THE BUY SIDE: MARKETS

Today's turmoil doesn't presage another Great Depression

AVNER MANDELMAN

Avner Mandelman is president and chief investment officer of Giraffe Capital Corp. and the author of The Sleuth Investor. amandelman@giraffecapital.com

October 25, 2008

Newspapers and TV seem to carry a daily talking head, warning us we are in 1929 all over again. That is, we're facing a repeat of the Great Depression. Are we?

Not likely. Rather, an interesting historical comparison between the 1920s-1930s and today puts us squarely in 1937. And if the comparison is right, we are about to experience a rising market quite soon.

Why the comparison? Because both historical periods saw the bursting of a speculative bubble that caused vast destruction of capital - which, first, caused a three-year market crash of about 90 per cent; in both periods the crash plunged the economy into a funk, which, after a five-year recovery (again in both periods) was echoed in a secondary market plunge of 50 per cent - yes, like the one we just had. In 1937, this plunge was followed by a fast market recovery - which, if history indeed repeats, we are now about to experience.

Should you rely on it? Perhaps not; but at the very least it's a neat antidote to the gloomy talking heads - none of whom, by the way, foresaw the Freddie and Fannie meltdowns. Besides, there are enough economic similarities to make the comparison plausible. So take a big grain of salt and read on.

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The first comparable past period is the decade from 1919 (the end of the First World War) to 1929, when Wall Street experienced an irrational exuberance (speculating in railway bonds), and the Dow (the dominant market then) soared several-fold, ending in the 1929 crash.

Fast forward some 70 years, to the decade between 1991 (end of the Persian Gulf War) and 2001, when the Nasdaq (the dominant market) soared several-fold, ending in a crash. Quite similar, you must admit.

Now back to the past: During the three years following the 1929 crash (1929-32), the Dow lost 90 per cent of its value. Since the U.S. dollar was tied then to gold, the U.S. government did not have today's ability to reflate the currency.

As a result, the crash turned into a depression. That's what gloomy talking heads fear we'll soon face.

But are they right? Not so fast. Go forward again: The three years following the 2001 crash (2001-03), saw the Nasdaq lose 87 per cent of its value (comparable to the 1929-32 90-per-cent loss), and the economy fall into a "mere" deep recession. That period (if the comparison holds) - and not today - was the equivalent of the 1929-1932 depression. And here's a view many may disagree with: 2001-03 did not turn into a depression because the much-maligned Alan Greenspan printed money liberally - something the United States could not do in the 1930s. Yes, Mr. Greenspan inadvertently saved us.

And so, once again back to the past: The five years following 1932 (to 1936), saw the Dow more than double. The economy recovered, and everyone thought the problem was over.

And the comparable present: During the 4¾ years of 2003-07, the Nasdaq more than doubled, and the economy recovered. Everyone thought the problems were over.

And now we finally arrive at the interesting part of the comparison: Between 1936-37, in one year, the Dow dropped a shocking 50 per cent, followed by the 1937 recession. This was when most people lost their shirts, because they had become complacent after the five years' rise. That's also why many 1937 headlines proclaimed that the 1929-32 depression was returning.

This is eerily comparable to today: from October, 2007, to October, 2008, in just one year, the markets (Dow, S&P 500, Nasdaq) lost a shocking 45 to 50 per cent, many retirement plans were decimated, and TV & newspaper talking heads exclaim we're facing another depression.

But are we? The timeline above may indicate that such fears are overblown. Warren Buffett for one is buying stocks hand over fist. What else do you need to know?

Just to be sure, let's dig into the 1937 recession. It was caused by excessive speculation in copper, when banks that lent money to the speculators went bust - just like banks who lent too much to home speculators today. And two other aspects of the 1937 recession are interesting: First, it was short; and second, from its bottom, the Dow rose 49 per cent over the next seven months, declined, rose again - pulled by a strong economy and war preparations - and by then it was 1939, which is when the Second World War started.

And here is where you must pick up an even bigger grain of salt: Because if the comparison holds (a big if), then starting about now, the market could rise significantly into mid-2009, lifted by a wave of freshly printed trillions of dollars - until 2010, when a great military conflict could erupt, as massive worldwide capital destruction has magnified all global conflicts.

Yes, that last part is where the comparison may break down (at least I hope it does); but the last part notwithstanding, I am fairly certain we're not facing a 1929-32 type depression, as the recent huge money-printing cushions the shock, but rather we'll see a garden variety 1937-type recession, during which the market - which looks nine months ahead - could rise strongly into 2009 in the teeth of much incredulity.