This little book by Charles Rivers Editors made very interesting reading for me over the Christmas period. It was not technical and was written in layman’s terms so it is well worth buying a copy if this brief summary piques your interest. I can only do scant justice to the lessons investors can draw from these historic events in an investment blog.
The crash in October 1929 was the culmination to what became known as the Roaring Twenties, as the US economy and stock market boomed, driven by strong industrial production and new technology. Employment was high and prices were stable. Prior to 1920 few ordinary Americans owned stocks but as prices rose through the 1920s middle class Americans piled in, often buying stocks on credit or margin. Stock prices had a momentum all of their own and became detached from the real economy and investment fundamentals. From 1922 they rose almost 20% p.a. on average, although not uniformly. Although concerns were raised in early 1929 the market continued to rise fuelled by speculators. From May 31st to August 31st 1929 Westinghouse Electric Corporation rose 89%, Steel was up 56% and the market overall rose by just under 25%.
On 5/9/29 Roger Babson, an entrepreneur and economist predicted a crash at a meeting of the National Business Conference. It was a repeat of an earlier warning he made at the same time in 1927 and 1928. Babson’s comments evoked retorts from economists and stock brokers. For example Professor Fisher, a noted Yale economist claimed, “stock prices are not high and Wall Street will not experience anything in the nature of a crash.” In early October 1929 Thomas Lamont, head of Morgan Bank wrote to President Hoover, “The future appears brilliant. Our securities are the most desirable in the world.” Almost every business leader and banker was saying how wonderful things were and the economy was only going in one direction, up.
The Dow Jones Industrial Average peaked at 381.17 on 3/9/29 and then declined to 320.91 by 21/10/17. The sharpest declines then occurred on Monday 28th October, with the index falling 12.82%. This was followed on Black Tuesday, 29th October by a further drop of 11.73%. Further losses occurred subsequently and the Dow finished the year at 248.48, a decline of 34.8% from the peak on 3/9/29. This was followed by the Great Depression with 50% declines in industrial output and international trade. Unemployment rose to 25% and around 9,000 banks collapsed. The stock market continued to fare badly. In 1930 the Dow fell a further 33.76%, in 1931 it lost 42.67% and in 1932 the market was down by 22.64% (Source: https://tradingninvestment.com/stock-market-historical-returns/ ). If the Roaring Twenties was a heck of a party the Thirties was the mother of all hangovers, with the Great Depression going global. The cause of the Great Depression is still not agreed by economists but it may not have been simply due to the 1929 Wall Street crash. One observer noted that the market slump reflected the change which was apparent in industry and the economy. In other words the stock market merely acts as a mirror on the economy i.e. cause and effect runs from the economy to the stock market, not the other way around. I am not convinced about this argument but space does not permit me to express my thoughts.
There are several other interesting facts to note. Firstly the Dow Jones did not recover back to its former peak until 1954, 25 years after the crash. Secondly the biggest ever one day fall was not in 1929 but on 19 October 1987 when the Dow fell 22.61%. What is it about October? This sell-off in contrast to 1929 did not lead to a recession. Thirdly on the reasons for the crash an article from the New York Times on Tuesday 22nd October 1929 was illuminating. This was before Black Monday and Black Tuesday but after three days of losses in which billions were wiped off the value of shares. Five reasons were given for the falls which I paraphrase:
*Readjustment of stock prices to levels that are justified by earnings, economic fundamentals and company prospects.
*Unanswered margin calls from thousands of small investors. In order to cover the loan repayments or interest payments stocks were sold. This downward pressure on the market was enhanced by stop-loss orders. These are where investors instruct sales once a floor in the stock price has been reached.
*Foreign selling on a large scale especially in railroad stocks as overseas investors protected their interests.
*Short selling by investors taking advantage of a falling market.
*Negative sentiment amongst stock holders even those with profits. This is about investor psychology, rushing on mass towards the exit.
This analysis more than 87 years ago feels like a modern commentary on the causes of stock market crashes in more recent times. Nothing has changed. Once the slide starts it is like a snowball gathering pace and size as it accelerates down the hillside. Big market crashes are sudden, (the warnings and red signals are not but the immediate triggers are), sharp and self-perpetuating. Nothing has changed and although we have not had a crash since 2008 why should we think another is not coming? John Templeton famously noted that the four most expensive words in the English language are – “This time it’s different.”
So what do I conclude and why have I raised this subject now as my first blog in 2018? It is certainly not because I wrongly called a correction in late 2017 and am seeking justification for my view. Moreover I don’t believe the economy and stock markets in 2018 are anything like they were in the US in 1929. I don’t think there is a bubble in equities in general nor have prices become universally detached from economic reality. My concern is due to a bullish and perhaps complacent attitude amongst investors. The global economy is going through a synchronised recovery, central banks are cautious and accommodative and people made money in 2017 from equities. So why not again in 2018? My message is investors need to keep in mind a sell-off will happen again, no-one knows when, and plan accordingly. That does not mean avoiding equities completely but being cautious and investing a significant part of a portfolio in defensive assets. This will require adjusting expectation of returns from “shoot the lights out” performance to beating inflation or cash, more modest outcomes. Of course individual needs and circumstances will dictate the correct investment strategy and asset allocation, notably investment timescales, attitude to risk, capacity for loss and cash reserves. There is no one solution for all.
Finally it is worth Babson got it wrong calling a crash in 1927 and 1928 but then it happened in 1929. I got it wrong in 2017. I hope I also am wrong in 2018 and I would take no pleasure should 2019 prove to be a terrible year for equity investors.
The content of this blog is my own understanding of the 1929 Wall Street crash and the global economy and stock markets today. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.