A question I’m often asked from the old-time bearish crowd (of which I happen to be a member) is, “Michael, what’s the economic difference between 1929 and today, and could what happened then happen again today?”
This summer, I spent considerable time researching and analyzing the events prior to the Great Depression and the great stock market crash of 1929. Here are some important highlights from one of America’s deepest economic crisis:
In 1927, the Governor of the Bank of England, the Governor of the Reichsbank, and the Governor of the Bank of France came to the U.S. urging an easing of American monetary policy. The Federal Reserve obliged and reduced the rediscount rate (now called the Federal Funds rate) from 4% to 3.5% and made money easy. Adolph C. Miller, a dissenting member of the Federal Reserve Board, later in testimony before the Senate Committee said this move by the Fed “resulted in one of the most costly errors committed by it or any banking system in the last 75 years.”
The stock market was already the place to be in 1927. Consumers became speculators and started buying stocks during the market euphoria as money was “easy” and interest rates were low. To a lesser degree, investor speculation in 1998 and 1999 in high-tech stocks led to a final blow out, with the NASDAQ never having recovered from its high of 5,000. (Today, five years later, the index stands at about 1,870).
Most interestingly, and the striking difference between the late 1920s and today, is that the real estate market crashed in the late 1920s, before the stock market crashed. Maybe investors moved out of properties that were declining in price and moved their money into stocks, which eventually crashed too.
Today, we have the opposite: the stock market has moved down. You could even say that with the NASDAQ being down 63% since from its high five years ago, tech stocks have crashed. We all know real estate prices have rallied. Could it be that this time around investors took their money out of stocks and moved it into investment real estate? In the end, will they both not crash just like they did after the boom of the 1920s?
Today, we see a stock market where there is very little motivation for investors to sell stock. In fact, motivation to sell stock is at a 10-year low. And we don’t have rapid speculation in stocks either. These are the most positive factors.
However, the negatives are what I define as “heavy.” If the economy continues to weaken, there will be very little “easy” money room for Greenspan to move, and that’s because interest rates are at a 40-year low already. Consumer savings are at record lows, so consumers have very little room to spend their way out of an economic slowdown. Finally, consumer borrowing is at record highs, so they’ll have a difficult time borrowing their way out of an economic slowdown.
Will stocks crash like they did in 1929? I really don’t think so. But, we can have major selloffs. As the economy weakens, and as the motivation to sell stock increases, a progressively falling stock market will be the order of the day. You’ll see mini-bull rallies here and there, but it will still be a bear market.