Memo To: SSU Students
From: Jude Wanniski
Re: The Analytical Power of Classical Economics
In my 25 years at Polyconomics providing analysis on the likely impact political decisions will have on the financial markets, I've never sat down to write a report on the accuracy of our work. It never occurred to me to do so, as I've assumed Poly's clients were well aware of how well we've done or we would not still be in business. For SSU students, it's another matter, in that our students have never been exposed to the research by which we make our living. It might make you more assiduous in your studies, I thought, if you could see the forecasting/analytical powers of the classical (supply-side) model that we have refined at Poly over these many years.
It just so happens that Wayne Jett, our representative in the western states, a few months back decided to compile a list of our extraordinary "calls" in the last few years. Wayne has been using it selectively for marketing purposes, but I decided to put aside my natural modesty and run his report as this week's SSU lesson. When I founded the company in 1978, I decided I could only justify charging clients for my insights and forecasts if they were on the mark more often than not, so they could benefit from the work and have a greater return on their own investments than they would if they had not had our research. Here is Wayne's report. Please excuse his concluding comments, which represent a sales pitch of course, but which I decided to leave in this "academic" lesson to give you the full flavor of Wayne's enthusiasm:
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Utility in forecasting economic and market performance makes classical economics the most powerful tool a portfolio manager can have.
After renaming classical economics “supply side” in 1976 and writing The Way the World Works in 1977, Jude Wanniski started the firm Polyconomics, Inc., in 1978 to advise institutional investors. Polyconomics has refined and proven the classical Supply Side Economic Model in forecasting economic and market performance during the past 25 years. Here are several recent illustrations of the reliability and accuracy of classical economic forecasting.
Forecast # 1
On January 2, 1997, Jude Wanniski advised Polyconomics clients of his forecast for the coming year. He first predicted a cut in the capital gains tax rate, perhaps as low as 15% [the cap gains tax rate was actually cut in 1997 from 28% to 20%]. He then forecast: (1) the Russell index rising 25-30% [it actually rose 20.4%]; (2) the Dow up 15-20% between 7,400 and 7,800 [it actually ended 1997 at 7,882]; and the long bond ending the year below 5.87% [it actually ended at 5.92%].
By mid-year of 1997, Jude was warning the Fed chairman of the onslaught of deflation. The Fed was failing to accommodate growth resulting from the capital gains tax cut with additional monetary liquidity. By August, Jude described the market sell-off as deflation oriented.
Failing to persuade Chairman Greenspan, Wanniski went to the White House and to Treasury advising of the approaching crash of commodity markets, but he was ignored (even ridiculed). From October through December, 1997, Jude was flying all the red flags about the economically damaging effects of deflation, which first showed up in Asia. Commodity prices crashed as Jude had warned, basic industries lost pricing power as the dollar gained value and prices fell, and capital was pressed towards intellectual property stocks. Technology shares finally were chased into a parabolic rise, as the terms of trade briefly favored intellectual goods over commodities. Then technology earnings and share prices collapsed as the customers of high tech had no more capital to invest in increased productivity as the deflation caught up with intellectual goods.
Forecast # 2
On December 17, 2000, in a report to Polyconomics clients entitled "BEAR SLIDE, WHEN WILL IT END," Jude Wanniski began with this statement: "If there are no counter forces to the deflationary drag on the markets, the gold price of $270 suggests a nominal Dow Jones Industrial Average of 7500."
At the time, the DJIA was just below 11,000; by October, 2001, the Dow dropped to about 8,500; and by October, 2002, it fell below 7,500. Not only was Jude's forecast accurate in the outcome; it was accurate for the stated reason: monetary deflation.
Forecast # 3
On March 7, 2001, Jude Wanniski advised Polyconomics clients “NO REASON TO HOLD EQUITIES.” At the time, he said he made this statement…
“… to emphasize as clearly as I [can] the severe nature of the economic forces bearing down on the equity markets. Unless and until the Federal Reserve changes its operating mechanisms in a way that will cause the price of gold to rise at least above $300, … we cannot expect a meaningful turnaround on Wall Street.”
