Arthur Laffer has done a better job making money for his investors than in proving that his economic models work.
His $250 million of accounts for institutional investors rose 60 percent after fees last year, outpacing the 26 percent advance of the Standard & Poor's 500-stock index. They fell 20 percent in 2002, a year when the U.S. benchmark dropped 23 percent. In May, he opened a mutual fund, the Huntington Macro 100, that has collected $12.5 million in assets.
Laffer, 64, advanced the notion as an adviser to former president Ronald Reagan that government revenue would increase because of the economic stimulus of federal tax cuts -- a theory that is still regarded with skepticism by many economists. As chairman and chief executive of his own money-management firm, Laffer now picks stocks by focusing on government taxes and spending, instead of income statements.
"All the work I've done, in academics, politics and business, is to try to figure out how government policies affect the world," Laffer said in a telephone interview from San Diego-based Laffer Investments Inc., which he started in 1999. "We don't look at any of the micro stuff of a company, and the bottom line is that all these people who do look at it don't do any better than us."
That approach led him to favor companies based in California, including Cisco Systems Inc. of San Jose and San Francisco's Wells Fargo & Co., after Gov. Arnold Schwarzenegger repealed an increase in vehicle taxes and reformed the workers' compensation insurance system, which had the highest premiums of any U.S. state.
"California has gone from one of the worst states to one of the good states, and you can see that in our portfolio selections," Laffer said.
The Macro 100 fund invests in about one-fifth of the country's 500 biggest companies. Since May 3, the fund is down 2.6 percent, compared with the 3.4 percent drop of the average large-cap growth stock fund tracked by Bloomberg. The S&P 500 fell 1.6 percent in the same period.
Laffer buys shares of companies whose workforce, clients and plants are located in states with the lowest income, sales and property taxes. He's partial to companies that produce goods that are traded internationally because he expects the dollar to fall.
Laffer also analyzes companies' sensitivity to changes in government spending and the yield on bonds of different maturities to forecast corporate profits. His biggest holdings at the end of June were Microsoft Corp., Cisco and Dell Inc.
Cisco, the world's biggest manufacturer of equipment to route Internet traffic, depends on Europe and Asia for more than 40 percent of its sales. Dell's headquarters and one of its manufacturing facilities are in Texas, where there is no state income tax.
"It's an unusual strategy, especially since in the last several years you really haven't seen people advertising a macro approach," said Paul Herbert, a fund analyst at Morningstar Inc. in Chicago.
In 1974, Laffer sketched on a cocktail napkin a curve explaining his theory that economic growth increases with cuts in marginal tax rates. His idea became a key part of Reagan's "supply-side" economic policy and earned him a place on Time magazine's list of the 100 "greatest minds" of the 20th century. Laffer was a member of Reagan's Economic Policy Advisory Board for both of the late president's terms.
Six months after Reagan took office in 1981, the U.S. economy slipped into a recession. The unemployment rate climbed to 10.8 percent by November 1982, the highest since the Bureau of Labor Statistics began to compile the data in 1948. Reagan cut marginal tax rates by 25 percent and lowered the capital gains tax rate to 20 percent from 28 percent to boost economic growth. The economy recovered and the nation's debt swelled to a record.
Many economists weren't convinced by Laffer's models. Former President George H.W. Bush called it "voodoo" economics when he was running against Reagan for the Republican nomination for president in 1980.
Laffer, who plans to vote for George W. Bush again in November and who picked Bill Clinton twice, says stocks are the cheapest they've ever been relative to corporate profits. The S&P 500 is down 1.5 percent this year because of concern about November's presidential election, he said.
"You're really going to see the stock market roar back," said Laffer, who graduated from Yale and Stanford. "The economy is in better shape today than it has been in my lifetime."
Laffer adjusts corporate profits to account for changes in the value of inventories and other items, and then divides them by the yield of the 10-year Treasury note to determine a theoretical target for the total market value of the S&P 500.
"We wouldn't be surprised if the S&P rose 15 to 20 percent in the next 12 months, based purely on economic fundamentals," said Laffer's son, who's also named Arthur.
Financial and technology stocks accounted for 77 percent of the Macro 100 fund's assets at the end of June. "When you have a market that's undervalued, these are the groups that really respond when the market catches up," said the elder Laffer.
The Macro 100 fund charges a management fee of $75 per $10,000 invested, compared with $56 for the Fidelity Magellan Fund. The fund is sold through financial advisers who charge a maximum fee, or "load," that's equal to 5.75 percent of assets invested.