1.2016–Russell 1000 Value +15.83% vs. Russell 1000 Growth +7.28%.
Since then, the iShares Russell 1000 Value ETF (ticker: IWD) has returned 17%, versus 9.1% for the iShares Russell 1000 Growth (IWF). The last stretch of significant outperformance for value ended in 2006, and it was a whopper. Value beat growth by double-digit percentages in five out of seven years, starting with the 2000 dot-com stock bust.
Trump, like Reagan is passionate about change, but he inherits a completely different America from an economic, military and globalization perspective.
Not sure if today’s stock market is overvalued? Warren Buffet uses a handy ratio that we’ll share.
Once the elections are over, root for whichever party is in office to make America thrive based on our underlying principles.
You’re not shy, you get around You want to fly, don’t want your feet on the ground You stay up, you won’t come down You want to live, you want to move to the sound Got fire in your veins, burning hot, but you don’t feel the pain Your desire is insane, you can’t stop until you do it again
— 1981 hit song, “Urgent” by Foreigner
It is neither my job nor my desire to comment on politics and elections. But, with our President- elect’s proposed policies being compared to Ronald Reagan’s, I feel the need to step up. As a financial and investment commentator, I thought it would be important to reflect upon the backdrop of Reagan’s America (1981) versus President-elect Donald Trump’s America today. This is not an opinion piece about whether or not Trump’s policies will work–I always root for America no matter which political party is in office. Whether or not I agree with Presidential policy rates is far less important than being a patriot who believes that America will thrive based on our underlying principles. It shouldn’t matter which party is in charge.
The world economic backdrop that Trump is walking into looks vastly different than the one Reagan inherited. Here we’ll discuss the many differences between 1981 and 2017 in terms of U.S. military spending, stock market valuation, interest rates, globalization and immigration.
When many people think of Reagan, the first thing that comes to mind is his legendary “tear down these walls ” speech and the collapse of the Soviet empire. Some would say the Soviet collapse was accelerated by Reagan’s military buildup, including the Star Wars program. But, remember, Reagan stepped into office during a post-Vietnam military drawdown that began with the Carter administration. By the time Reagan completed his second term, he had expanded the U.S. military budget by a staggering 43 percent over what the country had spent during the height of the Vietnam War!
Today, coming out of the post-9/11 war on terror, it’s a very different story. President Bush II ramped up military spending to $700 billion from $400 billion during his term and it was not until President Obama’s second term that we started to see a decline in military spending. Now it looks we’re going the other way (again). Trump wants more military personnel, more ships, more aircraft and enough Marines to fight two wars. But, he wants the money to come from “cuts in waste.” When it comes to government spending, cutting waste is much easier said than done.
National defense spending: Carter to Obama Administrations
Now let’s take a look at the financial markets of three decades ago compared to today.
Stock market valuation: 1981 vs. today
In 1981, Reagan’s inaugural year in office, the price-to-earnings (P/E) ratio of the S&P 500 Index was a historically low 9. By contrast, the market’s P/E ratio is about 26 today. Reagan entered office during the final phase of a secular bear market that began in 1966. By August 1982, the Dow had closed at its secular low of 776. Following a 1981-1982 recession, Reagan’s economy grew at a real rate of 16 percent. Compare that to today when real U.S. growth is plodding along at a paltry 2 percent almost a decade after the Great Recession.
With the stock market at its all-time high and the economy in slow-growth mode, is there still a relationship between the economy and the markets? Well, investing guru, Warren Buffet, uses a ratio comparing the economy (as measured by GDP) to the stock market capitalization to determine whether or not the stock market is overvalued . A ratio used to determine if a stock market is overvalued or undervalued. It is equal to stock marketcapitalization divided by gross domestic product times 100. The result of this calculation is the percent of GDP represented by stock market capitalization. A result of over 100 percent is a sign the market is overvalued. A result of 50 percent or less is a sign the market is undervalued. This shows the drastically different valuation during the two Presidents inaugural years.
When Reagan was elected, we were coming out of the 1970s when interest rates were a sky-high 20 percent and the big hammer Paul Volcker was just running out of ammo on the upside. Fast forward to today with rates bottoming near 2 percent. This is especially important because the overall debt in the U.S. economy was on a 30 year downtrend since the end of World War II when Reagan took office.
