Eerie Parallels: January 2018 - January 1987

                             "History doesn't repeat itself but it often rhymes"
                                               Attributed to Mark Twain

The amazing run of stock prices since the start of the year has me thinking about a similar rise in January 1987. Thus far this month the S&P 500 is up 7.5%, not as extreme as 13.2% gain recorded in 1987, but nevertheless quite a move. We all remember what happened after that as stocks continued to a gain of 39% by August, but to give it all back and then some by October. From peak to trough the S&P 500 declined by 33%. However by year end the index ended up for the year by a nominal 2%.

The parallels to 1987 look striking when we look at the economic back drop then and compare it to today. Because history rhymes I will also note a few striking differences.

                                               Simlarities

Indicator                                     January 1987                     January 2018

S&P 500                                       +13.2%                               +7.5%*
Extended Bull Market                Started 8/82                     Started 3/09
Computer Trading                      Portfolio Insurance         Algo Trading
Economy                                    Strengthening                      Strengthening
Profit Growth                             Accelerating                         Accelerating
Dollar                                         Weakening                           Weakening
Oil Prices                                    Up from lows.                     Up from lows
Inflation Rate                             Increasing                            Increasing
Fed                                             Tightening                           Tightening
10-Year Treasury Yields            Bottoming, about to rise    Rising       
Pro-Growth Tax Reform            1986 Tax Act                     2017 Tax Act
Trade Tensions                           Japan/Germany        China/NAFTA
White House Scandal                Iran/Contra        Russian Interference

                                                 Differences

Europe                                        Uniting                                   Dividing
Big Power Rivalry                      Declining                               Increasing
Shiller CAPE                               14X                                        35X

*-As of January 26.

To me the parallels to 1987 are too striking to ignore. So if 2018 stock market rhymes anywhere near its 1987 history we should see a continued advance in stock prices through the summer with the S&P 500 rising well above 3000 and then a severe decline thereafter with stocks ending the year with a modest gain. Fasten your seat belts; it's going to be a wild ride.

Why is the Economy so Strong?

Forget about the below consensus 2.6% increase in real GDP for the fourth quarter. Looking under the hood we find that final sales to private domestic purchases, which takes out the effects of trade, inventories and government, increased at a very strong 4.6% annual rate. Growth was propelled by a 3.8% increase in consumer spending and an 11.4% increase in equipment spending.This follows two quarters of 3% real growth. Simply put the economy is hot and the bond market looked through the headline number and declined. Moreover inflation as measured by the deflator for personal consumption expenditures increased at 2.8% well above the Fed's target and services inflation ran at a very hot 3.1%.

What accounts for this strength after years of so-so 2%  growth? In my opinion it represents a combination of the lagged effects of the extraordinarily easy monetary policies of the past decade, a rebound in the global economy, the deregulation policies of the Trump Administration and the prospect of major tax cuts that were enacted at the end of the quarter. It is not only the deregulation policies, but also businesses no longer live in fear that new regulations will not come from out of the blue as was the case under the Obama Administration. Thus of a sudden capital spending is exploding witnessed by the very strong gain in equipment spending.

Further we appear to be in a self reinforcing cycle of rising stock prices working to push up both consumer and business spending. Nevertheless the party won't go on for too long as the economy is running out of labor in an environment of low productivity growth and that will further increase inflation and lead to more Fed tightening that the market now expects.

My Amazon Review of Tim Harford's "Fifty Inventions that Shaped the Modern World"

The Making of the Modern Economy

Financial Times columnist Tim Harford has written a very enjoyable book about the inventions the brought about today’s globalized economy. At the outset he pays tribute to science historian James Burke who brought us “Connections” the late 1970s BBC series on the history of science.

As the title notes Harford discusses the origins and the implications of 50 inventions. I note ten of them below to give you a sample:

·        Barbed Wire – Established the practically of legal boundaries in the American West.

·        The Pill – Enabled female sexual autonomy that opened the way for women to enter the professions in the 1970s.

·        The Dynamo – The broad transmission of electrical energy.

·        The Shipping Container – Without which global commerce would be a shadow of its current self.

·        The Elevator – Perhaps the foremost mass transit invention that enables dense cities.

·        Double- Entry Bookkeeping – The way measure and control

      the efficacy of enterprise.

·        The Limited Liability Company – Enables risk taking on a grand scale.

·        The Compiler – Enables computers to be programmed in English (well sort of).

·        Property Registry – Converts land into tradeable capital.

There are, of course 40 more and Harford tells the story of all of them in a very breezy style. The chapters are short and that makes the book easy to put down and pick up with ease.

To sum up I highly recommend Harford’s book for lay readers, history buffs and economists alike interested in getting a better understanding how our world came to be.

