Why Obama Might Be the Next FDR -- for the Stock Market

It's been four years since the end of a devastating crash. Unemployment remains elevated, but it has fallen far from its recent heights. The economy, once fueled by rampant speculation and extreme leverage, has pushed past its old levels thanks to a stronger business environment fueled by rising consumer demand. With the darkest days behind him, the president turns his attention toward spending reductions promoted by influential conservatives to stabilize the national budget, as well as tax increases to provide funding for the nation's social-assistance programs.

This might sound familiar -- because it's happened before. The year was 1937, and the economy was about to collapse all over again.

The Roosevelt Recession
President Franklin D. Roosevelt won an overwhelming re-election in 1936 based on the strength of an economic recovery underway since his 1933 inauguration. As he began to lay out a second-term agenda in the spring of 1937, it was easy to see signs of that recovery. The Dow Jones Industrial Average (DJINDICES: ^DJI  ) had risen 260% from Roosevelt's first day in office. Unemployment, which surpassed 25% in the first months of his presidency, had fallen to about 11% shortly after the start of his second term. The real corporate earnings of most large American companies had nearly recovered to their 1929 peak after more than doubling over the course of Roosevelt's first term, and real national GDP had grown as much in those four years as it had during the course of the entire Roaring '20s, surpassing its 1929 high-water mark before Roosevelt had even begun his re-election campaign.

This was almost entirely undone within a year. After peaking in early March of 1937, the Dow fell 49% in 12 months. Unemployment fell below 11% that summer but spiked to 20% a year later. Corporate earnings were cut nearly in half, and industrial output went into a tailspin. According to historian David M. Kennedy, it was a faster economic collapse than that seen during the early years of the Great Depression.

At the time, Roosevelt's economic inner circle contained some prominent fiscal conservatives, including Treasury Secretary Henry Morgenthau. These men wanted a balanced budget, an argument Roosevelt readily accepted once the worst of the Great Depression seemed to have passed. From 1936 to 1938, the government undertook one of the largest spending reductions ever seen in the absence of a war, even while the tax take soared as Social Security taxes were collected for the first time. Spending declined by 17% as total federal receipts grew by 72%. An inflation-fighting policy shift toward monetary tightening at the Federal Reserve only made the decline worse.

Roosevelt reversed course the following year, increasing federal spending by a third in 1939. By the time the United States entered World War II, unemployment had returned to levels not seen since 1930, and the economy was growing at one of the fastest rates in modern history. However, the downturn of 1937 prolonged ultimate recovery for years, and it took a World War to return the country to full employment.

Could the same thing happen again?

History (kind of) repeats itself
The numbers behind the present economic recovery look rather similar to those of Roosevelt's first term. The Dow has nearly doubled since President Obama's first inauguration. Unemployment peaked at 10% several months into his first year in office and has since declined to just less than 8% -- a slower decline from a much smaller peak. Real corporate earnings have nearly recovered to precrash highs, and real GDP has already surpassed its late-2007 level. Unemployment has declined at a slower rate than it did in Roosevelt's first term, but women rarely worked in 1937, and blue-collar jobs in cyclical industries were then a far larger part of the workforce.

Obama is also pursuing several measures that will have a similar effect as Roosevelt's austerity. He has agreed to a firm $1 trillion in spending cuts over the next decade as a result of 2011's debt ceiling deal. The sequester, which is set to start tomorrow once the Office of Management and Budget submits its official notice (due before midnight tonight), contains an additional $1.2 trillion in across-the-board cuts for the next decade. Some commentators, including former Reagan policy analyst Bruce Bartlett, expect it to be short-lived, but some additional cuts beyond the agreed-on $1 trillion could still be in the offing.

Tax hikes are already taking hold as well. The payroll tax cut expired at the end of last year, and that will combine with anticipated Obamacare taxes and the new taxes on high-earners from last year's fiscal-cliff standoff to create a $174 billion tax-related drag on the economy. If the sequester holds up, the total drag on the economy in 2013 will be worth about $304 billion, or 1.9% of GDP, according to The Washington Post's Brad Plumer. Without it, we'll see a $226 billion drag, equal to about 1.4% of projected U.S. GDP this year.

This is nowhere near as bad as the damage caused by Roosevelt's policy shifts. Tax receipts are only expected to rise 18% this year, while government spending remains flat from 2012. That's less than half the growth in tax receipts seen in 1937, a year in which government spending declined by 8% and no one actually saw an immediate benefit from the new Social Security taxes (which were not first distributed until 1940). However, real GDP growth has been less potent during the current recovery than it was during Roosevelt's first term. GDP only barely made it to a positive result in the fourth quarter of 2012 and posted a moderate 2.2% growth rate for the full year. In contrast, real GDP grew 13% in 1936 and continued to grow another 5% in 1937 before falling by 3.4% in 1938.

What lies ahead
The situations in 1937 and in 2013 aren't truly comparable. Seventy-five years ago, much of the working population was on farms or in factories, and families waited in bread lines with no Social Security and had a far less comprehensive system of unemployment insurance. It's hard to compare that to a world in which millions are covered if they lose their jobs and more of the population actually holds or seeks a job in the first place. The recovery started from a far deeper pit in 1932 than it did in 2009, but it's been just as much of a struggle to climb all the way out this time. The government has actually supplied far less of a stimulus boost than it did during the Great Depression -- annual federal spending grew 79% over the course of Roosevelt's first term, but only 9% during Obama's first.

