Is 1929 Being Replayed This Year?

July 18, 1997

Maybe. Here's why:

If you take the run up in the stock market between January, 1920 and April, 1930, and overlay the present day run up in the market you will see remarkable similarities. Look at the weekly Dow closes. You'll see the bottom line is the stock market run up in the '20's (black line) and the present day run up in the market (red line). The 1920's line (black) is the Dow Jones average multiplied by 22. This factor takes into account changes in the Dow and changes in inflation. While the lines are not exactly the same, they are uncannily close!

This was updated on 7/18/97

What does the graph tell you to expect?

By the way, after 4/98, the market resumes a year's long slide to about 907 in June of 2000 IF we follow the historical curve that far.

The market should top (on a weekly basis) the week ending either 8/22 or 8/29 of this year with the highest ending weekly Dow at 8367. You may see a closing day slightly higher, but it's the weekly close we're concerned with here. And the peak could be a month early or late. It's better to be out one month early than one day late.
The market isn't expecting any BAD news till the middle or end of August - and if there is any, it will be shrugged off. When a trigger event comes, it is not likely to be a war - but watch copper prices as an indicator. Copper prices (especially the futures) generally accelerate upward. So does gold. When the trigger event comes, look for a major natural disaster or a political trigger as most likely.
Commodity prices should be falling. Wheat, corn, even gold (real money) should be dropping pretty quickly now. Look for auto sales to be sluggish. Remember that auto sales slumped in the summer of '29 and GM that year dropped from 224,000 units per month (June) to 94,500 units per month (Dec.) and we may see a late summer/early fall slump in computer sales as a prelude to this year's correction.
The slide may go as low as 5032 by the week ending 11/29/97.
We should have a little rally back to the 5400 level around Christmas.

Of course history doesn't repeat itself exactly, so anything goes. History suggests that we are tracking fairly close to the 1929 run-up curve. Could this set up a replay of the crash of 29 for later this year? I've purchased SPBOT (S&P500 March ('98 600 puts with the S&P at 914). [This is not investment advise, I'm just sharing with you what I have personally done, dollar cost averaging into out-of-the-money puts over the past month.]

Look for the market to continue up until mid-August, then a late summer trigger event that will take everyone by surprise. This could take the form of Whitewater indictments, a North Korean insurgency, a Russian counter-revolution, a Middle-East oil threat or even a large earthquake in Japan which could trigger the biggest slide of an economy since the Roman Empire.

At the office, I have a little $20 bet going with my boss that the market will be below 6,000 before January 1, 1998. His view - and it's the conventional wisdom on the street - is that the market is too high but that things look better than they ever have so there's no reason for the market to head south. The Street logic is that the Baby Boomers are madly saving for retirements and will continue to scrimp and save - and they will have to put their money some place and that place is the market.

Maybe. But I think not -

If we study long-wave economic theory (Kondratieff, et al) we should have had a big correction to the stock market not more than 64 years after the last crash. This means we should have seen the crash not later than 1993-4. But here we are, three years later, and the Crash is not here yet. So what gives?

Well, not all the historical elements were in place in 1992. Here's a list of some of the historical elements, some of which are just now falling into place:

Kondratieff and the long wave theorists speak of "peak" and "trough" wars. In other words, wars tend to break out following economic peaks and following economic valleys. If you look at the long wave of history, you'll see wars (or war substitutes*) occurring roughly every 50-60 years. The Civil War and WWI were Peak Wars. So was the war of 1812. If you have peace, you have a chance of economic panic. If you have war, everyone closes ranks and pulls together.
Given that wars tend to occur at or following the peaks and valleys of an economy, you then should look at the timing of past depressions and panics. These tend to cluster in the window from 10-15 years after the end of a Peak War. Historical evidence: The panics of 1832, 1873 and 1929-30 all fit this mold.
What's the Peak War that has recently ended? The Cold War between the US and Soviet Union and the subsequent dissolving of the Soviet State into the CIS. Although it was not a "shooting war" with a lot of physical casualties, it was actually a pretty good war in terms of meeting the economic objectives of war - namely to waste at least 10% of the GDP of participating countries over some period of time. [See: "A Report from Iron Mountain on the Accessibility and Desirability of Peace", Allan Lewin, 1970, Dial Press]
People are living longer. The economic and cultural memories of our grand parents (and parents) tend to keep the next generation from repeating follies which beset the previous two generations. In other words, if Mom & Dad lived through the Depression, they will train you not to repeat the mistakes they made. The traditional brake on excess is being released as the number of people who remember the Depression decreases.
Depressions tend to occur about 40 years after a key technology begins to permeate society. For instance, the precursor technology to the 1873 panic was the railroad expansion in America in the 1830-50's. The Railroad Barons were the singular titans of industry. Then automobile technology, which evolved in the 1890's, hit 40 and the mid-technology depression of the 1929-1933 resulted. Will the 40-year figure hit again? I'm afraid it may.

