No wonder this expansion has been called the "long boom." Actually, "superboom" is more like it. And talk about a pleasant surprise. Few people 25 years ago--optimist-in-chief Ronald Reagan being a notable exception--would have predicted that America was on the verge of such a terrific streak. "There was no reason for anybody to expect it," says longtime Wall Street veteran Hugh Johnson. "We had just come out of the 1970s with high inflation, and then we had a severe recession in the early 1980s. It was a very painful period."
Of course, one could make the case that things aren't so hot right now, either. While unemployment remains at a historically low level and the economy continues to grow--albeit slowly--concerns abound. The housing market is imploding, gas prices rising, the dollar sinking. Beyond those more immediate concerns, America faces aggressive economic competitors abroad in China and India and an apparent inability here at home to deal with obvious fiscal problems such as Social Security and healthcare. Why, it's almost enough to make you stuff your retirement dough in a mattress or bury a few gold bars beneath the deck out back.
Room to run. But don't. America has all the tools and capabilities to make 2008 mark the beginning of another sterling, 25-year run of prosperity and climbing stock markets. Another 2,000 percent gain for stocks? Well, probably not. The market was at such a depressed level when it bottomed in 1982 that stocks had plenty of space to soar. The price-earnings ratio of the S&P 500 composite had shriveled to just 7; it's closer to 19 these days. And while the stock market's performance was primarily driven by corporate earnings growth on the back of the booming economy, "you also had that extra kick from just the revaluation of the P/E ratio," says Gus Sauter, the chief investment officer at Vanguard.
Today's investors should expect no such boost going forward. Still, Robert Doll, the global chief investment officer at BlackRock, expects the market to generate average annual returns in the "high single digits" over the next quarter century. Sure, that's less than the 13.6 percent annual average of the past 25 years, but it's still pretty darn compelling. "If you own equities over [the upcoming] 25-year period, you're going to have a higher return than the guy to your left, who owns bonds, and the guy to your right, who is in cash," Doll says.
But there are certainly no guarantees that stocks will do so well in coming years. Economic stagnation can stifle a stock market. In Japan, for instance, the Nikkei 225 stock index finished just shy of 39,000 in 1989 before beginning a long, downward trend that reflected the nation's economic woes. Right now, nearly two decades later, the Nikkei is sitting around 15,000.
The key, then, for America is to keep its economy growing as fast as possible without triggering inflation. The U.S. economy would grow to $23 trillion over the next quarter century if it expanded at a so-so 2.5 percent yearly pace. But if it grew at 3 percent, it would reach $26 trillion. That extra $3 trillion is like growing another Germany, with enough left over for a Saudi Arabia. Think of it: extra dough to pay down the national debt, fund a new social insurance system, or invest in energy independnce. Worried about growing economic inequality? A bigger economy means more resources for education and worker training.
So how do we make the long boom last even longer? We can start by understanding the big economic lessons from the past 25 years that helped create a climate where innovation and risk-taking could flourish:
Keep competition high. When companies fiercely compete with one another, the result can be lower prices and more innovative companies, products, and services. "The key to the last 25 years is the opening up of all sorts of sections of the economy to increased competition," says Paul London, a former Clinton policy adviser. Starting in the 1970s, many American industries were deregulated, including transportation, banking, and communications.
Keep inflation low. Along with deregulation, tighter monetary policy under Federal Reserve Chairmen Paul Volcker and Alan Greenspan saw inflation fall from double-digit rates to 2 percent or so today. "It is important to avoid spikes in inflation that have to be reversed by recessions like the one at the start of the 1980s," explains Martin Feldstein, head of the National Bureau of Economic Research. "Inflation is also deadly for financial assets like stocks and bonds."
Keep taxes low. The Reagan tax cuts dropped the top rate from 70 percent to 28 percent and indexed tax brackets for inflation. But don't forget the landmark capital-gains-tax cut of 1978 or the 1997 capital-gains-tax cut, both signed by Democratic presidents. All reduced penalties on working and investing. Indeed, new research from the University of California-Berkeley found that U.S. tax cuts since World War II have had "very large and persistent positive output effects."
And where do we stand today? The American economy is still more than double the size of China's. It's also the world's most competitive, at least according to the highly respected World Economic Forum in Davos, Switzerland, based on America's great higher education, flexible labor markets, and superior innovation.
Admittedly, the long boom is a tough act to follow. "In terms of taxes, regulation, and inflation, we are probably not going to do as well in the next 25 years as we did in the first 25 years," says John Silvia, Wachovia's chief economist. "We've made the big moves [already]."
Perhaps. Yet there is more America can do to ensure the good times keep rolling (Page 48). But sequels, as any movie buff knows, are rarely as good as the original article. For every Empire Strikes Back, there are plenty more Phantom Menace types. But that doesn't mean "Superboom: The Next Generation" can't be a heckuva ride.
By James Pethokoukis, with Luke Mullins