HOME › SECULAR MARKETS › 1966–1982
The 1966–1982 Stagflation Era
Sixteen and a half years. The index went nowhere. The dollar lost two-thirds of its value.
The 1960s had taught Americans a new kind of confidence. The economy grew five percent a year. Inflation sat below three percent. Unemployment stayed under four. The Great Society built the modern safety net; NASA put a man on the moon; the Dow Jones kissed 1,000 for the first time in January 1966. Everything that had worked since 1949 was still working.
What was changing beneath the headline numbers was more important. The guns and butter of Vietnam and the Great Society were being paid for by both, by taxes AND by inflation. The dollar, still formally anchored to gold at $35 an ounce, was being inflated faster than any central bank could pretend otherwise. By August 15, 1971, when Richard Nixon closed the gold window on a Sunday evening and told the country via television, the postwar monetary architecture was dead. In its place came a decade of oil shocks, double-digit inflation, falling real wages, and a stock market that went nowhere in nominal terms and lost half of its real value.
The S&P 500 closed December 31, 1965 at 92.43. It closed August 12, 1982 at 102.42. Sixteen and a half years, nine points, before inflation. Inflation cumulatively ran 240 percent across the period, meaning the real purchasing power of equity capital was halved. The investors who stayed the course earned negative two-and-a-half percent a year in real terms. The investors who panicked earned less.
The Dow Jones Industrial Average famously tried eleven times to cross 1,000 between January 1966 and November 1972 before succeeding. Our chart tracks the broader S&P 500 throughout, same measurement discipline as the other eras in this series.
Numbered bands mark each cyclical phase; the sections below walk them in order. On measurement: we use the S&P 500 throughout this series rather than the Dow Jones Industrial Average. The S&P samples five hundred companies against the Dow’s thirty; it is the only common ruler that spans every secular era from 1929 to today.
1
▼ CYCLICAL BEAR
The 1966 Credit Crunch
Ten months. Minus twenty-one percent. The first visible crack in the postwar monetary order.
The S&P 500 crossed the 1966 calendar at 92.18. In the first week of January the Dow Jones Industrial Average briefly touched 1,000 for the first time in history, a round number that had become the symbol of post-war American confidence. The economy was growing almost five percent a year. Unemployment was below four. Inflation had just crossed three percent, higher than it had been in a decade but still inside the postwar normal range. Everything was working. Then the Federal Reserve raised bank reserve requirements twice in six months and discovered what every subsequent Fed would re-learn: the economy that had looked solid at full employment was actually operating with no margin.
What the Fed was trying to do was cool an economy that Lyndon Johnson refused to cool fiscally. In 1965 Johnson had privately told his advisors that any tax increase to pay for Vietnam would kill the Great Society in Congress, so he chose not to ask for one. The guns and butter would be paid for by the central bank, which could tighten money without a congressional vote. In the second half of 1966 the Martin-era Fed tried to do exactly that, raising reserve requirements, draining liquidity through open-market operations, and watching mortgage rates spike from under five percent to over seven in six months. The savings-and-loan industry nearly collapsed as thrift depositors moved their money to higher-paying Treasury bills, a process that would recur under worse circumstances in 1979-82.
On October 7, 1966, the S&P 500 closed at 73.20, down twenty-one percent from its late-1965 peak. The decline is remembered today as the “credit crunch” rather than a recession because the economy never technically contracted; GDP growth slowed to under three percent in the second half of 1966 but never turned negative. The Fed reversed in early 1967 and the market recovered. But the pattern of the next sixteen years had been set: the Fed would try to control an inflation that the fiscal authorities refused to help contain; the equity market would get caught in the middle; and after each attempted tightening cycle the inflation would come back worse.
The recovery that followed carried the nifty-fifty rally to its 1968 peak.
“The guns and butter would be paid for by the central bank, which could tighten money without a congressional vote.”
2
▲ CYCLICAL BULL
The Last Postwar Bull
Twenty-five months and a nifty-fifty peak at the end of American consensus.
