“Glory days, well, they’ll pass you by
Glory days, in the wink of a young girl’s eye
Glory days, glory days” (Bruce Springsteen)
Glory Days for Investors: 1982-2016
Ronald Reagan and Paul Volcker helped plant the seeds for more than 30 years of growth in the stock and bond markets. Despite two steep equity market corrections in the 1990s, the S&P 500 Index (with dividends reinvested) provided double-digit annualized returns during the multi-decade rally. Bonds also rallied strongly, providing significant price appreciation as 10-year U.S. Treasury yields declined from double-digit to low single-digit levels.
American presidents typically receive too much credit for bull markets and too much blame for bear markets, but Reagan’s tax cuts and easing of regulatory burdens helped provide a market-friendly foundation for the U.S. economy. Federal Reserve Chairman Volcker’s actions were as controversial as Reagan’s economic policies, as the Volcker Fed took unpopular steps to reduce inflation. The “Volcker recession” caused unemployment rates to reach double-digit levels, but created a steep and sustainable decline in inflation. Investors also benefited from favorable demographics, with baby boomers at peak earning and spending years, as well as from increasing global trade. The “peace dividend” experienced during the 1990s after the fall of the Berlin Wall also provided a boost to markets.
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‘One Step Up and Two Steps Back’ (Springsteen)
However, investors now face less favorable investment conditions, as many of the positive factors from past decades are slowing or reversing.
Inflation and interest rates: The Fed took extraordinary actions to prevent the U.S. economy from falling into a deflationary spiral. After several years of monetary stimulus, inflation is finally approaching the Fed’s 2% target. At current levels, there is more of a risk associated with rising interest rates and inflation than potential benefit from a decline in either.
Aging of the baby boomers: At the start of this decade, the ratio of Americans aged 20-65 to Americans aged 65 or older was more than 4.5 to 1. By 2030, the ratio is projected to decline to less than 3 to 1. Absent significant policy changes, the aging of the baby boomers will create significant budget challenges. Mandatory outlays, including entitlements such as Social Security, Medicare and Medicaid, are projected to exceed 80% of federal revenues by 2030. When interest costs are added to mandatory spending, the cumulated spending commitments are projected to be nearly 100% of federal revenues by 2030.
Geopolitical threats in a multipolar world: Terrorism is a continuing threat, and is compounded by anarchy in “ungoverned” states in the Middle East and Africa as well as the nuclear ambitions of North Korea and Iran. The rise of China and the expansionism of Russia create heightened risk of superpower conflict, after an extended period in which the U.S. was the dominant superpower. Consequently, defense and security spending is likely to rise in coming decades, making the peace dividend of the 1990s a distant memory.