Investors wondering how this combination of tax hikes and spending reductions will affect the economy might use the Dow's performance from 1937 onward as a rough guide. The Dow didn't regain its 1937 high until 1946, and it wasn't until 1949 that it put that level behind it for good. We've spent more time in the shadow of the dot-com peak (adjusted for inflation, the Dow topped out at more than 15,300 13 years ago) than investors of the '30s had spent in the shadow of 1929, and the economy is more stable today than it was in Roosevelt's day. However, the risk of a politically driven downturn appears quite real, as a combination of higher taxes and lower spending doesn't have to be as extreme as it was in 1937 to send a more fragile recovery back over the brink.

Obama might wind up with an FDR-like legacy -- just not in the way he'd like.

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Read/Post Comments (11) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 01, 2013, at 8:40 PM, eMoney003 wrote:

    Are you really surprised the stock market is having issues. Every time you turn around the current administration is threatening one product after another. Gun sales are through the roof, but who wants stock in companies that may or may not be shut down soon? Who wants stock in auto dealerships who sell gas guzzlers if gas prices keep rising and the Federal government keeps pushing for Smart Cars? The current administration needs to get their nose out of all the companies and merchandise across the globe. They need to stop telling people what to buy or not buy, and just let them live their own lives.

  • Report this Comment On March 01, 2013, at 10:07 PM, ethelmerman wrote:

    Failure in every sense of the word.

  • Report this Comment On March 01, 2013, at 11:53 PM, knudknudson wrote:

    I am very surprised by this article. It is not the Motley Fool's m.o. to publish outsized scare articles. Assuming the vicious, crazed, obstructionist, anti-American Tea Party Republicans do not get their way (which represents a minority of Americans), and the sequester is ended, there is no reason why the economy would not continue on its positive trajectory. And speaking of cycles, after 10 years of a flat market, physics calls for a continuing, even roaring bull market. A very big difference between America after the Depression and America post Great Recession; American corporations have never been more cash rich. Oligopolization and globalization also makes the comparison between post Depression and now a non sequitur.

  • Report this Comment On March 01, 2013, at 11:57 PM, whereaminow wrote:

    ---> President Franklin D. Roosevelt won an overwhelming re-election in 1936 based on the strength of an economic recovery underway since his 1933 inauguration. <---

    That's probably the most simplistic view on Roosevelt's re-election I have ever seen. It's also completely false.

    David in Liberty

  • Report this Comment On March 02, 2013, at 12:07 AM, chnge wrote:

    what stupid article...clearly an Obama supporter...i guess the fact that we entered WW2 which created thousands of jobs virtually instantly had nothing to do with the recovery...

  • Report this Comment On March 02, 2013, at 12:27 AM, TMFBiggles wrote:

    @ knudknudson -

    Physics does not call for anything. The average length of secular market cycles, which includes both long bulls like the 80s and 90s and the Great Depression era secular bear market, is slightly under 17 years:

    http://www.fool.com/investing/general/2013/02/25/the-complet...

    Also, keep in mind that the Nikkei has spent about 25 years now falling from its 1989 peak. The only major market period shorter than the current one was the Roaring 20s. There is no law that says a stock market has to rebound simply because it hasn't for a certain length of time.

    Cash in reserves also seems like the real non-sequitur to me. What are corporations doing with it? Paying dividends? Hiring more people? Anything that might be considered economically stimulative? If they aren't doing any of these things now that the economy is expanding, there seems to be no reason to expect them to do so in the event of a downturn.

    I'm not saying we'll have another Great Recession. I just believe that it's important to be aware of the very real political headwinds to continued expansion at this time.

    - Alex

  • Report this Comment On March 02, 2013, at 12:43 AM, TMFBiggles wrote:

    @ David -

    This wasn't an article about the 1936 election, but: FDR won 61% of the vote (one of the largest margins in history) and all but 8 electoral votes, and real GDP had surpassed its 1929 level by the time of the election after turning up in 1933:

    http://goo.gl/Bo5K3

    So I'm not really sure what part of that is factually wrong. Maybe you have a different definition of "overwhelming" and "recovery," but the data backs the use of both words up rather unequivocally.

    - Alex

  • Report this Comment On March 02, 2013, at 6:50 AM, skypilot2005 wrote:

    On March 01, 2013, at 11:53 PM, knudknudson wrote:

    “Assuming the vicious, crazed, obstructionist, anti-American Tea Party Republicans do not get their way..”

    Labeling people. Now. That’s real intellect.

    Come on.

  • Report this Comment On March 02, 2013, at 11:26 AM, Lew3555 wrote:

    Obama= total fail

    The stock market continues to do well DESPITE what Obama does to try to destroy our country.

    Obama isn't even worthy to lick the boots of FDR.

  • Report this Comment On March 03, 2013, at 11:52 AM, porschetech wrote:

    I am completely blown away that people created profiles on fool.com to make comments on this story. It just further convinces me of paid bloggers.

    Anyways back to the article. I do not believe that America will fall into another recession, however I do believe that we must change our investment style if these cuts stay permanent. It is good food for thought.

  • Report this Comment On March 04, 2013, at 10:24 AM, rdub76 wrote:

    The above comments show what is causing the lack of any level of certainty in the recovery. Each side blames the other in politics. The fact is 99% of politicians and far too many business leaders are out to achieve the same ends. Enriching themselves by any means possible including threatening the global economy if the government doesn't give them what they want. The government needs to be extracted from the market so that the public can determine what products and companies are worthy of remaining. Let bad companies go under and good companies rise. The recent HSBC money laundering wrist slap proves that governments are more interested in maintaining friendships and donors than pursuing justice.

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