U.S. Treasury Bond interest rate comparison: Reagan vs. Trump
Debt as a portion of the U.S. economy: Reagan vs. Trump
According to Stephanie Pomboy of Macromavens, non-financial obligations now total 251 percent of our nation’s GDP. Compare that to a level of just 135 percent when Reagan came to office with $2 trillion of corporate debt coming due in the next two years . National debt in the chart below is over 100 percent of U.S. economy compared to 35 percent when Reagan kicked off his tax cuts.
Reagan took office at the end of an 80 year sideways move in immigration, while Trump takes over during a 25-year boom in foreign workers coming to our country. This boom means different things to different social classes. To some, the boom is a positive driver in terms of more educated talent, entrerprenurship and low-cost labor all in one. To others, the boom means competition for American jobs needed by our own long-time citizens. Reagan didn’t even have the immigration debate on his economic plate while Trump made it a key focus of his campaign.
Although both Trump and Reagan have burning hot fire in their veins for change , the economies they inherited have different urgencies. The major economic factors such as debt, interest rates and stock market valuations the two Presidents faced are not just different, they are polar opposites. It could be argued that Reagan kicked off globalization, but Trump is now dealing with a world economy that has added over a one billion people to the workforce, thus driving down wages and upending job safety in developed countries like the U.S. Again, I root for whoever is President to enact postive change for our country, but the economic canvas you start with is not blank. If Trump’s goal is to paint an economic masterpiece, then his vision will have to look very different from Reagans.
You say it’s urgent, make it fast, make it urgent Do it quick, do it urgent, got to run, make it urgent Wait it quick, want it urgent, urgent, emergency, urgent, urgent, emergency Urgent, urgent, emergency, urgent, urgent, emergency So urgent, emergency
— 1981 hit song, “Urgent” by Foreigner
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1.Read of the Day….Josh Brown with a Look at Why it’s Impossible to Time Markets Based on Fundamentals.
Candidate for Read of the Year.
The one thing you need to understand about stock market valuation
Published on December 19, 2016CEO at Ritholtz Wealth Management
Last week, we held our quarterly conference call for Ritholtz Wealth Management, in which Chairman and CIO Barry Ritholtz tackled a host of topics – from presidents’ impact on stock markets to interest rates to annual returns. The call was accompanied by our regular quarterly letter.
One section I found to be very helpful for clients had to do with the CAPE ratio and the concern that valuations on US stocks are elevated relative to history right now. Here’s what Barry and our director of research, Michael Batnick, had to say on the subject:
Let’s start with CAPE – the Cyclically Adjusted Price to Earnings ratio. Think of it as the 10-year P/E. It is high for US equities by historical averages, elevated for Japan, moderate for Europe, and low for emerging markets. If we wanted to scare people, we would selectively pull data out showing at present we have the highest reading outside of 2000 (43.2), 1929 (32.5) and 2007 (27.6). But we don’t cherry pick dates to scare people, instead we use data to look for evidence.
Since 1990, the S&P 500 has been trading above the average CAPE ratio during 307 out of 324 months – that’s a total of 95% of the time. If you exited US equities when the CAPE ratio was overvalued, you would have missed gains of more than a 1000% over that time. In fact, had you only invested when the CAPE was 25% overvalued – i.e. when stocks were “very expensive” – your total returns since 1990 would have been 650%. This is one of the many reasons why it is ill advised to use valuation as a timing mechanism.
The most we can really say about a higher than average CAPE is that when it is significantly above its long-term average, we should lower our expectations for future returns. When we look around the world, we see the United States is more expensive than Europe, or emerging markets, or Japan on nearly every single valuation metric. This should not be surprising, given how much the United States has outperformed other countries since the financial crisis ended in 2009. The good news is that our portfolio is exposed to global equities, and as the equity leadership shifts – whenever that might be – our portfolios will benefit from it.
Josh here – one interesting thing to keep in mind is that, while the CAPE for US stocks is currently 25.5, the CAPE for Europe is a more reasonable 15.6 and just 14.4 for Emerging Markets stocks. Additionally, the massive profit wipeouts from 2009, which are obviously biasing the ratio higher, will be rolling off in 2020. Finally, as Professor Jeremy Siegel has pointed out, we’re comparing apples to oranges to some extent, given the fact that the accounting treatment of earnings and losses has changed from one era to the next, which changes the composition of as-reported numbers.
Rather than dismissing valuation concerns out of hand, we prefer to think about them in the context of an overall asset allocation plan. For as long as you will be an investor, there will always be valuation concerns for one asset class or another.
If you’re interested in learning more about how we work with clients on their financial plans and investment portfolios, talk to us here: