Beware the Obama Stock Bubble

Ronald Reagan’s presidency will be remembered for many achievements, one of which was to break the so-called Tecumseh’s Curse.

Starting in 1840 with President William Henry Harrison—who some years previously had fought in a battle in which the great Native American chief was defeated—every American president elected in a year ending in zero died in office. Seven such presidents later, Reagan—who, at nearly 70 years of age, became the oldest man to move into the White House, and survived an assassination attempt—nevertheless completed his two terms. Since then, George W. Bush, elected in 2000, also served eight years, confirming that the old spell had been broken.

But Reagan may have started a new curse that dogged him and then every other president elected for two terms thereafter. Every two-term president since Reagan has followed the same pattern, assuming the presidency in a business downturn or even severe recession inherited from his predecessor, then presiding over a recovery or strong economic boom and ending up with a financial bubble that burst not long before he left office. Barack Obama is now in danger of following in their footsteps.

Early Warning

When Reagan was elected president, inflation was running at a double-digit pace with little precedent in U.S. economic history. It was combined with the highest rate of unemployment in the post-World War II era and, to use Jimmy Carter’s words, a “crisis of confidence” (in what is remembered as the “malaise speech”).

(Check out Marc Faber: 3 Reasons a Crash Is Coming on ThinkAdvisor.)

Economic reforms implemented during the Reagan era jump-started the economy and freed it of excess government regulations and oversight. The stock market, which had been in hibernation throughout the 1970s, took off. Starting below 800 in mid-1982, the Dow Jones industrial average broke through the 2,000 mark in early 1987, representing a 150% gain for investors in four and a half years.

Then, almost a year before the 1988 presidential election, the Dow suffered its largest one-day drop in history, falling 22.6% on Oct. 19, 1987. It was a carnage that raised the specter of 1929, and many analysts feared a rerun of the Great Depression scenario. However, the seemingly catastrophic market drop proved to be a non-event as far as the real economy was concerned. Alan Greenspan, recently appointed chairman of the Federal Reserve, pumped extra liquidity into the markets. The bottom held, economic activity didn’t stall and by early 1988 shares began to recover. Even though it took two years for the Dow to return to its pre-Black Monday’s levels, the market meltdown had no major impact on the U.S. or global economy.

However, it proved a harbinger of events to come, presaging the boom-bust pattern in financial markets that has bedeviled two-term presidents ever since. After George Bush, president 41, failed to win a second term, Bill Clinton’s presidency began in the midst of an economic downturn, though it was milder and less entrenched than what Reagan had faced.

Dot-com Debacle

Once again, the economy righted itself under a new president. The technology revolution created what was then known as a “new economy,” resulting in an entrepreneurial boom on the Internet and a labor shortage. On the strength of this economic performance, Nasdaq rose sevenfold in only six years, to over 5,000. But after reaching a peak in March 2000, the dot-com bubble burst spectacularly in the final year of Clinton’s presidency. The tech index went down to nearly 1,000 by late 2002. By then, the Dow had also come off the boil, ending the market’s longest bull run.

Enter George W. Bush, president 43, who was elected in time to deal with the economic mess produced by the bursting of the market bubble. The economic downturn was exacerbated by the Sept. 11, 2001 terrorist attacks, but by 2003 a combination of massive tax cuts, easy monetary policy and government spending on military operations and domestic security got the economy back on track.

Growth soon became robust, stoked by the residential housing sector, which allowed consumers to supplement their incomes with cheap and convenient borrowing against the accumulated equity in their homes. That seemed like yet another El Dorado, since everyone knew that house prices never go down and that homeowners rarely default on mortgages.