On October 7, 1966, the S&P 500 bottomed at 73.20, down twenty-two percent from its December 1965 peak. The credit crunch that produced the decline, the Federal Reserve pulling the brakes on an overheating economy, bank reserve requirements raised twice in six months, mortgage rates spiking from under five to over seven percent, had been Washington’s attempt to cool inflation without raising taxes to pay for Vietnam. Lyndon Johnson, who had privately told his economic advisors in 1965 that any tax increase would kill the Great Society in Congress, now watched as his monetary authorities did the restraint his fiscal authorities would not do. Over the next twenty-five months the market would recover and climb to a new high, but the political consensus that had carried the postwar bull for seventeen years would not survive the ride.
Nineteen sixty-eight was the single most violent year in modern American political history. On January 30 the North Vietnamese launched the Tet Offensive, a coordinated attack on more than a hundred South Vietnamese cities and towns, including the U.S. Embassy compound in Saigon, and demonstrated to American television audiences that the war was not being won, no matter what MACV reports claimed. Walter Cronkite went to Saigon in February and came back to say so on the CBS Evening News. On March 31 Johnson announced he would not seek reelection. On April 4 Martin Luther King was shot in Memphis. On June 5 Robert Kennedy was shot in Los Angeles. On August 28 Chicago police beat demonstrators in Grant Park outside the Democratic National Convention. On November 5 Richard Nixon was elected the thirty-seventh president.
And yet the market rallied through the entire sequence. Institutional investors, who were pricing in the end of the inflationary expansion but not the end of growth, continued bidding up the P/E multiples on the “nifty fifty”, IBM, Xerox, Polaroid, Avon, Coca-Cola, McDonald’s, a group of fifty growth stocks that institutional memos described as “one-decision” stocks: you buy them and hold them forever. By November 1968 the S&P 500 had reached 108.37, up forty-eight percent from the credit-crunch low. The nifty fifty traded at an average P/E of forty-two. Capital was flowing into equities faster than ever. The confidence was late-cycle.
Within eighteen months the P/E multiples would be cut in half and the postwar economic model would be in open collapse.
“Institutional memos described them as ‘one-decision’ stocks: you buy them and hold them forever. Nineteen sixty-eight was the year that stopped being true.”
3
▼ CYCLICAL BEAR
The Nifty-Fifty Peak Cracks
Eighteen months. Minus thirty-six percent. The one-decision stocks required a second decision.
Richard Nixon took office on January 20, 1969 with two central preoccupations: ending the Vietnam War without appearing to lose it, and getting himself reelected in 1972. The first required a strategy his advisors would call “Vietnamization”, withdrawing American troops while transferring combat responsibility to the South Vietnamese army, combined with secret bombing of Cambodia to pressure the North. On July 20, 1969, while 528 million people watched on television, Neil Armstrong stepped onto the Sea of Tranquility and spoke the single most-rehearsed sentence of the century. The Apollo program was the final deliverable of Kennedy’s 1961 “before this decade is out” promise, and it was also the end of the postwar federal-government-as-engineer era. The 1970 NASA budget was already being cut.
On May 4, 1970, four days after Nixon announced the invasion of Cambodia, Ohio National Guardsmen fired into a crowd of student protestors at Kent State University, killing four. Nationwide, more than four million students went on strike; 450 college campuses shut down. On June 21, 1970, Penn Central, the largest railroad in the United States and the sixth-largest American corporation by revenue, filed for bankruptcy, the largest corporate failure in American history to that point. The Federal Reserve, which had been raising rates since 1968 to control inflation that was already running six percent, flooded the system with liquidity to prevent a commercial-paper market seizure. It worked. But the market had already fallen.
The S&P 500 lost thirty-six percent peak-to-trough, from 108.37 in November 1968 to 69.29 on May 26, 1970. The nifty-fifty P/Es, which had reached forty-two in 1968, were cut to the mid-twenties by 1970. The institutional conviction that growth stocks could be bought at any price and held forever was being revised in real time. Meanwhile Xerox, Polaroid, and IBM were still growing earnings at over fifteen percent a year, but the market was no longer paying for the growth. The multiple compression that would characterize the entire sixteen-year stagflation era had begun.
Then on August 15, 1971, Nixon closed the gold window.