Some long-time Polyconomics clients say this was Jude’s best call ever. From the date of the forecast, March 7, 2001, the Dow fell from just below 11,000 to about 7,200 in October, 2002 [a 35% drop], and has since risen to about 9,800.
Jude’s basis for the forecast was right again. On March 7, 2001, gold was slightly above $260 and did not rise to $300 until April, 2002. Gold rose to $320 by June and remained there until the market lows of October, 2002, when the Fed finally added sufficient monetary liquidity to relieve deflationary pressures entirely as gold later rose to $350 and above.
Forecast # 4
On December 18, 2001, Jude Wanniski issued a report to Polyconomics clients entitled “IS THIS HOLIDAY RALLY FOR REAL?” and answering the question as follows:
“Probably not. We are most likely seeing just another in a long series of nice little rallies on Wall Street this year, each one pulled apart by the ongoing deflation process. But there are a few encouraging signs, enough to suggest a policy breakthrough perhaps early in 2002 that will give us back a genuine Bull Market.”
As it occurred, the hoped-for “policy breakthrough” at the Fed did not occur until the October 2002 market lows, and the new bull market’s birth was deferred until March, 2003.
Forecast # 5
In mid-March, 2002, the economist who has been top-rated by Wall Street institutional investors for the past 23 consecutive years was reported in BARRON’S as forecasting GDP growth “… as high as 6% in 2002 (although his official forecast was for 4%), leading to a 30% rise in S&P 500 operating earnings, to $50 per share.”
At that time, Polyconomics clients were proceeding under the December 28, 2001, advisory from Jude Wanniski that,
“If the deflation is not rectified, we would expect the markets to end the year lower (DJIA 8,600, or worse).”
This forecast was directly on target, and for the correct reason. The DJIA hit its October lows of about 7,200 and then rose to close the year at about 8,500 as the Fed and outside political influences, at long last, moved the dollar from monetary deflation to reflation.
Forecast # 6
Within the over-riding year-long forecast for 2002, Polyconomics advised of opportunities provided by changing conditions of monetary liquidity. On March 6, 2002, Polyconomics clients were advised of “SUBSTANTIAL UPSIDE IN COMMODITIES” as follows:
“We think there is more upside in basic commodity prices and metals with gold in a $290-300/oz. trading locus…. Gold at the $300 level implies upside in metals, grains, and many other basic commodities.”
Gold ended 2002 in the range of $340 and is now in the $410 range. The Dow Jones Commodities Spot Index on March 6, 2002, was at about 100, began rising that same month, spiked above 200 in July, and ended 2002 at about 150. Since October 1, 2003, that spot index has risen above 170. The Dow Jones Commodities Index has risen from 110 to 137, about 24%, during 2003.
Forecast # 7
On May 23, 2003, upon passage of the Bush tax cuts, Jude Wanniski advised Polyconomics clients:
“The legislation is far better than any of us could have imagined could come out of this Congress just a few months back. As it is, the dramatic cuts in the cost of capital embodied in this first truly supply-side package will feed economic growth far into the future, with its rosiest impact on the employment numbers showing up in time for the 2004 presidential elections.”
On May 30, 2003, Jude followed with this:
“What we have is the beginnings of a bull market…”
On July 2, 2003, Jude had this forecast:
“Q3 should confirm the baby bull by edging upward in sawtooth fashion. The superior tax climate for capital formation is now showing up at the edges as we have said it would…. A client (and old friend) told me last night that my February 2001 warning, ‘No Reason to Hold Equities,’ was the ‘greatest call of my career.’ … [T]hat call was the best because Poly was absolutely alone on Wall Street in seeing the monetary deflation. We did not have another supply-sider anywhere who agreed with us. Why mention this? Because I feel almost as strongly now that we are back on track.”
