Too many pundits compare our current tribulations to the Great Depression.
Since May, the stock market has cratered, losing 4,500 points on the Dow Jones Industrial Average (as of Friday). All five of America's investment banks -- Bear Sterns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley -- have either disappeared or are no longer independent investment banks. The largest savings and loan, Washington Mutual, and largest insurance company, AIG, had to be rescued by the federal government. The largest mortgage companies, Fannie Mae and Freddie Mac, are wiped out. Recession is now certain. And there are other indicators of major trouble, such as George W. Bush's 26% approval, a low matched only by Richard Nixon's Watergate heyday.
But these pundits are off the mark. We are not in a 1930's environment. Consider:
• In the 1930's the government continuously made grave errors, and both Hoover and FDR pursued policies that exacerbated the country's problems. Raising taxes (income tax was as high as 63%), and raising tariffs (the Smoot Hawley act) are exactly not what we are doing now.
• The Fed back then was choking the economy by reducing the money supply, while now the Fed, run by a chairman who is an avid student of the '30's, is flooding the economy with liquidity.
• Back then, interest rates were raised, and they are at record lows now and were recently cut again.
• Unemployment was as high as 25% in the '30's. It is 6.1% now.
• The Great Depression was born with excess speculative binge in the stock market, which reached new highs in the summer of 1929. This current debacle started with the market at reasonable valuations, and certainly not excessive ones.
• Since the Depression, governments have become much more aggressive about intervening when credit markets freeze or economies struggle. And they have also become much more efficient in doing it. The undergoing effort is unprecedented in size and it is apt to have an impact.
And this was not completely unexpected, either. We had market crashes in 1819, 1837, 1857, 1873, 1893, 1901, 1907, 1929, 1946, 1961, 1968, 1973, 1980, 1987, and 2000. We had 13 recessions since the 1930's. This is the nature of the business cycle. Yes, this one is more violent than most but it would be foolish to expect that every bear market will turn into a Great Depression. And even if you did assume that, we are already at a point where the scales of crisis in the stock market, albeit not in the economy, are not far off from the precedent of the Great Depression.
This bear market is already over 8 years long (the market topped in March 2000). Anyone buying the S&P 500 a decade ago has gained nothing (the only time this happened before was...you guessed it, in the 1930's). Consider the explosive technological innovations and exponential productivity breakthroughs that took place over the past decade, and this is really remarkable. The point being that we are already in the midst of a market break that is pricing a Great Depression in, even though the economic fundamentals are nowhere near the same cataclysms.
This disaster was created by Wall Street, making a gigantic bet with other people's money that the most questionable mortgages extended to the most fragile of borrowers will end up being money good. Low income borrowers with shaky credit ratings were encouraged to lie on their loan applications. And the bet failed. That is regrettable, to say the least. There is a huge transfer of wealth going on, and Wall Street and banks are on the losing end of it. As a result, the credit markets froze and no lending is being done. But those homes are not gone. They are not worth as much as they were thought to be a year ago, but no real property has been destroyed.
Stocks are probably falling because of a combination of panic and forced selling by hedge funds that must meet margin calls from their lenders. In many cases, prices no longer reflect economic realities, they reflect fear.
According To Barron's, in the last 60 years the average US recession lasted 10 months, and stocks typically hit their lows about three months before the recession ended. So if the US entered a recession July 1, as many economists now believe, and the recession was to last until April 2009, a typical bottom in stocks would occur very shortly.
A major concern for any investor is buying too soon. There is no way to tell if the market will stop declining after the first 35% move, and when the tide will change. In 1930 there were tempting bargains, and anyone who bought them would have to endure the decline of the following 3 years. But I believe that the stock market is now priced to generate hefty gains in the long run.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment partnership.
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