The computer is now turning 40. Remember, you didn't need the transistor for computers to evolve. Certainly, silicon has helped. But Brainiac, Eniac and Univac were vacuum tube technology computers. Von Neumann's math doesn't require SMT or Alpha chips or Windows&trade.
Is there a correlation between singular titans of industry? If you look at the premier technologist of the 1920's (Henry Ford) and extrapolate what his personal fortune was in 1929 you come up with something in the neighborhood of what Bill Gates is pulling down in the computer business. The guys with all the marbles in the 1873 panic were the railroad barons. One man or a very few men always seem to end up with the reigns of a dominant new technology as it turns age 40.
Lots of social patterns of last Depression are being set up. This may seem a little like seeing pictures in clouds, but consider some of the social parallels: Coffeehouse society of the 20's has been rebuilt by Starbucks. The Lost Generation of the 20's is our own Gen-X. White opals, and other semi-precious stones, are again being touted - just as they were in 1928. Kids in school in high school in the '20 were trying to act tough, like the "gangsters" of the day: Alfonse Capone and Dutch Schultz had a certain panache which kids admired. Today, even in the upper middle class 'burbs, the kids are cloning gang clothing and speech. Kids in the late '20's wanted a Tommy Gun. Today, in the words of rap singer(?) Rappin' Fortay, "rat-tah-tat-tat, 'cuz you gotta Gat. You like it like that." Different market? Well, different guns: Gats & Glocks.
Housing has become unaffordable for an increasing portion of the population. As good housing becomes less attainable, upward pressure on housing prices eases. Seeing the value escalation slow, people are likely to wake up one morning and in large numbers say, "Hey, time to get out of this big house and into something a little more affordable".
Of course, personal debt has continued to climb, too. Personal bankruptcies will top 1.3 million this year - up from last year's record.
There's the problem of war, which is coming. Depressions happen 8-12 years after the end of a war. 1873's depression followed the end of the Civil War, the '29 crash followed the end of World War I and we're now 8 years after the fall of the Berlin Wall (1989). 10 years after the de facto end of the Cold War. The week ending 7/18/97 saw more than 3000 rounds (including mortar fire), exchanged between North and South Korean troops along the DMZ. It was underplayed by mainstream media, but the peninsula could flare up any time.
If this is the late 1920's all over again, who will play the role of the Weimar Republic? The remnants of the Soviet Empire. Just like Germany was "shredded" after World War I, so too the Soviet Union has been shredded. The danger I see 5 years from now (or sooner) is that we'll see a replay of the Weimar Republic complete with a Hitler-like beer hall uprising. Look for the emergence of a supernationalist in the CIS who will rearm Russia. Does it have to happen? No. Is it likely to happen? From the historical perspective, yes. Expect to see pictures of Russians with wheelbarrows full of money to buy a loaf of bread with the Russian government inflates to pay workers - and turns on the printing presses of money creation.
Are stocks overpriced? Yes. The historical Price/Earnings ratio of stocks is something on the order of 12 - 14 times earnings. In other words, a stock which earns $1.00 per year (in growth of sales) would be fairly priced at about $12-$14 per share. Lately the ratio has been much higher. Coca-Cola is up around 43 times earnings. In other words, people are buying Coke stock thinking it will go up from here! Go look up something called the "bigger fool theory" of markets.
Are stocks overpriced? Yes. The valuation of all stocks has historically been about 48% of the US GDP (Gross Domestic Product). In other words, the value of all companies on listed exchanges has been about 1/2 of 1 year's economic output of the country. Today stocks are priced at 118% of GDP (Thanks to USA Today for the stats). The last time we had a BIG Crash ('29) stocks were priced at 77% or GDP and dropped to 33% of GDP. In 1987 stocks were priced at 64% of GDP and fell into the 40's.
Are stocks overpriced? Yes. The fair value of the Dow is about 3,200 based on earnings, and dividends.
Are stocks overpriced? Yes. Every time traders have said "This time it's different..." the crap hits the fan. What's "different" this time is "growth" stocks. The buzzword is "growth". But it's another way to say "a stock, which can't pay a dividend". The same great sales organizations which mislead the American Public on inflation ("Prices go up" instead of "The value of your money is going down") are now touting Growth instead of yield.
Are stocks overpriced? Yes. Many high tech stocks are sort of like a Ponzi Scheme. If you were building a Ponzi Scheme, at a high tech company, here's how you would do it: You'd pay the chairman his compensation as a bunch of stock. The chairman would then turn around and sell the stock on the market and pocket the cash. Next, the company goes to the open market and buys the stock back, which the chairman just sold. The amount of stock doesn't go up, but demand is flamed and the Chairman makes all the money. Interestingly, it doesn't matter much to the chairman if the stock price goes up or falls, as long as he can keep the scheme going. Why should a dividend be paid, when the chairman can make all the money in the world simply getting and reselling the same stock over and over again?

