John's bio | Tweet
The disinflation we have experienced in our economy from 1982-2007 (until what I call the silent inflation of the last couple years turned into a more evident broader inflation in recent months) has been in my opinion one of the major underpinnings of the long term bull market in equities during much of the former period. This time was punctuated by the 1987 crash and the 2000-2003 post bubble era bear market. In addition, the lower regulation and non interference with the economy ushered in by the Reagan administration over two decades ago created an atmosphere conducive to investing in stocks and bonds - not to mention Paul Volker of the Federal Reserve Board being determined to successfully break the back of the 1970's embedded inflation.
In contrast to the buoyant 1980's - 1990's, stocks went nowhere between the 1966 beginnings of Vietnam war era inflation through the 1970's until 1982, sixteen long years later, when the Dow Industrial average finally pierced through its old 1966 high. Economic policies such as excessive regulation, artificial wage and price controls, and poor general economic conditions were anathema during the 70's to stock and bond investments. For example, many long term bonds my family held back then (bonds were usually thought to be a safe haven for investments), lost almost half their value as interest rates soared skyward into double digits in the late 70's..
We have experienced after the post 2000 bubble bear market, a bull market in equities starting in 2003, a multiyear ascent in the share prices of oil and oil service firms and more than a doubling of the gold price. No one seemed to notice until recently that the gold price, oil price and oil service share price increases are to a strong degree the same behaviors experienced during the 1970's, the last heyday of economic inflation. If you have been invested in these inflation hedges in the last few years, you likely have benefited from a reflation of asset hedge prices. I have been pointing to those similarities between the 70's and recent times for over a year on my website article blog.
Oil prices recently exceeded a level approximately equal to the inflation/adjusted high achieved during that last heyday - many commentators and pundits today are only now sounding warnings that the enemy of the stock market, inflation, is rearing its ugly head for the first time in recent memory. There seems to be today less sensitivity to inflation than three decades ago (those whose mortgages are not subprime and who bought their homes earlier still may have booked housing price gains - they may have extra dollars to absorb price increases of goods and services). There is also little current reflection on how inflation in the past has affected stocks and bonds which has allowed this stock market to propel upward until recently in the manner of a false illusion. Remember, increased inflation pushes up interest rates, which in turn puts pressure on paper assets such as stocks and bonds. That the Federal Reserve is now lowering rates vigorously in the face of the subprime and credit crisis may jolt the stock market upward until the resulting greater inflation may take hold down the road.
Politicians recently have also spoken of dramatically increasing the taxes on private equity deals and capital gains - which, if enacted, would pull a leg out from this stock market. It might be likely to see policies hostile to stock investment enacted should Senator Clinton or Obama come to power after the next election. In fact, we could return to the same type of regulatory morass and high tax policies that caused so many problems in the 1970's. This would not bode well for the stock market and for industries regulated and re-regulated by a Democratic administration for the first time in a generation.
Speaking of the coming election, the Iowa Electronic Markets (a kind of presidential futures market) has a good record of anticipating future presidential election winners. It is run by the faculty of the business school at the University of Iowa with bettors wagering real money. The current quote is showing a Democratic victory in 2008, as shown on the Iowa Electronic Markets website; see at http://iemweb.biz.uiowa.edu/graphs/graph_Pres08_VS.cfm.
It is possible that the stock market will decline as the presidential election approaches and the market anticipates the probable democratic winner of the election. I think it is important to realize that if we do return after 2008 to the decades ago battered policies of regulation, re-regulation, trade tariffs, or the socialization/government takeover of the healthcare sector - I think the stock market could experience a contraction of price/earnings ratios reflecting those policies. The combination of an increased inflation and the politics of regulation could result in a stagflation last experienced decades ago. Should the next administration be elected on a left leaning platform, but moderate their policies to the political center, we could be spared a bear market in the economy and stocks. A McCain presidency would likely be a positive for stocks.