Watergate and Financial Markets

The Watergate Scandal and Today’s Financial Markets
I’ve always enjoyed a good political scandal. There’s something sort of satisfying in seeing powerful people get caught out. Sex scandals in particular. Remember Wilbur Mills and the Argentine Firecracker? You can’t make this stuff up.

The Watergate scandal of the 70’s has come to mind lately, and how it seemed to drag on and on. As I look at the current scandals in Washington (Hillary’s emails; the FISA Court), I began to wonder what happened to financial markets during Watergate, and whether there are any lessons for us today? I decided to do some research to find out.

Please note: I mean to observe historical facts here, and see if I discern any financial market parallel responses to political scandal. Although it is my objective to stay away from political opinion, please forgive any transgressions.

The Mid-70’s
President Nixon was running for a second term. The Vietnam war raged on. Protests on campuses. The Hippie movement. Hallucinogenic drugs. The Republicans hired burglars to bug the offices of the Democratic National Committee, in the Watergate complex. They planted microphones, which subsequently malfunctioned. Their operatives broke in a second time to replace the mics, but this time they got caught. During the ensuing scandal details came out bit by bit, and it became clear that the authority to both commit and cover-up the crime came directly from the Nixon White House.

There’s an excellent synopsis of the Watergate scandal here: https://www.history.com/topics/1970s/watergate

The break-in occurred June 1972, and the President resigned in August 1974. The media, no friends to the Republicans then and now, churned this thing for as long as it had life, and everyone was sick to death of it. Everyone was also sick to death of the Vietnam war. This was the first war that Americans could watch on live TV, so the horror of it was quite real. All in all, it was a sour time as I remember it.

Quite as an aside, the Watergate complex in DC is architecturally stunning. Too bad it is forever linked to this break-in. Ever since then, Washington scandals have the suffix -gate attached, as in Spy gate.

The Current Scandals
In today’s scandals, details continue to seep out. Long story short: Hillary’s campaign hired a British firm to research Russian collusion with the Trump campaign. The result was the infamous dossier, full of salacious detail. They would leak this dossier to the press. Known widely at upper levels of State and the CIA to be false, the dossier implicated a Trump associate, one Carter Page. Some bad actors went to a FISA court (The Foreign International Surveillance Act of 1978 created FISA courts to spy on foreign actors working within the US) to get a warrant to surveil Mr. Page, and consequently the Trump operation. In applying for the warrant, they used the phony dossier to prove foreign collusion. The details are all still coming out. This scandal is as major as Watergate, if not moreso, and will without a doubt drag on for years.

And then there is the issue of Hillary’s emails. At any organization – including CameronDowning – all email must be sent through an approved server, for compliance purposes. The compliance of it is that, at a government entity, any email is public record, and must be retained. So why would you have your own server in your bathroom closet? Clearly to go around the public record. Hillary’s emails were subpoened by a Congressional Committee. Rather than turning them all over, she deleted 30,000 of them, and instructed staff to use bleach bit and hammers to destroy hard drives.

Mirror Images
So here we have mirror-image scandals. In the 70’s the Republicans tried illegally to gain opposition research on the Democrats. In 2018 the Democrats now have been exposed in trying to gain opposition research on the Republicans. Plus ca change, right? The more things change, the more they stay the same. In both cases it isn’t one bad actor – it is the larger political party supporting the agenda of the focal bad actor.

Again, though, my point: what is the effect of this unfolding scandal likely to be on financial markets? How did financial markets react to the Watergate scandal?

Consider the timing. It took a little more than two years for Watergate to completely unfold, from burglary to resignation. At this writing, the FISA/email scandals are both well more than two years old. This will grind on a long time yet.

The economic situations couldn’t be more dissimilar, however. In the 70’s we were in a recession, evidenced by high unemployment (9% peak in 1975) and high inflation. The term stagflation comes from this time. There was a middle east oil embargo that began in ’73. There was a ’73 – ’74 stock market crash. Unemployment didn’t come down to 6% until June ’78. The top individual marginal tax rate was 70%, and the top corporate rate was 48%. (Anyone remember Gerald Ford’s WIN buttons? Whip Inflation Now. As though wearing a button would accomplish anything). And the Vietnam war raged on and on. The news was, to say the least, depressing.