Homework assignment: Explain how this is different from what Microsoft does.
Are stocks overpriced? Yes. Dividends are disappearing. It used to be that when you bought a piece of a company you would be paid interest on your investment on a quarterly or annual basis through a dividend. Any appreciation in the underlying stock price was a nice bonus...but the game was total yield: dividend plus growth in the underlying company which enhanced its value. Now, none of that matters. I strongly suggest to you that times have not changed. Good companies still have cash left over which can be used to pay dividends. Growth companies are generally cash strapped. My view is pretty simple: If a company doesn't pay a dividend, don't invest in it. Oft quoted Professor Irving Fisher of the prestigious Harvard Business School was busy telling people in August 1929 "We have reached a new plateau" and the rules have changed. Sure. You'll hear "new plateau" statements everywhere today.
Commodities are stalling (in many cases falling). Bumper crops are coming amid flat demand due to declining exports. It's more supply and stable demand. What is that a formula for? Falling prices. When commodities fall, markets follow - in time. There are some great, but rather short term profits...but eventually as goes the farmers (and General Motors!), so goes the economy. This is something you can track all the way back to Tulipmania in 1634-1637 when the Dutch ran up the price of tulip bulbs to incredible prices. There's the South Sea Company bubble.
The Mutual funds of today are the bubble. More people are selling funds than at any time since the '20's. Oh, excuse me. In the '20's they were called Trusts. The name was changed in the Depression to protect the guilty. Trusts were closed end mutuals. A few survived. The "new" name for Trusts is Mutual Funds and they are predominately open end in structure. There are more "trusts"...er...mutual funds...than there are major stocks to invest in!
Did I mention the recent epidemic in third world currency devaluations? The Philippine peso follows Thailand, Malaysia and others. This sets up a foreign debt collapse which could also be a trigger event. Don't forget that loans to South America were popular in the '20s and contributed to the liquidity crisis after the Crash in '29. Watch the Brazilian stock bubble collapse. It has not spread to a lot of neighboring countries (yet), but Brazil is in a heap of trouble.
One last thought: we're in another mass migration of the population. Not only from East to West but from the BIG megacities to the smaller cities of 50-100,000. This is why small towns like Boise Idaho are going gangbusters and LA is stagnant. California's future growth, for example, is more likely in San Luis Obispo than in San Francisco.

Can it happen again? Sure. It's only a matter of timing. Read Rees-Mogg "The Great Reckoning" for some of the global implications of deficit spending and the high cost of peace.

It's reasonable to expect that this crash will play out differently. Margin won't be blamed. Options and derivatives may be, but more likely is the huge mountain of personal debt, especially the runaway inflation of real estate prices fueled not so much by demand, as the availability of easy money. Second and third mortgages, wraps and other creative financial schemes have run up the price of housing. Over a long period of history, you could only afford a house priced at twice the income of the primary breadwinner. Today, both breadwinners' incomes are counted and then it's 4-10 times annual income. That's a sure formula for disaster because when financial markets melt down, liquidity is what saves the day. The wealth of most Americans is neither accessible nor real, as they will likely soon find out in painful, personal terms.

Fueling the real estate bubble has been the explosion in personal real estate contracts. This type of money creation is totally out of control of the Fed. It's one reason why M1 is up slightly but M3 is up dramatically. When you create a personal real estate contract, you're creating money. Just as the barter economy is beyond federal control, so too, real estate contracts.

This time, instead of margin calls, look for layoffs in key industries - starting later this year perhaps in computers and autos. You may not see these layoffs at first because they will happen in "soft jobs". There are two kinds of "soft jobs": Large airlines, like Delta and others, now use temporary workers to answer phones. Why? In the event of a slowdown they are not "employees" - they can be instantly trimmed with no revenue liability. Other declines will occur as businesses realize that "information systems" departments and other non-essential staff jobs can be eliminated because the difference in typing speed between Word 2.0 and next week's version of Word is zero.

As these instantly downsized millions of highly leveraged homeowners discover they're out of a job, they will flock to dump securities and mutual funds to keep their bellies full and a roof over their heads, tax consequences be damned. No, it won't be the same as margin calls, but the effect will be the same. Banks will likely end up with big stocks of property which they will sell at deep discounts, providing large losses for them on paper, but making lower priced housing available within a few years for today's young people. We may not have a run on banks: we may have cash machine networks shut down. American consumers are a sadly gullible lot. Where else in the world would people tolerate paying a fee to get their money out of a bank as many do when they use an ATM machine?

I'm not positive how close we'll follow the chart. But watch the stock market closely and listen for the first person to yell "FIRE!" in this very crowded theatre.

Many financial academics insist that markets operate efficiently and are rational. But the people who panic in the crowded theatre looked pretty rational too when they neatly lined up, and sat in assigned seats.