Valuation-Informed Indexing #182
by Rob Bennett
Barack Obama is having a rough presidency. That’s not a partisan statement. Most Democrats would agree.
All sorts of explanations have been advanced. His enemies say he is not up to the job. His friends say the problems troubling us as a nation are just too darn complex and Washington has become just too darn partisan to overcome them.
I believe it is more simple than that.
I believed on the day that Obama was elected that his presidency was all but doomed. Not because of any personal deficiencies of his. Because of the P/E10 value that applied at the time he came into office.
Shiller’s revolutionary (his word) research showed that valuations affect long-term returns. That means that long-term returns can be predicted. When prices are very high, they are headed downward over the course of the next 10 years or so. When prices are very low, they are headed upward over the course of the next 10 years or so.
At times when valuations are on the increase, spending power is being pumped into the economy. At times when valuations are on the decrease, spending power is being removed from the economy.
Voters care about economic results more than anything else. Any President who serves at a time when valuations are on the way downward struggles against a headwind. Any President who serves at a time when valuations are on the way upward enjoys a strong wind at his back. P/E10 values alone don’t determine which presidencies succeed and which one fail. But they can be a big factor.
P/E10 values were high through most of the 1960s. They first dropped below 20 (the beginning of the danger zone) for a brief time in 1966 and then again in June 1969. Both the Kennedy and Johnson presidencies were generally viewed as successful. The Vietnam War was a non-economic factor that served to bring Johnson down in the end. But the feeling that economic times were good supplied him with enough political capital to push a good deal of major legislation through the Congress.
I would describe the first term of the Nixon presidency as being at least to some extent an exception to the general rule that I am trying to advance here. When Nixon came into office, the P/E10 value was 21. That’s very much on the high side. In November of 1972, when he was reelected in a landslide, the P/E10 value was 18. That’s still a high number. But it is not as high and there were a good number of moderate P/E10 values recorded during those years (a 14 in 1970, a 16 in 1971). The theory here is that dropping P/E10 values take money out of the economy and cause it to falter and ultimately collapse. In this case, it seems that the faltering began prior to the reelection campaign but that the fear of collapse had not become serious enough at the time the vote was taken for Nixon to suffer its ill effects.
He suffered ill effects of accelerating drops in P/E10 values big time in his second term, however. We went from a P/E10 value of 19 in January 1973 to a P/E10 value of 13 in 1974, and of 9 in 1975. Many historians note that it was the bad economy of the early 1970s that caused Nixon’s base to abandon him in his Watergate struggles. Had it not been for the high P/E10 value that applied when he was reelected (and which suggested a loss of consumer spending power up ahead), his odds of weathering the storm he brought on himself with his ethical violations might have been improved.
President Carter never for one day enjoyed a high P/E10 value. He came into office with a P/E10 value of 11. He left office with a P/E10 value of 9. It might be that the fellow never stood a chance. Presidents who serve during the sorts of economies associated with those sorts of P/E10 values are not ever popular.
President Reagan may well have been an economic genius. But the full truth here is that he enjoyed a good bit of luck to come into office when the P/E10 value was 9. That’s a bad number, of course. The good thing about coming into office at a time when the number is bad is that it has nowhere to go but up. And, sure enough, the P/E10 value had zoomed to 15 by the time Reagan completed his second term.
The P/E10 number was actually on the low side for most of Reagan’s presidency. The important thing, though, is not whether the number is low or high, it is whether it is rising or falling. When the P/E10 value holds steady, investors are enjoying gains of 6.5 percent real per year. So consumer spending is increasing in that scenario. It is only when the P/E10 value is dropping hard that consumer spending power is being destroyed and presidents are finding themselves in trouble in the polls.
The first Bush presidency started with a P/E10 value of 15 and ended with one of 20. So Bush should have been in good shape. Perhaps it was that Ross Perot wild-card factor that threw things a bit off!
If a falling P/E10 value magnified Nixon’s scandal problem, it may be that a rising P/E10 value saved President Clinton’s neck. His presidency saw the P/E10 value rise from 20 to 44. Yikes! If you started out your presidency knowing that you would be enduring an impeachment proceeding, you would dream that it would take place in that sort of P/E10 environment.
The P/E10 value had nowhere to go but down when the younger Bush took office. He was in a strange situation. The P/E10 values that applied through his presidency were very high numbers. But they were low compared to the number that applied when he came into office. So the economy was being pumped up but to an increasingly diminished extent. Bush enjoyed great popularity in his early years but left office with an exhausted presidency.
President Obama entered office with a P/E10 value of 15. In different circumstances, that could be a very good sign. A P/E10 value of 15 suggests a lot of upside potential. The trouble for Obama is that we never see P/E10 values turn upward during a secular bear market until they have hit a low of 7 or 8 and we remain today at least one price crash short of those targets. So, while the P/E10 value has risen all the way to 26, the increase in spending power has not been enough to make investors and consumers forget the even higher P/E10 values we saw during the wild bull. The feeling that the biggest bull in history is going to end badly still prevails and it is my assessment that it will continue to prevail until we achieve the capitulation that can only come from a P/E10 value of 7 or 8.
If valuations come down before the next President takes office, he (or she!) will be blessed with the best possible start to a presidency, a P/E10 value that is headed upward for the long term.