What the 1929 crash tells us about stocks today
By
Dominic Frisby Mar 18, 2010
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I was lucky enough to hear a presentation last week by Tony Plummer of Helmsman Economics on the psychology of market patterns and cycles. Tony has kindly sent me some of his charts. I'm going to look at them in today's Money Morning.
'Those who cannot remember the past,' wrote the Spanish philosopher George Santayana, 'are condemned to repeat it'. Judging by historical patterns, it seems investors are a forgetful bunch.
It really is astonishing how history repeats. Humans just go on making the same mistakes.
On the one hand, it's a shame that we don't seem capable of learning. But on the other, it means that smart investors can take cues from the past to get some idea of what might happen in the future…
People make the same mistakes time after time
Let's start with perhaps the most famous stock chart in history. You've probably seen it many times before in one form or another. It's the Dow Jones index through the boom of the 1920s, the bust of 1929 and the Depression of the '30s.
Fast forward half a century and cross to the other side of the planet – it doesn't make any difference, man goes on making the same mistakes. You can't stop him. The chart below shows the boom and bust of the '80s and '90s in Japan (the red line) superimposed on the Wall Street Crash (the black line).
The side axes are slightly manipulated, with Wall Street measured from 50 to 400 and the Nikkei from 500 to 4,500. But even so, the similarities are quite remarkable. Of particular note is the similarity in the duration of each boom and bust. Even the bear market rallies to 1936 and 1996 correspond.
One major difference is that the panic low in Japan of 1992 was higher than the Dow's in early 1932. Not that it would have felt that way to the Japanese. It's also worth noting that 20 years on, in 2008/09, the Nikkei was sinking to new lows.
That's very different to the Dow's experience. Twenty years after 1930, the highs of 1929 still hadn't been revisited, but the Dow was in a clear uptrend. The Depression was over.
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Why Japan's crash should worry the West
Modern Western policy-makers, take note. Japan's policy of interventionist economics created all sorts of mal-investment, from zombie banks to roads to nowhere. Rather than helping matters, it only delayed the inevitable, dragging out the bear market almost beyond belief.
The 2008/09 lows in the Nikkei at 7,000 (and there's no guarantee it won't go lower still) could have been reached a lot sooner, if only policy makers hadn't intervened to prop up a market which needed flushing out. How much better would it have been for Japan had the authorities just left the market alone?
Now we superimpose the dotcom boom-bust on the Wall Street Crash. The side axes are on slightly different scales again, with the DJIA from 50 to 400 and the Nasdaq from below 1,000 to 6,000. The similarities are again remarkable, right up the secondary crash of 2007/08 and 1936/37.
In fact these two are so similar, I'll make a prediction for you. Just as the 1937 low on Wall Street was retested in the early 1940s, I believe that the Nasdaq lows of 2008-9 – and with them the lows of the Dow and S&P 500 – will be retested within the next three or four years. But if Western policy-makers continue to follow the Japanese bail-out model, it'll take longer before we get the retest.
... and don't forget China's bubble
Meanwhile, for all the excitement about China saving the global economy, it's forgotten that China's stock market too enjoyed a speculative bubble. It peaked in 2007. Here it is, superimposed on Wall Street. (The side axes are slightly different again: DJIA as always 50 to 400; Shanghai Composite from 1,000 to 7,000)
Again the boom-bust has the same anatomy. The coming years will reveal whether the Chinese stock market will continue to play out like Wall Street in the 1930s. But for now we're on track. China's bounce out of the crash has happened faster than Wall Street in 1929. But we're now at levels where you might expect it to peter out.
Yes, these charts are slightly manipulated on the side axes, but, in terms of duration, the repeating patterns are uncanny. Human psychology doesn't change. Man will go on experiencing greed, fear, and every other emotion that afflicts investors and market traders. It's one reason it pays as an investor to think for yourself, rather than follow the crowd.
So where are we today?
But where do these repeating patterns say we are in the grand scheme of things today? Assuming that the Nasdaq will continue to track the other major indices, such as the FTSE, the Dow and the S&P 500; and assuming that it continues to follow the old Wall Street model above, we can look to Wall Street in the late 1930s for clues. The Nasdaq, just as Wall Street did in 1937/38, has just bounced after its secondary crash. That model suggests – to my surprise, I admit – that there may be a little more upside left in this rally before the market turns and the lows of last year are retested.
Nevertheless I remain of the mind that the economic house has not been properly put in order; nor has the system been flushed out. I would, therefore, argue that though the upward trend is currently our friend, the greater risk is to the downside.
Another well-known cycle also suggests that the lows for the year lie ahead - the four-year presidential cycle. I'll be looking at this – and what it means for stocks in 2010 - in more depth next week.
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