Top-down economic forecasting does not work, and has an abysmal record, when the wrong economic model is used. Monetarist models and Keynesian models have failed in forecasting economic performance and financial markets. In stark contrast, the forecasting record of the classical, supply-side economic model as practiced by Polyconomics, Inc., is astonishly good.
The Supply Side Model Portfolio
In August, 2001, Polyconomics launched the Supply Side Model Portfolio advisory services in the domestic and global arenas as a demonstration of the means and method of applying its macro economic and public policy guidance to investment selection. As with the forecasting performance of the Supply Side Economic Model, the analytical results have been superior, confirming and even surpassing expectations.
The chief market strategist of Polyconomics, Stephen Anderson, has guided the domestic model portfolio effort. The Domestic SSP has gained 63% so far in 2003 (to ll/25/03), while the S&P 500 index has gained 19.8%. In the little more than two years since its launch, the Domestic SSP has gained 83.2% while the S&P 500 has lost 11.7%.
Thus, in about 27 months, the Domestic SSP has nearly doubled, while the S&P 500 has lost more than 10% of its capital. In 2003 alone, the principles and practice of classical economics have powered the Domestic SSP to gains MORE THAN THREE TIMES the gains of the S&P 500 index.
How does Polyconomics do it? First, the monetary prong and the fiscal prong of the Supply Side Economic Model are applied in analyzing their effects on each business sector of the economy. Each sector is weighted, partly in proportion to the extent the sector has already accommodated the influences of monetary and fiscal policies, and then the sectors are ranked. With the guidance of this ranking, bottom-up analysis aids selection of the companies within the top-ranking sectors most worthy of investment. On occasion, short positions are selected from the sectors most disadvantaged by monetary and fiscal policies. The Global SSP is managed by a similar strategy.
Classical Economics: Capitalist Tool
Classical economic theory is a powerful tool that can guide governments in setting public policy, and is a powerful tool for portfolio managers in forecasting economic and market performance. A working understanding of classical economics provides the logical framework for investment strategy and tactics. Properly used, it answers whether the investor should be in the market and, if so, where and how.
The effects of government fiscal policy and monetary policy on investment decisions are constantly changing. Tax policy is presently the most favorable we have seen since at least 1966, and potentially will get even better. The budget deficit produced by increased spending is a negative. Some business sectors will benefit more than others by the effects of these policies.
At the same time, monetary policy remains presently the primary wild card in U.S. economic affairs. During the past 24 months, the value of the dollar has dropped from $280 per ounce to about $400 per ounce of gold. That is a decrease of about 43% in the value of the world’s primary reserve currency within two years. By comparison, during the deflation of 1996-2001 the dollar’s value increased by about 44%. If the Federal Reserve Board continues causing the dollar’s value to swing upward and downward in a 45% range with increasing frequency, investors must be well-advised to stay whole and to prosper.
The expressed view of Polyconomics since early 1997 is that the dollar’s value should be adjusted to $350 per ounce of gold. Had that been done in 1997, the world could have experienced solid economic growth and increased prosperity since then, rather than crashing commodity prices, failing economies, and collapsing stock markets.
Polyconomics studies tax changes and evolving monetary actions of the Fed, makes adjustments required by the cross-winds of significant political events, and ranks the business sectors of the market according to the beneficial or negative impacts on them. By this disciplined, analytical approach, the advisory support of Polyconomics can prevent the problem that affected so many investors and investment advisors in 2000-2002. As investors should have learned in those difficult years, bottom-up stock selection is vulnerable to being hammered in the stock market by unforeseen market or political forces.
If you are a money manager or investment analyst, talk with us about the advisory services of Polyconomics. Our services include frequent written advisories distributed by the internet with email alerts. And they include model portfolios, both domestic and global, that are outperforming the relevant indices.
We encourage and invite your comparison of the performance of Polyconomics described above with those of any other individual or firm. We are confident you will not find any other forecasting record matching that of Polyconomics. We have made such a comparison between Polyconomics and the economist/firm that was top-rated by institutional investors throughout the ten years in which the comparison is made. If you would like to review that comparison, just ask and we will gladly provide you a copy.