“The institutional conviction that growth stocks could be bought at any price and held forever was being revised in real time.”
4
▲ CYCLICAL BULL
Nixon Shock and Watergate Hidden
The dollar came off gold. The Dow crossed 1,000. The president committed the crime that would end him.
On Sunday evening, August 15, 1971, Richard Nixon preempted the popular TV series Bonanza to tell the nation that he was closing the gold window at Treasury, imposing a ninety-day wage and price freeze, and placing a ten percent surcharge on all imports. His speech lasted eighteen minutes. In those eighteen minutes he dismantled the Bretton Woods monetary system that had organized global trade since 1944. The dollar would no longer be redeemable for gold at thirty-five dollars an ounce. Within eighteen months every major currency was floating. Within three years the dollar had lost thirty percent of its value against the German mark. The exorbitant privilege of being the world’s reserve currency was intact, but the discipline that was supposed to come with it was gone.
On February 21, 1972, Nixon arrived in Beijing to shake hands with Mao Zedong. The visit, planned in secret through Henry Kissinger’s back-channel diplomacy, ended twenty-three years of American non-recognition and reset the Cold War along a three-power axis. On June 17, 1972, five men were arrested breaking into the Democratic National Committee headquarters at the Watergate Hotel in Washington; the story would barely register for the next five months. On November 7, Nixon was reelected in a forty-nine-state landslide against George McGovern, winning sixty-one percent of the popular vote. On November 14, 1972, the Dow Jones Industrial Average closed above 1,000 for the first time in history, six years and eleven months after it had first touched the level during a January 1966 intraday peak.
The S&P 500 peaked at 120.24 on January 11, 1973, up seventy-four percent from the May 1970 low, up thirty percent from the November 1968 nifty-fifty peak. In nominal terms it was the highest level in American history. In real terms, after four years of six-to-seven-percent inflation, it was below its 1968 peak. The dividend yield had fallen below three percent for only the second time since 1929. The market was pricing seventeen years of continued multiple expansion in companies whose earnings were about to be hit by the most severe commodity shock of the postwar era.
Seventeen days after the January peak, Egypt and Syria began planning the Yom Kippur War.
“In eighteen minutes he dismantled the Bretton Woods monetary system that had organized global trade since 1944.”
5
▼ CYCLICAL BEAR
OPEC and Watergate
The deepest cyclical bear between 1932 and 2008.
On January 27, 1973, the Paris Peace Accords were signed. The United States agreed to withdraw remaining ground troops from South Vietnam within sixty days; North Vietnam agreed to return American POWs. The accords did not end the Vietnamese civil war, the Communist North would conquer the South two years later, but they ended twenty-one years of American military involvement. Meanwhile the Senate Watergate Committee convened on May 17 and began nationally televised hearings. John Dean testified in June, implicating Nixon directly. Alexander Butterfield testified in July that there was a tape-recording system in the Oval Office. By late 1973 the question was not whether Nixon had participated in a cover-up, but whether the recordings would reveal him doing so.
On October 6, 1973, Yom Kippur, the holiest day of the Jewish year, Egypt and Syria launched a coordinated surprise attack on Israel. Within a week the Nixon administration had committed to a massive airlift of military supplies to Israel. On October 17 the Organization of Petroleum Exporting Countries, dominated by Arab producers, announced an oil embargo against the United States and the Netherlands. On October 19, Saudi Arabia cut all oil shipments to the U.S. Within three months the posted price of crude oil had quadrupled from three dollars to twelve dollars a barrel. Gasoline rationing returned; odd-even license-plate days were implemented in major American cities; service stations ran out of fuel. The entire American industrial economy had been built on cheap oil, and cheap oil was over.
On August 9, 1974, Richard Nixon resigned the presidency after the “smoking gun” tape proved he had ordered the FBI to drop its Watergate investigation. Gerald Ford, who had become vice president only ten months earlier when Spiro Agnew resigned amid a bribery scandal, became the only person ever to serve as both vice president and president without being elected to either office. On September 8 Ford pardoned Nixon. The S&P 500 made its bear-market low on October 3, 1974 at 62.28, down forty-eight percent from the January 1973 peak, the deepest cyclical bear between 1932 and 2008. Unemployment hit nine percent. Inflation hit twelve percent. The word “stagflation” entered the American political vocabulary.
