roaring Twenties were stoked by a period of deregulation and protectionism that was a reaction to the Progressive-era that proceeded it. The first two decades of the 1900s were marked by social reform that championed protection for workers and the rise of women’s rights (including the passage of the 19th amendment in 1919 granting women the right to vote). The progressive era also fostered an era of “government knows best” including the advent of the Federal Reserve in response to the credit crisis of 1907 and the moralistic enactment of prohibition. By 1920, many Americans had had enough, resulting in a populist-led election of Harding, the last businessman elected President before Donald Trump.

Today we find ourselves with an ineffective President who similarly was nominated due to a deeply divided and con­tested Republican primary. Trump’s slogan of “Make America Great Again” parallels the essence of Harding’s campaign perfectly. Threats of withdrawing from NATO, building a wall, and border taxes are modern era incarnations of the same nationalistic swell of 1920. As was true a century ago with woman’s suffrage, debate over the legalization of same sex marriage intensified a divide across the United States. A swelling environment of political correctness was pierced by Trump’s brash campaign and continues to be confronted head on by the likes of the Alt-Right extremes and Fox News. As was true prior to Harding’s election, taxes had recently expanded under President Obama along with burdensome regulations prior to the Trump election. As both Trump and Harding came into office, American businesses were primed as regulations eased and the tide of taxes appeared to be heading out after 8 years of rising.

It is these last similarities that are most important. The post crisis period of 2009-2016 was one of the most economi­cally anemic in history, with GDP growth creeping along well below a two percent per year pace. Business leaders across America stockpiled cash and hesitated to invest in labor and resources for growth due to increased banking regulations under Dodd Frank and impeded by the costs of implementing ACA (Obamacare). Further, increased regu­lations from the Federal government as well as states like California muted recovery in the housing, healthcare and manufacturing sectors. The Democratic platform that appeared to be heading into the White House in 2017 projected even higher taxes, more government entitlements and still stricter regulations on business and Wall Street. By the time Trump rolled into office, the mere relief that business conditions were not going to get even more challenging gave American businesses a sense of liberation. Then the numerous rollbacks of environmental and financial regulations gave CEOs and other business leaders confidence to stretch their legs. Likewise the dismantling of an overbearing administrative state was an important factor in hastening the expansion of the 1920s. Many who doubt the potential for further gains in the stock market and U.S. economy should take note of these important similarities.

The Roaring Twen­ties were some of the most profitable for American and subsequently international corporations and led to massive gains in the U.S. and global stock markets. The present economic recovery may not be growing long-in-the-tooth… in fact, it may have just begun.

How the Markets Fared16

The bond markets have been mostly quiet on the high-quality end of the credit spectrum, returning a bit better than their coupons. More risk exposed markets like high yield and emerging market debt have fared much better. Part of the international story is related to the decline of the U.S. dollar since the beginning of the year (after a big rally post-Trump’s election).

17Globally, most developed market equity indexes returned another 4%-6%, bringing year-to-date gains into the 10%-20% range. There was no clear leader in Q3, with most indexes advancing similarly. For 2017 as a whole, however, international stocks have outpaced domestic indices by more than 4% and growth oriented industries have trounced more cyclically oriented value names by better than 10%. Small cap stocks have lagged a bit over large caps here in the U.S., the same is not true overseas, where they have outpaced their more multinational-focused larger peers.  Emerging markets equities  continue to dominate those in the developed markets, posting returns nearly double the U.S. indices.

PIERing Ahead

There is nothing new about this quarter’s report on the economy. We have been painting a rosy picture of business and consumer activity for nearly two years now. What is new is the lofty valuation of the U.S. stock markets. At nearly 18 times earnings, the S&P 500 is valued at 20% more than historical norms. However, if we are beginning an era similar to the 1920’s these valuations are com­pletely justifiable and may prove to be quite a good buying oppor­tunity. After all, if the market simply maintains its current valuations, once the S&P 500 adds another 15% to earnings (which is pres­ently predicted for the coming year), stocks could advance propor­tionately. If the global economy is just starting to heat up, we could have several more years of enhanced growth, thus leading to mean­ingfully higher levels in equities. As a reminder, stock prices better than tripled before the 1929 crash. Much of that appreciation was due to corporate earnings better than doubling dur­ing the decade of the twenties.

Eventually, speculation, over-deregulation and protectionism led to the 1929 crash and subsequent depression of the 1930s. If the coming years do, in fact, follow in the footsteps of the 1920s, the same boom and bust cycle may repeat itself. With high levels of Federal debt and an aging Baby Boomer generation that is starting to consume their wealth instead of adding to it, there are plenty of pitfalls ahead. And if companies do grow profits at elevated rates for the next few years, one can be certain that investors will be getting drunk on gains, leading to even higher valuations like we saw in 1999. It can be a fine line between economic optimism and financial hubris. Human behavior has shown time and time again that few are sober enough to notice when the line is crossed. So should we stay home from the party? Absolutely not! It may just be getting started. Just be sure to leave early enough to get home safe when things get a little too crazy.