February 15th, 2010

1930 or 1974 Recovery? Are You A Pessimist Or An Optimist?

I watched a disturbing video earlier this week from MarketClub. True, it was a promotional video to convince investors to buy their service but it was disturbing none the less. The video’s title, “Is it Deja Vu Again For The Dow?” says it all (although leaving themselves options by posing it as a question). What most struck me was that their case, one we hadn’t heard for about a year, the case that the market today might be similar to the 1929-33 Great Crash.

They summed up the argument in what they claim is an old Hungarian saying, “The past is the teacher of the future,” meaning that historical precedent has a lot to teach about the present. The similarities they find emerging are – again – between the Great Crash and the current situation. Here’s the lead slide from the video:

I, too, believe models for today’s situation can be found in the past. But the “past” is a very long time; one can overlay many past periods onto the present and find well-fitting models. Rather than going to the extremes of the Great Depression (something that might be good for marketing but not necessarily good for investment decision-making), I’ve long found similarities with the 1970’s (see “1973 and 2001 Market Crashes and Today’s S&P 500 Index” from nearly -can’t believe it – two years ago) and today’s market.

For example, I’ve tracked the S&P 500 Index since 1938 and monitored its 7.5% per annum growth bounded within a band +/- 44% from the midpoint; I labeled the chart “Reversion to the Mean” (click on image to enlarge):

Over the past 70 years, the Index has fallen marginally under the lower boundary only three times, the first time in 1974. According to Wikipedia:

“The 1973–1974 stock market crash was a stock market crash that lasted between January 1973 and December 1974. Affecting all the major stock markets in the world, particularly the United Kingdom, it was one of the worst stock market downturns in modern history. The crash came after the collapse of the Bretton Woods system over the previous two years, with the associated ‘Nixon Shock’ and United States dollar devaluation under the Smithsonian Agreement. It was compounded by the outbreak of the 1973 oil crisis in October of that year. It was a major event in the 1970s recession.”

How, then, is today’s market tracking against that recovery? Very well, thank you. Since the bottom of the two crashes, the recoveries have been nearly identical:

After a correction which, based on the 1974 track, should extend to 1000 but for reasons I’ve outlined elsewhere could stretch to 960, the market could resume its recovery track and peak at around 1250 by year-end.

So history does offer some precedence and can be a good teacher. If you’re an pessimist and believe the world is hurling towards another world-wide depression, go back to 1932 as your model. If you believe that a monetary crises “only” on the scale of the collapse of Bretton Woods (floating exchange rates replacing fixed rates), revaluation of currencies relative to the US Dollar, the unpegging of gold prices and an Oil Embargo Crises, you need look no further back than 1974.

However, all bets are off for 2011. We wouldn’t be out of the woods, so to speak, because there was another test of the lower boundary again in 1978, corresponding to 2011 today, back again at about today’s Index equivalent of 950-1000.

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  • Chris

    guru …I like the charts … the recovery does feel like 1974 so far, which is good … all it will take is a little heavier correction than we are all expecting (1000-950ish) and people will be all over 1930 though … and then we get more stimulus and maybe even another cash-for-clunkers … sorry, don't mean to get political … anyway, good info … thanks!

  • Z

    I've seen these charts before..
    In the 30's the US was on the gold standard so I'm not sure about the comparison. My vote is for 1974 too although I'm not bullish.

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