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A Behavioral Approach to Investing

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40 Years Later - MMM v2-13

Tuesday is the 40 year anniversary of the assassination attempt on President Reagan. I remember this because it was on my 7th birthday. I of course feel terrible for my selfish feelings of 'my day' being ruined by all the adults only wanting to watch news coverage of this and not celebrate me. Hey, I was 7 and didn't understand how serious this was.

For the last 10 years I've been taking a look at the economic legacy of President Reagan. I do this because so many Republicans cling to this idea of "Reaganomics" as being the gold standard of economic policies. The problem is the "idea" of small government, free market capitalism, and no government interference is not what was actually implemented during the Reagan years.

Don't get me wrong. I think Ronald Reagan was one of the greatest presidents of all-time. He took over a nation and a world in chaos and figured out a way to find solutions with a divided Congress. He was a true deal maker who made difficult decisions. I've said for a decade I do not think he or Bill Clinton could win their parties primaries in today's environment. The leadership in their parties are far too right and left to accept such moderate candidates. Nothing in this article is meant to be a slam against President Reagan, but rather a look at the data behind "Reaganomics" and the legacy it has left on our economy.

This chart plots the changes over the past 40 years in some key indicators. The legend on the left ranks each by where they were at the end of 2020.

Huge Increases in Spending and Government Debt

By definition, "small government" should lead to less debt. Instead, President Regan oversaw the largest percentage increase in government debt of any president since the end of World War II (what economists refer to as the modern era.) He also oversaw an 8 year increase in government spending of 69%. This was only surpassed by the 83% increase we saw during President Trump's 4 years in office. To be fair to President Trump, spending increased 17% during his first 3 years in office. The spike came during the COVID19 "stimulus" bills he signed.

An Addiction to Debt

It wasn't just government debt that has exploded the last 40 years. This chart shows the various levels of debt along with GDP (the dashed line). I marked 1981 on the chart. As you can see at that time our country actually had less overall debt than our economy was producing. The other line marks 2008. You can see the exponential increase in debt between 1981 and 2008, followed by a reset in economic growth. We've since seen another exponential increase in the growth of debt while the trend growth in GDP has been reduced.

Corporate Friendly Policies

We also saw a big change in the business environment. In the quest to compete with Japan President Reagan pushed to make it easier for corporations in the US. Lending standards were relaxed, regulations reduced, and major tax breaks were given to the largest corporations. This helped provide a big boost to the S&P 500, but we also saw a very large increase in corporate debt levels. At the same time the Federal Reserve took a major role beginning in 1998 with their bailout of the banks exposed to Long Term Capital Management, a firm who had borrowed so much money from the Wall Street banks to make risky bets it risked collapsing several of them.

Since then we've seen several more bailouts. It seems we are in an environment where there is capitalism on the way up and socialism on the way down. Ironically this morning we are learning of another hedge fund creating large losses at a couple of big banks. Once again they lent way too much money to a firm who took it to make risky bets.

The use of debt to boost the flow of funds to corporations has created much bigger swings in stock prices the last 30 years. This chart from Advisor Perspectives highlights the correlation between the two. On average, margin debt peaks 2-3 months before the stock market. Typically you see margin calls as the riskiest bets collapse. Time will tell if the news this morning is the beginning of the end for this bull market.

Weak Economic Growth, Few Quality Jobs

The push to beat Japan started by Reagan led to a widespread move towards globalization. The drive was to make as many products as cheaply as possible. This meant outsourcing the high paying manufacturing jobs and sourcing most of the components from countries who didn't have the same labor standards as the US. Ironically, Reagan's quest to beat Japan created a much bigger economic opponent – China.

The profits from corporations did not "trickle down" to the rest of the economy. Large corporations got bigger, shareholders got richer, but the average American has stagnated. While the S&P 500 has gained 9% per year the last 40 years, Personal Income has increased a mere 4% per year. This has compounded to a very large divide.

GDP over that time has grown at 3.3% per year.

This chart summarizes the changes over the past 40 years:

Dual Deficits a Drag on Growth

While GDP averaged 3.3% over the past 40 years, we have struggled to hit that number.

In the 21st century we have only exceeded the long-term average growth rate in 7 quarters.

Notice the long-term trend (the dotted line). Before the 1980s, for the most part any profits generated by corporations in the US stayed in the US. The components were made in the US. When we have a trade deficit the money spent in the US leaves and goes to other countries. This chart looks at the GDP components. Our trade deficit has been subtracting about half a percent from GDP over the past 30 years.

Now combine that with our heavy debt load. Some of the income has to be used to pay back the money borrowed, plus interest. This has been and will continue to be an issue in the US.  The money borrowed for the "stimulus" bills will not be as effective because the money will not be reinvested in the US, but rather to purchase foreign goods. It will also be used to pay back money already spent, plus interest.

Only 2 Ways to Grow

One of the economic tenants that cannot be changed by any president is the way our economy grows over the long-term.

Any economy comes down to two questions – how many people are working and how much are they producing?

Any spending bill should consider if it:

a.) increases the labor force and/or

b.) makes workers more productive

If we are simply giving people money to spend (whether via direct deposits or tax breaks) and not incentivizing a and b above, it is a waste of money and will create additional drags on growth in the future.

It's as simple as that. All things equal, the long-term growth rate of the economy should be the sum of the growth in productivity and the growth in the labor force. When it doesn't it is because money is leaving the system (via our dual deficits). Adding to the deficit AND not addressing the 2 key questions only makes it worse.

Reagan may have started the trend, but every president from both parties has continued it. This is not a POLITICAL statement, but an ECONOMIC one. Neither party has been "great". Both have added to the problem.

As Americans we need to put aside our ideological beliefs that we need to get back to the policies of President ____________. The data is clear. None of them have worked. They have all made our situation must worse.

I'll continue to offer my services to any Congressional representative that wants to look towards the future with their economic policies. I've made the offer for 10 years and have yet to hear from anybody. Feel free to pass my contact information along to your representative.

Market Update

As for the markets, our tactical systems moved to a cautious stance a few weeks ago. They remain there. The dynamic systems are also cautious and skeptical about the strength of the recovery, especially after the lackluster economic activity in January and February (which followed the second round of "stimulus" payments in December). Our strategic systems will reallocate next week. They sold large cap growth in both October and January to buy mid-cap and small-cap stocks. So far it looks like they may do a bit more of that, but we'll see what this week brings.

In general, the extreme valuations and wild swings are not a sign of a healthy market. Caution is warranted. If you received a stimulus payment, I would encourage you to pay down any debt, rebuild your emergency fund, and invest the money. Don't spend it on something that will lose value. Tougher times are ahead economically, which will not bode well for the stock market.

The government may not have any fiscal discipline, but that doesn't mean you shouldn't.


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New Kent, VA
Jeff joined SEM in October 1998. Outside of SEM, Jeff is part of the worship team at LifePointe Christian Church where he plays the keyboard and bass guitar. He also coaches a club soccer team.