The complete Amazon URL appears at: https://www.amazon.com/review/R1S73ESGPG95DZ/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Douglas A. Irwin's "Clashing over Commerce: A History of U.S. Trade Policy"

Trading Places

Dartmouth economist Douglas Irwin has written a very long (832 pages in the print edition) and sometime tedious history of U.S. trade policy, but in many respects it is a tour de force. In a way he is writing American history through the lens of trade. His history starts with the economic impact of the French and Indian War’s (The Seven Years War globally) on Britain’s fiscal and colonial policy. The Boston Tea Party was the result. After independence and the chaos caused by the failed Articles of Confederation one of whose attributes were tariffs among the states a new constitution was written that centralized trade policy within the national government. In fact the second law enacted by the first Congress was a tariff. It was needed to fund the government. Thus Trade policy is as old as the Republic.

Irwin divides his history into three eras: tariffs for revenue (1789-1860), tariffs for restriction (1861- 1933) and tariffs for reciprocity (1934-Present?). Initially export oriented (cotton and tobacco) South favored low tariffs (for revenue only) and the North supported tariffs to restrict imports as well. Given that geography Democrats were for low tariffs and Whigs/Republicans were for high tariffs. By the late 20^th century the two parties traded places with Republicans favoring open trade while the Democrats became far more restrictionist. Irwin tells his story by going into the details of all of the major congressional debates on tariff questions. Sometimes this is very interesting and sometimes it gets a bit tedious, but it is history in the making.

The first real battle over trade took place in the 1820s where the political genius of Henry Clay pushed through a restrictive tariff which both protected northern industry and raised revenue to fund internal improvements. That was his American System. By 1832 led by John C. Calhoun the South rose up in protest against what he called the Tariff of Abominations and introduced the doctrine of nullification. Irwin notes that the fight over the tariff became a proxy war over slavery. Nevertheless, with the Southern Democrats largely in control tariffs were largely used for revenue only prior to the civil war.

With the Republicans coming to power in 1861 the tariff was first used to raise revenue to fund the civil war and afterwards to restrict the entry of foreign goods into the United States.  Irwin found no real evidence the high tariff policies of the Republicans promoted economic growth. This was due, in part, to the economy being wide open to immigration and technology transfers. It was also helpful that the U.S.’s leading trading partner was Britain which then had a zero tariff policy. It is unfortunate that Irwin did not note that the success of textile manufacturing in New England was due to stolen technology from Britain.

Although the Republicans were in the high tariff camp, both Presidents Garfield and McKinley in his second term were open to reciprocity. Unfortunately both were assassinated before they could implement their new ideas.

After growing unrest with the high tariff policies of the Republicans which were thought by the Democrats to promote monopoly and act as a tax on consumers, the new Wilson Administration moved swiftly to lower tariff. Irwin highlights how Wilson was very hands on in working with Congress to pass the Underwood Tariff which significantly lowered import duties. Something else was going on as well. The U.S. was becoming a major exporter of industrial goods. This was due to the discovery of huge iron deposits in the Mesabi Range of Minnesota which made the U.S. the world’s lowest cost producer of steel.

However after World War I and the Republicans returned to power tariffs were raised dramatically in 1923 with the Fordney-McCumber Tariff. That was followed by the Hawley-Smoot Tariff of 1930 which raised the already high tariffs by 15%. Irwin debunks the idea that the Hawley-Smoot Tariff caused the stock market crash and the depression. It did, however, exacerbate the global collapse of the early 1930s.

With the arrival of the Roosevelt Administration tariff policy takes a U-Turn. Secretary of State Cordell Hull established a policy of reciprocal trade, first with Latin America and then with the rest of the world. If anyone person is a hero in the book it is Cordell Hull. Under the leadership of state department official Will Clayton, the Truman Administration follows up deal by deal reciprocal trade agreements with broad multinational agreements(GATT now the WTO).

By the 1970s the parties traded places. The Republicans supporting trade in financial services and high technology products become free traders, while the labor oriented Democrats fearing the loss of union jobs become protectionists. Further the long free trade oriented South, switches sides as its textile manufacturing business come under stress. All of this came to a head with Democrat Bill Clinton supporting NAFTA against a majority of his party. NAFTA passed with Republican votes, but the fissures the battle engendered made Americans more suspicious of trade deals.

Those fears bore fruit with the leading Democratic candidates in 2016 opposing the Trans Pacific Partnership along with Donald Trump. Now with a protectionist in the White House and a protectionist Democratic Party it appears that the long era of reciprocal trade might be behind us. Irwin thinks there is too much momentum and it took the Civil War for policy to transition from revenue to restriction and it took the Great Depression to transition for restriction to reciprocity. My question is whether the Great Recession was another such trigger. I hope not.

In sum Irwin’s book is a long slog, but for those serious about how our trade policy came to be, it is well worth the effort.

