Pondering the Current Markets

by Inya Ivkovic, MA

Mark Twain once wrote, “History does not repeat itself, but it sure does rhyme.” What I see in this quote is really an extension of frequently asked questions by our readers, family and friends, all wanting to know if we are dealing with a bear market rally, all worrying if we may have entered a depression. And although we cannot answer these questions for certain, we believe the subject is deserving of some thought.

On a very high level, there are some uncanny similarities between what had happened during the Great Depression and what is happening today. First, both the Great Depression and “Great Recession” originated in the U.S. Second, excess leverage appears to have been fueling the speculation in the 1920s, as it has been in retail mortgage products and complex securitized derivatives today. Third, during both periods, home prices have been severely deflated. And fourth, during both periods, massive government policy, fiscal and monetary stimulus was needed.

During the 1930s, it was the “Smoot-Hawley Tariff Act” that many blamed for turning what could have been a bad recession into a depression. In essence, the Act introduced huge taxes on imported goods to the U.S. It was protectionism taken to the extreme, with dubious results. Today’s government intervention is called by some “manipulation of the debt market,” but it is in essence just another form of policy intervention, whereby world governments buy mortgage debt in hundreds of billions of dollars in order to keep rates for mortgages affordable and to stimulate home prices.

At face value, measures taken to address the economic downturn in the 1930s, as well as today, make sense and offer plausible supporting arguments. But digging deeper into the current severe economic downturn, while some of the government interventions are yielding benefits in the short run, we have to acknowledge that mistakes have already been made in the long run.

We hope that mistakes will not be as devastating as those made during the Great Depression, but people have to realize that no one can get everything right, because no one has the detailed map out of this mess and because crystal balls are in short supply lately. That does not mean that having central banks worldwide acting as lenders of last resort is necessarily a mistake. But just because something is working in the current distorted environment, does not mean that we should neglect searching for the new normal in the longer term.

Going back to comparing the Great Depression and Great Recession, did you know that, after the market crashed in 1929, it rallied 48% immediately, only to decline significantly more over the next few years? One cannot but wonder what people were thinking then. That said, after the market tanked in 2008, it rallied in the spring, and memories of a similar bear rally sprang to many minds.

We doubt that the same pattern is going to be repeated this time around, at least not to the same extent, despite the rebound we have experienced and in spite of the weeks of weakness that still occur. On the other hand, at this point, it is also still too early to tell if we are really heading towards a worsening situation. The current market behavior indicates that the worst is behind us. However, we are not completely sold that the market has it right this time and that the future is going to be easier for us from this point on.