This is a chart showing the S&P 500, a broad market index, for the full years of 1973-1974.  It shows a typical U-shaped recession, with the stock market dropping, remaining bottomed out for several months, and then climbing once again. 

Wikipedia presents the picture of the ’70’s economic situation here.

All this contrasts with our current economic boom, set off by the Trump tax cuts. The pre- 1973-74 recession unemployment rate was 4.6%. We are about one point below that now, with black and Hispanic unemployment at a historic low – ever! The top marginal income tax rate is now 37%, and the top corporate rate is 21%.

This chart shows the S&P 500 from 2016 through Sept. 14th, 2018. 

Is Watergate a Predictor for Today’s Markets?
What is my conclusion, then? Is the Watergate scandal any sort of predictor for us today? Short answer: No. Although we have mirror image political scandals going on, financial markets respond to financial news, and not political news so much. What moves markets is not the latest headline, but expectations of corporate profitability. Who sleeps with whom doesn’t affect financial markets. But changes in Congress’ fiscal policy sure do.

Monetary and Fiscal Policy
There are two sets of government policy to watch here – monetary policy and fiscal policy. The Federal Reserve governs monetary policy. If the Fed sees the economy heating up too much, it raises interest rates to coll things down. For example, during the Obama years the Fed took interest rates to just off zero to try to goose some growth out of the economy, with very little success. During the Nixon years inflation was a problem, so the Fed kept interest rates high to try to wring it out of the economy. Both efforts were met with limited success.

Fiscal policy is that which comes from Congress. Here the two political parties couldn’t be more dissimilar, with the Democrats now being the party of big government, running openly socialist politicians. The Republicans, on the other hand, are always accused of running the government to favor big business at the expense of the little guy. Based on the graph above, clearly investors favor whatever the Trump Administration is doing.

See related article: The Big Tax Code Revision

During the Nixon years, an Arab oil embargo sent shock waves throughout the economy. We had continuing high fuel prices. High inflation with no sign of abating. High marginal tax rates. A never-ending Asian war. Taken together, all these stifled economic growth. Did Watergate have a deleterious effect on financial markets? Certainly on consumer sentiment. The rest of the economy languished for all the other the reasons I’ve just cited. Watergate just made everything feel more sour.

What are the expectations now?
We are in the longest running bull market in history. The US is now a net energy exporter. Lowest taxes in generations, with the expectation that the Republicans will make the tax cuts permanent. Streamlined regulations. Obamacare, a giant jobs killer, is nearly repealed. And the Treasury has taken in a record amount in taxes, cuts notwithstanding.

The fact that the bull market is the longest running in history makes a lot of observers nervous, meaning the end of it should be near. What are the headwinds? The Fed continues to raise interest rates to a more normal range. All borrowing will cost a little more: your auto loan, or your adjustable rate mortgage. Consequently the housing market is hurting (WSJ, 10.19.18), and housing starts tend to be leading economic indicators. Consumer spending always drives the economy, so if consumers have a little less to spend, rate rises will have the effect of tempering growth.

Do we have full employment, based on the statistics above? Meaning, if a business wants to expand, will it not be able to do so because there’s no one left to hire? This is a major concern. If businesses can’t expand because they can’t hire workers, that suggests a natural ceiling on economic growth. If there are too few workers, wages should be rising in the aggregate, as employers bid in the marketplace for new hires. The expected wage increases have only recently begun to materialize. The labor force participation rate hit the lowest measured since WWII during the Obama Administration. Now we have the reverse. What we’re seeing now is something else that is hard to quantify – people who have left the workforce are now returning. See WSJ article on 9.13.18.

Here is My Conclusion:
The scandals then and now have many fascinating similarities, but markets still move on expectations of corporate profitability. In the mid-70’s we were in a recession and the stock market was in a correction. Currently we’re still in a bull market, which looks like it has a little way to run yet. The Washington political scandals will grind on. I can’t remember ever a time when there wasn’t one scandal or another brewing. It will go on for several years, doubtless. What effect will the current scandal have on your portfolio? Same as on previous scandals – ultimately, I think, not a lot.

So to the investors who read this: don’t be swayed by headlines. Keep your head. Watch economic fundamentals. Good quality is still good quality, even if the price changes. Invest for the long term, knowing full well that bull markets correct themselves over time.

See related article: Don’t Get Distracted by Financial Headlines – Stick to Your Financial Plan


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