The economy had not seen anything like it in forty years. What followed was two years of recovery that would turn out to be the lull before a second oil shock.
“The entire American industrial economy had been built on cheap oil, and cheap oil was over.”
6
▲ CYCLICAL BULL
Energy Crisis Recovery
Two years of relief, bicentennial optimism, and a Fed that had learned the wrong lesson.
Gerald Ford was the first president since Chester Arthur to inherit the office under genuinely catastrophic circumstances. He faced a Democratic Congress elected in the November 1974 midterms by a margin that reflected national disgust with Watergate, an economy in the worst recession since 1938, and public approval ratings that would not recover from his September 8 pardon of Nixon. Yet the economic data turned fast. The 1974 recession, which had been triggered by the oil shock and deepened by the Fed’s refusal to accommodate it, began to lift in the spring of 1975 as oil prices stabilized and inventories ran down. On April 30, 1975, the last American helicopter lifted off the roof of the U.S. embassy in Saigon; the war that had defined American foreign policy for a generation was over. On July 4, 1976, the United States celebrated its bicentennial with tall ships sailing into New York Harbor.
The S&P 500 rallied from 62.28 to 107.83 over twenty-four months, a seventy-three percent gain, almost exactly matching the recovery from the 1970 Penn Central low. GDP grew six percent in 1976, the fastest expansion of the decade. Unemployment, which had reached nine percent in May 1975, fell to seven percent by late 1976. Industrial production recovered to its pre-oil-shock peak. The commercial-paper market, which had seized in 1970 and then again during the oil crisis, functioned normally again. Volcker was not yet at the Fed; Arthur Burns, Nixon’s hand-picked chairman, continued to prioritize employment over inflation. Burns’ Fed cut rates even as inflation stayed above five percent, convinced that the oil-shock inflation was a one-time price-level reset rather than an embedded expectation.
On November 2, 1976, Jimmy Carter, a one-term governor of Georgia whom no one in Washington had heard of two years earlier, defeated Gerald Ford by two percent of the popular vote. He inherited an economy that looked, on surface, like it had recovered. But oil prices were already climbing again as the Shah’s regime in Iran began to crack. Inflation, which had retreated to four percent in late 1976, was heading back toward six percent by the time Carter took the oath on January 20, 1977. Arthur Burns’ bet that inflation expectations were anchored was being proven wrong. The second oil shock, when it came, would make the first one look manageable.
The recovery peaked in September 1976. The second oil shock was coming.
“Burns’ Fed cut rates even as inflation stayed above five percent, convinced that the oil-shock inflation was a one-time price-level reset rather than an embedded expectation.”
7
▼ CYCLICAL BEAR
Second Oil Shock Approaching
Eighteen months of slow grinding retreat as the recovery’s foundations gave way.
Jimmy Carter brought to Washington an engineer’s conviction that complex problems could be solved by diligent application of the correct policy. His first major address to the nation, delivered on April 18, 1977 from a sweater and seated by a White House fireplace to signal energy conservation, called the energy crisis “the moral equivalent of war.” The speech was mocked within hours, Washington columnist George Will immediately noted that MEOW spelled “meow.” But the sentiment was correct. The United States was importing eight million barrels of oil a day in 1977, up from six million in 1973. The country had responded to the first oil shock by consuming more oil, not less. The Department of Energy was created in August 1977 to coordinate what Carter believed would be a decade-long national project.
Through 1977 and early 1978, the economy sent conflicting signals. GDP grew five percent in 1977, fast, but inflation accelerated faster, hitting seven percent by year-end. The dollar fell twenty percent against the German mark. The trade deficit, which had been in surplus every year from 1945 until 1976, swung negative in 1977 and widened dramatically in 1978. On the New York Stock Exchange, the S&P 500 drifted sideways through 1977 as corporate profit growth was eaten by rising interest costs, rising energy costs, and the dollar-cost of imported inputs. The index fell nineteen percent from 107.83 in September 1976 to 86.90 in March 1978, not technically a bear market by most definitions, but a slow grinding retreat that eroded the hope the 1975-76 recovery had built.
