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Generational Dynamics Web Log for 30-Oct-04
Yesterday was the 75'th anniversary of Black Tuesday, October 29, 1929, the stock market crash

Web Log - October, 2004

Yesterday was the 75'th anniversary of Black Tuesday, October 29, 1929, the stock market crash

Analysts and historians yesterday completely missed the point.

There were lots of retrospectives yesterday, talking about what happened when the stock market crashed 75 years ago, and why it couldn't happen again. The AP story by Michael Martinez is a great historical summary.

The reason that most people give that it can't happen again is because the Federal Reserve has changed policy since 1929. Unlike 1929, today the Fed policy is to make a great deal of money available during times of financial crisis -- that's why interest rates have been near-zero for the past few years. That didn't happen in 1929.

Major stock market declines <font size=-2>(Source: WSJ)</font>

Major stock market declines (Source: WSJ)

Those who say it can't happen again point to the day in 1987 when the stock market fell by the greatest amount (on a percentage basis) in history. The Wall Street Journal used the adjacent graphic. According to one analyst I saw on tv, "The Fed made plenty of money available in 1987. If it weren't for that, a new Great Depression would have begun in 1987."

This represents a complete misunderstanding of what's going on, but before we get to that, here's a table of then ten worst days in the history of the stock market, as measured by falls in the Dow Jones Industrial Average (DJIA):

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So if you see this table, you might be inclined to agree. After all, if we recovered so quickly in 1987, then we can recover any time, can't we?

Historical Price/earnings ratio for S&P 500

Historical Price/earnings ratio for S&P 500

The reason that these analyses are wrong is because stocks were generally not overpriced in 1987. In fact, price/earnings ratios had been below 10 in 1980, and were rising slowly.

In 1929, stocks were way overpriced, with price/earnings ratios into the 30s. No Fed action in 1929 could have prevented the stock price fall that brought price/earnings ratios below 10 again.

So I completely disagree that the Fed saved us from a new "great depression" in 1987. The Fed's actions kept a lot of things running smoothly of course, but even without them, stocks would have returned to the growth path they exhibited through the 1990s.

Total credit market debt <font size=-2>(Source: PIMCO)</font>

Total credit market debt (Source: PIMCO)

Today, things are much more like the 1930s, in that stocks are still way overpriced. The Fed's zero-interest policy has kept stock prices up, but that can only work so long.

The price/earning ratio is not some obscure measure that I made up to make some sort of point; P/E ratios were commonly used by analysts until the last decade or so to decide the relative values of stocks. Back in those days, prior to the early 1990s, all the senior financial managers in the country were people who had lived through the 1930s Great Depression, and so were very risk-averse investors. They considered P/E ratios to be one of the best measures of stock value.

In the last ten years, senior financial managers have all been in the generations born after the Great Depression, and these risk-seeking people have thrown out P/E ratios as a valuable indicator. Nonetheless, it simply doesn't make sense for investors to purchase stocks from companies whose annual earnings per share of stock are less than 5% of the value of that share of stock.

We're now into some three years of consistently wrong forecasts of jobs, inflation rates and output by a wide variety of analysts of all kinds - forecasts that have been proven overly optimistic to the point of wishful thinking.

I've recently been highly critical of statements by Alan Greenspan and Fed Governor Ben Bernanke that are increasingly self-serving and questionable, so much so that economists are becoming increasingly skeptical of the Fed's credibility.

On the 75'th anniversary of the 1929 stock market crash, the risk-averse generation of people who lived through the Depression are gone. Today's financial leaders are from subsequent risk-seeking generations, and are getting increasingly restive and confused about what's going on in today's economy. (30-Oct-04) Permanent Link
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Generational Dynamics Web Log for 30-Oct-04 Yesterday was the 75'th anniversary of Black Tuesday, October 29, 1929, the stock market crash

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Generational Dynamics Web Log for 30-Oct-04
Yesterday was the 75'th anniversary of Black Tuesday, October 29, 1929, the stock market crash