Almost as soon as Donald Trump entered the race for President, some pundits began comparing him to Ronald Reagan. Just enter “Trump and Reagan” into your favorite search engine and you’ll have enough reading material to last a lifetime.
You can see why the comparison is so tempting. Like Reagan, Trump is a B-list entertainer turned politician. Like Reagan, Trump will be 70 years old during his first year as President. And like Reagan, Trump was behind in the polls in the final weeks of the race but rallied to win the White House.
Trump, like Reagan, will also inherit some economic challenges. Reagan had to deal with stagflation – the nasty combination of high inflation and high unemployment that plagued much of the 1970s. Trump will have to wrestle with a U.S. economy that has failed to keep pace with its long-term growth rate since the 2008 financial crisis.
Which brings me to another similarity. Trump, like Reagan, hopes to kick-start the U.S. economy through a combination of aggressive tax cuts, regulatory relief, and an increase in military spending (and, in Trump’s case, an increase in infrastructure spending as well).
Many Americans remember Reagan’s presidency as a golden age of economic prosperity and rising household wealth. Given the similarities between Trump and Reagan, some are no doubt hopeful that Trump will be able to recreate the Reagan era.
There is one big difference, however, between the environment that Reagan inherited and the one that Trump now inherits. And it’s a crucial difference. Namely, Reagan took office when US asset prices were at extreme lows, whereas Trump will take office when asset prices are at extreme highs.
Take a look, for example, at U.S. stocks. According to data compiled by Nobel laureate Robert Shiller, the cyclically-adjusted price-to-earnings (CAPE) ratio for the U.S. stock market has averaged 16.7 since 1881. When Reagan took office in January 1981, the CAPE ratio was 9.3. Today the CAPE ratio is 26.6.
That is no trivial difference. If you had invested in the S&P 500 in 1981, you would have enjoyed a return of 14.2 percent annually during the eight years that Reagan was in office (including dividends). But if you had invested in the S&P 500 in 2005 when the CAPE ratio was as high as it is today, your return would have been 4.2 percent annually over the following eight years.
The difference in actual wealth creation is huge. A $10,000 investment in 1981 would have grown to $29,000 by the time the Gipper left office, whereas the same investment in 2005 would have grown to just $15,000 eight years later. No wonder so many Americans have fond memories of the go-go Reagan era.
It’s not just stocks. There were lots of ways to get richer in the 1980s. According to Shiller’s data, the yield on ten-year U.S. treasuries has averaged 4.6 percent since 1871. When Reagan took office, that yield was 12.6 percent. It’s now 2.1 percent.
Here too, that difference is considerable. Long-term government bonds returned 14.2 percent annually from 1980 to 1988. You have to go back to the 1940s to find interest rates as low as they’ve been recently, and the returns from bonds were hideous back then. For example, long-term government bonds returned 1 percent annually during the eight years from 1946 to 1953. That means investors effectively lost money net of inflation — a result familiar to bond investors today.
I can go on. According to NAREIT, yields on equity real estate investment trusts have averaged 6.8 percent since 1972. When Reagan took office, that yield was 7.9 percent. Today that yield is 4 percent. You get the picture.
Ironically, the investing landscape may get even trickier for American households to navigate if Trump’s pro-growth agenda succeeds. Higher growth will almost certainly be accompanied by rising interest rates, and rising rates are kryptonite for nearly every conceivable investment.
Rising interest rates mean lower bond prices, for starters. They mean higher discount rates for cash flows, which may translate into lower stock prices. They mean higher mortgage rates, which may translate into lower home prices. And don’t forget about investments that rely heavily on leverage, such as private equity. Higher borrowing costs mean lower returns there too.
Bond traders are already envisioning higher rates in the coming Trump era. Interest rates are up sharply since election day. The yield on ten-year U.S. treasuries, for example, has spiked from 1.9 percent to 2.1 percent in just two days.
So let’s not be so quick to anticipate another Reagan-like golden age. Reagan was uniquely fortunate to take office when U.S. asset prices were at historic lows, and U.S. households benefited enormously when asset prices rose.
Trump will try to recreate that 1980s magic without the tailwind of rising asset prices – and very likely with the headwind of deflating asset prices. That’s no easy trick.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.