For the full Amazon URL see: https://www.amazon.com/review/R3U5XU27SA6HNX/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

E-Commerce Dominates Holiday Sales

Although brick and mortar retail had a much better than expected holiday sales season, e-commerce dominated the retail scene. Between October and December e-commerce accounted for 49% of the growth in seasonally adjusted total retail sales and 60% of the growth in its addressable market (Defined as total minus autos, gasoline and food services and bars). What this means is that more store closings are on tap as traditional retail reconfigures its store base to account for the growing competition.  Needless to say this eventuality will not be helpful for the struggling mall REITs. The data are below:

                                            In  $ Millions

Category                     October       December      Change

Total                              489,468        495,381        5,913

Less: Autos                    102,794         102,060
          Gasoline                 39,322           40,497
         Rest. & Bars            56,884           57,549

Addressable Mkt.            290,468          295,275      4,807

Non-Store Retail                52,677            55,562      2,885

Non-Store Percent of Total Change  - 49%
Percent of Addressable Change        -  60%

Too Soon for the Democrats to Break Out the Champagne

All of the signs are now pointing to a Democratic wave election this coming November. Both the President Trump and the Republican Congress are in the doghouse in terms of poll numbers and 2018 is looking like a mirror image of the Republican sweep in 2010. For example in the 2009/10 period the Republicans took the governorships in New Jersey and Virginia and won a surprise victory in the special election for a Senate seat in Massachusetts. This year the Democrats won in Virginia and New Jersey and won a special election for a Senate seat in very red Alabama. Moreover the Democrats passed Obamacare with a straight party-line vote and this year the Republicans passed a massive tax cut on a straight party-line vote.

So what's wrong with this picture? Unlike 2010 when the economy was in the dumps the economy appears to be entering a boom phase. The unemployment rate in November 2018 will approximate a very low 3.5%. Moreover the expectations for the Trump tax cuts are so low that most voters will be pleasantly surprised when they see the tax cuts in their pay checks in February and the real pain on the limitation of state and local tax deductions won't show up until tax filing time in 2019. Thus the Republican poll numbers have nowhere to go but up.

Of course we shouldn't under-estimate the ability of the Republicans to screw up. For example Trump could blow up NAFTA triggering a stock market drop and increasing the likelihood of a recession in 2019. And over all of this looms the ongoing Mueller investigation of the 2016 election and likely a host of irregularities in the Trump Organization.

As a result the Democrats will make big gains in the House of Representatives, but whether it will be  enough to take control remains to be seen.

My Amazon Review of Victor Sebestyen's "Lenin: The Man, the Dictator, and the Master of Terror"

Paving the Way for Stalin

Victor Sebestyen has written a masterful biography of V.I. Lenin in which he covers both the personal and the political. On the personal side it is obvious Lenin, the son of an upper middle class family was no proletarian. His tastes and lifestyle strived to be middle class. Although he lived austerely he was very sensitive for the need for creature comforts. He enjoyed mountain walks and hunting. He also skillfully managed his very socialist ménage a trois with his wife Nadya Krupskaya and his 10 year mistress Inessa Armand.

However it is on the political side where Lenin becomes a man of history. He was strategically inflexible in pursuing a socialist dictatorship for Russia, and oh did he succeed. Nevertheless on the tactical side Lenin was extraordinarily flexible and was willing to be expedient to further his strategic goals. He could be for democracy and against democracy, he could hate the Germans and then become their ally, and when “war communism” failed he flipped and supported the proto-capitalist New Economic Program (NEP). All of this was in the service of his communist dictatorship.

Sebestyan clearly portrays how Lenin paved the way for Stalinism. It was Lenin who created the Cheka (forerunner to the KGB) with its terror cells for political opponents. It was Lenin who initiated the forced grain requisitions from the peasantry and made villains out of the better off by calling them Kulaks. Stalin would kill millions of them a decade later. It was Lenin who attacked deviations from the Left and the Right turning those into anti-party enemies. And it was Lenin who showed no mercy when he crushed the Kronstadt sailors rebellion. All of this was in place by 1924, the year he died. All Stalin had to do was to refine it and make a cult out of Lenin in whose name he ruled.

On two minor notes, I am glad that Sebestyen highlighted the role of the Russian feminist Alexandra Kollontai as one who was very close to Lenin and was in the room when the decision was made to overthrow the Kerensky government in October 1917. I did catch one error in that Sebestyen described Armand Hammer as an oil magnate when he entered into deals with the Soviet government under the NEP. True Hammer was an oil magnate, but that came much later. In Russia he sold pencils.

All told Sebestyen has told the story of a personality whose iron will made Soviet communism possible. For reader interested in learning more about this period in history I would suggest the Stephen Kotkin biographies of Stalin.

For the full Amazon Review see: https://www.amazon.com/review/RD5VLEG2EEQ64/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv