5/1/2009 9:09:53 PM
Now vs 1929
It's an interesting to compare now to the depression, here's an interesting post I found posted November 17th 2008.
It also talks about why it may not be an accurate model... reminded me of the earlier discussion about it being an inflationary depression, or deflationary.
The post can be found here
“Those who do not learn from the past are doomed to repeat it”
If someone wants to dispute the viewpoints, that’d be great. I’m not looking to be right, I’m looking to learn. As such I will present potential cases for why the comparison may be valid, and why it may not. My bias certainly could show, so that’s why I want to encourage discussion.
First we are going to start off with the 1929 comparison, simply because there’s no comparison more attention getting then a “pre depression” scenario. And there’s so much fear and forced selling, and a deflationary situation, that we might as well take a look.
This first 2 charts compares the percentage run up before the decline from 1929 and onward, a 31 year time horizon from 1900-1931 and from 1972-2009, which has yet to be completed.
Can you guess which one is which? Clearly in 1971 we came off the gold standard, and the dollar became a currency. This will naturally lead to inflation. Since the indices are priced in money, and not things, the run up from 1972 to 2008 is expected to be larger, and its not necessarily a reason to panic. So while some might say “we’re going to crash even worse”, others will clearly disagree, because everything’s different. An interesting thing to note is the 5 year percentage chart. Not NEARLY the magnitude of the move in the last 5 years as 1925-1929. However, 1996-2000 has roughly the same magnitude of the move. But again, this supports 2000 being closely correlated with 1929.
When looking at some of the charts above, it’s important to note inflation, and for this, it may be better to look at an inflation adjusted dow. The link shows that the longer term gain of value is not significantly worse than 1929. Interestingly, the run up didn’t begin in 1900, and inflation adjusted from 1900 to 1920 actually shows a decline. But around 1921-1929 is when the market really rallied from real relative lows. And it was not until 82 or so until 2000 when the market really rallied. The inflation adjusted rallies from 1921 to 1929 are quite similar in strength to those from 1982-2000. This is just information, that come to think of it, in the comparison, may be more telling that 2000 top is similar to 1929, and now we’ve had one of the post 1929 rally attempts, anywhere from 1929 to 1937, and continued the following patterns. But we’ll get to those comparisons another time. As of now, we’re slightly more focused on how the price run up LOOKS, and the type of psychological effect it may have on our ability to price our own ability to produce. But we still want to recognize that the magnitude of the move due to inflation requires an adjustment.
Below will be another chart. I don’t remember the dates but the time frames are not the same length. Seeing this 1929 chart, was the primary reason for me making the connection from the technical comparison. When I saw the 1929 chart, I knew it would be similar, and it proves to be more so than I thought…. However, consider the time frames is not the same, so if you expect history to repeat and take the exact length of time, to play out, you are using the wrong comparison.
When actually evaluating the same time period, the declines from the top don’t match up. 1929’s decline occured much more quickly.
If you’re curious, this is what matching up the same length of time would look like.
Clearly not the result we are looking for.
We came off of all time highs with a significant decline, and we can see the behavior, and psychology is similar, based on collectively what everyone believes the prices of several stocks on average is worth using a variety of factors.
Finally, lets look at fundamentals:
According to a 2007 google video with Robert Prechter
2007 dow div yield: 2%
Has been 13 years since they have been higher than 1929
: I found a good article about 1929 fundamentals here.
“Barrie Wigmore (1985) researched 1929 financial data for 135 firms. The market price as a percentage of year-end book value was 420% using the high prices and 181% using the low prices. However, the return on equity for the firms (using the year-end book value) was a high 16.5%. The dividend yield was 2.96% using the high stock prices and 5.9% using the low stock prices.”
“To summarize: There was little hint of a severe weakness in the real economy in the months prior to October 1929. There is a great deal of evidence that in 1929 stock prices were not out of line with the real economics of the firms that had issued the stock. Leading economists were betting that common stocks in the fall of 1929 were a good buy. Conventional financial reports of corporations gave cause for optimism relative to the 1929 earnings of corporations. Price-earnings ratios, dividend amounts and changes in dividends, and earnings and changes in earnings all gave cause for stock price optimism.”
“Although it can be argued that the stock market was not overvalued, there is evidence that many feared that it was overvalued — including the Federal Reserve Board and the United States Senate. By 1929, there were many who felt the market price of equity securities had increased too much, and this feeling was reinforced daily by the media and statements by influential government officials.”
“the Federal Reserve Bulletin of February 1929 states that the Federal Reserve would restrain the use of “credit facilities in aid of the growth of speculative credit.”"”
The market did not fall just because it was too high — as argued above it is not obvious that it was too high.
The actions of the Federal Reserve, while not always wise, cannot be directly identified with the October stock market crashes in an important way.
The Smoot-Hawley tariff, while looming on the horizon, was not cited by the news sources in 1929 as a factor, and was probably not important to the October 1929 market.
The Hatry Affair in England was not material for the New York Stock Exchange and the timing did not coincide with the October crashes.
Business activity news in October was generally good and there were very few hints of a coming depression.
Short selling and bear raids were not large enough to move the entire market.
Fraud and other illegal or immoral acts were not material, despite the attention they have received.
Thursday, October 3, 1929, the Washington Post with a page 1 headline exclaimed “Stock Prices Crash in Frantic Selling.” the New York Times of October 4 headed a page 1 article with “Year’s Worst Break Hits Stock Market.” The article on the first page of the Times cited three contributing factors:
A large broker loan increase was expected (the article stated that the loans increased, but the increase was not as large as expected).
The statement by Philip Snowden, England’s Chancellor of the Exchequer that described America’s stock market as a “speculative orgy.”
Weakening of margin accounts making it necessary to sell, which further depressed prices.
While the 1928 and 1929 financial press focused extensively and excessively on broker loans and margin account activity, the statement by Snowden is the only unique relevant news event on October 3. The October 4 (p. 20) issue of the Wall Street Journal also reported the remark by Snowden that there was “a perfect orgy of speculation.” Also, on October 4, the New York Times made another editorial reference to Snowden’s American speculation orgy. It added that “Wall Street had come to recognize its truth.” The editorial also quoted Secretary of the Treasury Mellon that investors “acted as if the price of securities would infinitely advance.” The Times editor obviously thought there was excessive speculation, and agreed with Snowden.
There’s some other great stuff in that encyclopedia article, I reccomend you check it out.
Now I will look at this comparison from 2 angles.
First I want to talk about why today could play out in a similar way: Before the crash, you have major amounts of credit at unseen levels. Some argue that we can print money at will, but the counter argument is “what good does it do if the banks won’t lend, and credit is contracting at a faster rate than we can create new credit. ” So if we do have a 1929 scenario, in some ways, things could occur more slowly, as we try to slow the effects down, and we have some tools to do so, that we didn’t before, but it might not be likely for these to change the outcome, just slow things down. Others may say we are expanded globally, and the flow of money is faster, and with better technology and more things happening at once in more areas around the world, that may “speed up” the effects, and the net result may be similar in pattern. While some might argue that this will not happen because things are so much different without the gold standard and federal reserve, we have to recognize that everything has expanded so much that although we do have certain things we can do, the problems have become unmanageable, which may have been the problems of the 1929. So while it’s easy to believe we can inflate our way out of this mess, there’s only so many people that want loans, and only so many people interested in borrowing, and with the increased lending restrictions, and regulation, even with all the creative ways to pump liquidity into the system, it simply may not be enough anyways. And while certain factors our different, human psychology does not really change all that much. We may learn from the past, but emotions still drives our actions and thoughts. If we act in fear of something happening, we may either create that thing because of fear causing irrational behavior, or create something much worse.
Again, I don’t seek to be right, this article is for us to both learn. So now…
why this comparison either isn’t good, or won’t work:
First of all, no gold standard. That means we have more control and can print ourselves out of the problem. Even if no one wants loans, we can always come up with creative ways to get out of the problem by increasing the money supply. We are doing the exact opposite as before. Without the gold standard, it is much easier to do things that will create more credit and more inflation. So whether or not that is a good thing, now we at least have the choice.
Second, in 1929 the opposite action was taken as rates were hiked and the fed attempted to slow down what was thought of as excess speculation and credit, while also returning the real value (gold) to the US.
Another thing you must realize is that the banking crisis didn’t start in 1929, but later on in the early 30s, after the 1929 lows were broken. This could mean things are more serious, or it could mean that we’re simply aware of the problem sooner, and can deal with it sooner. Regardless the timing and effect it will have is different, and will most likely have different results. An interesting thing is that some may say that the 1930’s banking crisis may have been a result of the Fed’s action in the late 1920s. If this is true, we might expect the exact opposite future, where rather than deflation, we will eventually have serious inflation in the next few years.