The economist Milton Friedman, writing in Newsweek through 1977 and 1978, warned repeatedly that inflation expectations were becoming “embedded”, that workers were negotiating cost-of-living clauses into labor contracts, that long-term bond yields were pricing in permanent five-percent inflation, that homebuyers were accepting double-digit mortgages because they expected home prices to compound faster. The Burns Fed had failed to break the expectation. Its hand-picked successor, G. William Miller, who took office on March 8, 1978, would prove even weaker. In sixteen months at the Fed, Miller would cut the federal funds rate while inflation accelerated past ten percent, the single clearest failure of American central banking in the twentieth century.
In August 1978 Miller resigned under pressure. The President replaced him with the deputy Treasury secretary, a six-foot-seven cigar-smoker named Paul Volcker, who nobody expected to be more than a holding action.
“The Burns Fed had failed to break the expectation. His successor would prove even weaker.”
8
▲ CYCLICAL BULL
The Inflation Trade
Iran, hostages, gold at $850, and a Fed chair who decided to break the cycle.
On January 16, 1979, Shah Mohammad Reza Pahlavi fled Iran. On February 1, Ayatollah Khomeini returned from fifteen years of exile in Paris to lead the Iranian Revolution. The Shah’s regime, which had been America’s most important Middle East ally for twenty-five years, was replaced by a theocracy that would within nine months storm the U.S. embassy in Tehran and seize fifty-two Americans as hostages. The hostages would be held for 444 days, through the end of the Carter presidency, through a failed military rescue in April 1980 in which eight American servicemen died, through the campaign in which Ronald Reagan would turn Carter’s July 1979 “malaise” speech into the political epitaph for the Democratic incumbent. Carter had told the country it suffered “a crisis of confidence.” The country responded by losing confidence in Carter.
Oil prices more than doubled during the Iranian Revolution, from fourteen dollars a barrel in late 1978 to thirty-four dollars by early 1980. Gold ran from two hundred and sixty dollars an ounce in 1978 to a record eight hundred and fifty dollars on January 21, 1980, as institutional and retail investors flooded into inflation-protected assets. Silver was briefly cornered by the Hunt brothers at forty-nine dollars an ounce. Real estate, oil-and-gas limited partnerships, art, and coins all outperformed equities. The S&P 500 nominally rallied, from 86.90 in March 1978 to 140.52 in November 1980, up sixty-two percent, but in real terms it barely kept pace with inflation. The index had not meaningfully compounded in real terms since 1965.
On August 6, 1979, Paul Volcker became the twelfth chairman of the Federal Reserve. On October 6, 1979, three months into his tenure, he announced the “Volcker Shock”, the Fed would stop targeting the federal funds rate and instead target bank reserves, allowing short-term interest rates to go wherever they needed to go to break inflation. By March 1980 the federal funds rate had reached twenty percent. The economy went into recession almost immediately. On November 4, 1980, Ronald Reagan was elected the fortieth president in a 489-to-49 electoral college landslide; the Iranian hostages were released on the day of his inauguration, after 444 days. The combination of a Fed willing to cause a recession and a president willing to let the Fed do its work would, over the next three years, break the inflation.
First it would cause the deepest unemployment since 1941.
“On October 6, 1979, three months into his tenure, Volcker announced that the Fed would stop targeting rates and start targeting reserves. The economy went into recession almost immediately.”
9
▼ CYCLICAL BEAR
The Volcker Shock
Twenty-one months of double-digit rates, double-digit unemployment, and the single greatest regime change in post-war American markets.