Bernanke clearly is “a student of the great depression” and wants to make sure it doesn’t happen again. He’s clearly afraid of letting something like that happening, so instead, he’s doing the exact opposite action. With an infinite amount of information available, it’s very easy if you’re used to studying something extensively to notice similarities. In doing so, it is very reasonable to assume that Bernanke will OVER react. While history does repeat, we learn from our mistakes, and 1929 is a mistake that too many people are refusing to make. While it may be too late to undo the factors that lead up to the great run up in prices from the 1970s on, Even if the decline was the same, the future will be completely different, as we will make sure the result will not be the same.
In Summary: If this scenario plays out, there should be a sharp rally at some point in the near future. In 1929 the rally was about 60% from the low. I believe right now it’s better to be positioned for the upside, if you must. I made a great flip as I took profits after noticing the overwhelming bearish sentiment, and making some trades. I believe that if we rally from here short term and it could be the start of a strong rally. I think it’s very likely that we gradually decline in price through massively large swings up and down with big up days and down days, but I believe there’s more upside in getting long here, particularly in OTM calls speculating on a big move. However, I do believe in system trades as well, and I don’t like playing one side too heavily, so I have no problem with you taking Woodshedder’s Big Bamboo trade, and likely will take the trade myself. I’ll take a lower win rate for higher reward potential here on the upside, hedged with a high success high reward system trade.
Starting this week I’m actually mostly neutral, but I will add on a decline and become short term bullish. Unless we break the 11/13 (weekly) lows, I actually think I will be long here, even though the thought of saying I’m bullish kind of “hurts”. This may be a “buy when you are most fearful play.” Which will happen if we retest last weeks lows. Large price swings could very well continue to be dangerously high, and as long as I’m looking short term, I will look to mostly position myself in out of the money Dec08 and Jan 09 calls and puts, rather than stock, to allow me to better manage these big moves without a large amount of capital at risk.
Personally I think it is very difficult to get much of an idea based off of just this one comparison, but I hope that after doing this series and looking at several, it will be much easier to get a more reasonable picture of the future. I think one of the reasons things are so volatile is because both individuals, and people looking at both angles disagree on the future drastically. On one side, you have the deflationary spiral and the belief that it will continue and that the worst is very much yet to come, and that Dow could hit 1000 or lower. On the other side, you have the massive inflation picture that may occur down the road.
I believe this post shows a valid argument on why it’s one of the reasons I am starting to like long gold and commodities and short stocks in the long run. I recognize the possibility that eventually there will be massive inflation in either scenario, even if it could be a long time from now. However, I also believe that during deflation, many stocks will get hurt much worse as stocks have been priced on their FUTURE ability to produce based on the idea that they could borrow to grow. Where it is my opinion that more consideration should have been put on their ability to survive severe downturns through plenty of cash, debt that’s easier to manage, and a solid balance sheet, as well as their ability to produce in financial Armageddon. More emphasis should have been on a dividend, as companies with dividends not only offer reassurance that they are making the earnings they say and not manufacturing them, but should things go wrong, they can cut the dividend and continue to operate at the same capacity and expand and grow, as if nothing ever happened. If other people come to this conclusion, or if problems play out and lending becomes scarce and growth becomes difficult, and credit drys up, and companies are forced to make layoffs, and the layoffs hurt the average income, which hurt housing prices and our ability to consume, which in turn not only hurts businesses, but businesses dependant upon other businesses. The outlook is very grim for businesses and stock, and many will head to zero in a deflationary scenario. Although it will hurt commodities, I don’t believe it will quite have the same impact. Bankruptcies for companies mean that the stock goes to 0 and never returns. In that scenario, the shorts on stocks will beat the shorts in commodities and ags. Also, I believe that Bernanke will fight deflation to the best of his ability. Long term that does signal inflation, but it could take a long time. Where stocks can go to zero, and businesses can no longer have demand, people will still need to eat, and globally, oil will be in demand, even if oil companies fail. Now eventually the same demand that we had may return, but the ability to supply that demand perhaps will not. I’ve been an oil bear, but I want to shift to being a bear on some oil companies now (I recently bought APR 2009 puts on MUR), as well as coal companies (KOL puts) and I eventually will accumulate a long term position on oil (USO) and nat gas (UNG), while also buying solar (TAN) as a hedge to a global diversification out of oil and into alternative energy.
Conclusion: I hope you learned a little something, even if you have no idea what the future will hold. Looking at any one situation independently will show both similarities, and differences to the world we live in today. However, looking at what happened and why in several historcial sitautions, should allow you to have a better understanding of the big picture, and allow you to recognize what’s happening quicker than everyone else, as well as see farther out into the most likely future, which should give you an edge, while those who fail to learn the lessons of history will miss it. History shall repeat,, and those who do not learn from history are doomed to repeat it.