Ronald Reagan took the oath on January 20, 1981. His economic program, developed in rough form during the campaign and refined by David Stockman at the newly created Office of Management and Budget, called for a twenty-five percent cut in marginal income tax rates over three years, a sharp increase in defense spending, and non-defense spending cuts that would never materialize at the scale required. On March 30, 1981, a mentally ill young man named John Hinckley Jr. shot Reagan outside the Washington Hilton; the president, wounded and bleeding internally, joked to surgeons that he hoped they were all Republicans. On July 29, 1981, Reagan signed the Economic Recovery Tax Act. Four days later, on August 3, when thirteen thousand air-traffic controllers walked off the job in violation of federal law, Reagan gave them forty-eight hours to return to work. When they refused, he fired them. The signal to American labor was unmistakable: the federal government under this administration would not help you.
The Volcker Fed held rates in the high teens through 1981, released briefly in the summer, and then raised them again in 1982. The federal funds rate averaged sixteen percent through 1981 and twelve percent through 1982. Prime mortgage rates reached eighteen percent. The unemployment rate climbed from seven percent in late 1980 to a peak of ten-point-eight percent in November 1982, the highest since 1941. The S&P 500 fell from 140.52 to 102.42 over twenty-one months, down twenty-seven percent. Latin American sovereign debt, which had been issued through the 1970s to recycle petrodollars at low rates, now had to be refinanced at double-digit rates. On August 12, 1982, Mexico defaulted on eighty billion dollars of foreign debt. The international financial system was in open crisis for the second time in a decade.
And yet. The inflation rate, which had peaked at fourteen-point-six percent in April 1980, fell to six-point-two percent by August 1982, to three-point-eight percent by June 1983. The ten-year Treasury yield, which had reached fifteen-point-eight percent in September 1981, began what would become a thirty-nine-year decline. The dollar strengthened. Corporate profit margins, released from the pressure of double-digit input inflation, began to expand. On August 12, 1982, the S&P 500 made its final low at 102.42. The next morning the market rose two-point-six percent. Within three months it would be up thirty percent. The sixteen-year secular bear was over. The man who had been chosen to be a holding action had broken the inflation and, in breaking it, set up the longest and strongest secular bull in American history.
August 12, 1982. The index at 102.42. In eighteen years it would reach 1,527.
“The man who had been chosen to be a holding action had broken the inflation and, in breaking it, set up the longest and strongest secular bull in American history.”
Sixteen and a half years. The index went nowhere. The purchasing power of equity capital was halved.
The 1966-1982 secular bear was the economic consequence of a government that chose inflation over honesty for sixteen years. Vietnam was paid for with inflation. The Great Society was paid for with inflation. The 1970s oil shocks were absorbed with inflation. The dollar was devalued with inflation. For a decade and a half, the political system found inflation easier than the alternatives, until Paul Volcker arrived and demonstrated that it was not easier, only slower.
Investors who panicked at every headline earned negative returns in real terms. Investors who held through the full sixteen and a half years earned close to zero in real terms. Investors who understood that the secular current had turned and allocated to real assets, oil, gold, real estate, commodities, outperformed the index substantially.
The lesson of the stagflation era is not that stocks are a bad investment. The lesson is that the ruler can shift. When the measuring stick itself is being inflated away, the asset you own matters less than the regime you own it under.
The Great Moderation
From 102.42 on August 12, 1982, the S&P 500 ran to 1,527 by March 24, 2000, a fifteen-fold increase, with dividends reinvested closer to twenty-two-fold.
The three decades of disinflation that followed the Volcker shock would compress long-term interest rates from fifteen percent to three. Federal Reserve chair Alan Greenspan would preside over the longest sustained economic expansion in American history. The personal computer would arrive, then the mobile phone, then the internet. The Berlin Wall would fall, the Soviet Union would dissolve, and American capitalism would briefly convince itself it had won the argument.
And one dot-com bubble later, the music would stop. Chapter four.
All trading involves risk. Leveraged trading has large potential rewards but also large potential risk. You must be aware of the risks and be willing to accept them to invest in the futures and options markets. Don’t trade with money you can’t afford to lose. This is neither a solicitation nor an offer to buy or sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed. The past performance of any trading system or methodology is not necessarily indicative of future results.
Our strategies have not been developed based on knowledge of or with reference to your particular circumstances. Hence no content or model published here constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. You alone are solely responsible for determining whether any investment, security, strategy, or any other product or service is appropriate or suitable for you based on your investment objectives and personal financial situation.