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What caused the stock market crash of 1929 and the bear market which followed? The period from 1929 to 1933 was the worst bear market in the history of the United States stock market. Many analysts have looked at the 1929 stock market in the United States, but what happened in the rest of the world, and what lessons can be learned from those fateful years? This newsletter will attempt to answer those questions.

1929: Ursa Major

One of the biggest games on Wall Street is to compare the current market situation to 1929 or 1987. The market is frothy. The bubble is about to burst. The lemmings are rushing in, and all those people in mutual funds will never get out alive. But is the current market like 1929? The problem with these analogies is that very few people actually understand what happened in 1929 because they have only looked at the United States stock market. Almost no one has looked at the big picture, specifically, how the world's stock markets behaved in the 1920s and 1930s. What happened in London? Paris? Tokyo? Berlin? Could you tell someone if they asked you? This newsletter will review what happened in the world's stock markets during the 1920s and the 1930s.

Everyone knows about 1929. That was the year the market crashed. The real crash. Not that fake crash in 1987, but the real thing that led to the Great Depression. People jumped out of windows. Investors went bankrupt. And were it not for Franklin Roosevelt, civilization as we know it would have come to an end. Was 1929 really that bad? Yes. In 1929, Wall Street was the most important stock market in the world, and its 86.2% decline between September 1929 and June 1932 is still remembered today.

But the United States isn't the only country in the world. What happened in the rest of the world? Did foreign stock markets scream upward as the bubble in stocks grew larger and larger, then collapse afterwards? How much did other stock markets decline during the 1929-1932 bear market? The sad fact is that until now, no one has ever asked and answered these questions until now. Here's a summary of some of our findings on these questions:

• For the majority of stock markets, 1929 represented a rally within a downtrend. Most countries which were tied to Germany economically saw their market tops in 1920, not 1929.
  
  
• The most spectacular rise in stock values during the bull market of the 1920s came in Germany, and both Belgium and France had larger bull market rallies than the United States had.
  
  
• Of all the world's stock markets, the United States had the largest stock market decline after 1929. This is why the 1929 crash is remembered so well in the United States.
  
  
• In many countries, the stock market indices did not recover their 1929 highs until the 1950s.
  
  
• Many of the stock markets which did recover their 1929 highs before the 1950s did so only because of inflation. Some markets have never regained their 1929 highs in real terms.
  
  
• For some countries, the 1929-1932 bear market was not the worst one in history. Germany's stock market fell by over 97% during the hyperinflation of 1922, and London's decline in 1973-1974 was worse than the decline in 1929-1932.
  
  

The 1922-1929 Bull Market

Following World War I, there was political and economic chaos. The boom which followed World War I proved short lived, as politicians failed to sort matters out at Versailles, the Brussels Conference of 1920, the Genoa Conference of 1922 and other international meetings. The result was a world-wide recession in 1921 and hyperinflation in Germany 1922 and 1923.

Between 1920 and 1922 world stock markets crashed, in some cases, more spectacularly than in 1929-1932. But by 1922, the tide began to turn, and most stock markets bottomed out and began the bull market which would last until the United States stock market topped in September of 1929 and crashed in October of 1929.

How big was the bull which lead to the 1929 crash? The table below provides data on 20 different countries. The table shows the month in which each stock market hit its low, the month in which the bull market ended, and the percentage increase in that country's stock market during the bull market.

International Stock Market Returns 1921-1929

Now, let's analyze one of the most famous bull markets from a world perspective. To do this, we'll divide the world's stock markets into four categories. First, there were the bubble markets which rose and crashed spectacularly.

The United States bull market of the 1920s has been studied numerous times, so there is no need to go into detail on the stock market other than to establish the United States as a benchmark with which to compare other stock markets. During the 1920s, a plethora of new products flooded the American market in the 1920s providing increased earnings and growth for numerous new industries, including automobiles, movies, radio, and even electric utilities; and with Europe in chaos, much of the money was kept in the United States. As we all know, the bubble fed on itself until it burst in 1929. A partial recovery ensued in 1930, but then it was straight down. The S&P Composite fell by 86.2% between September 1929 and June 1932. It wasn't until September 1954 that the S&P Composite passed its September 1929 levels—a 25 year wait. But what about the rest of the world?

Second, there were the European economies which posted new highs in 1929. Only four European countries achieved new, all-time highs on their stock market's indices in 1929: Belgium, France, Italy and Spain. The probable reason? None of these countries suffered economically from the reparations and other war-related costs which were imposed upon Germany, nor were their economies dependent on Germany's. In fact, both the French and Belgian stock markets did quite well during the 1920s, increasing by over 400%. But these two stock markets were also among the worse performers in the bear market which followed.

Third, there were the northern European economies which were tied in one way or another to Germany. Without exception, these countries' stock markets failed to reach a new high in the bull market of the late 1920s. None of them recovered from the collapse in their stock markets which occurred in 1921 and 1922. The combination of war reparations, political chaos, hyperinflation, and other economic problems prevented a strong recovery from occurring.

But wait! If you look at the table on the previous page, Germany's stock market had the strongest recovery of any stock market in the world. However, these figures are deceptive. The strong recovery only reflected how much the hyperinflation of 1922 and 1923 devastated German financial assets. In real terms, between May 1918 and November 1922, German shares declined by 97.4%, a collapse even worse than that which occurred in the United States between 1929 and 1932. Even with a tenfold recovery between 1922 and 1929, the German stock index was still 29.6% below its level in May 1918.

Those countries which had their economies tied to Germany suffered similar, if less onerous fates in the 1920s. The 1929 rally was a rally within a downtrend, not a bubble that burst. The table below shows the behavior of these countries' stock markets, showing the month for which each stock market hit its high, how much the 1929 peak was below the all-time high in 1920 or earlier, and how long it was before the stock market index overtook its historic peak.

Stock Markets Declining in the 1920s

For both Switzerland and the United Kingdom, the 1929 peak was more in the nature of a double top than a rally within a downtrend. The London stock market was in a secular bear market from 1900 until 1921, and even though the market rallied strongly in the 1920s, it still failed to overtake the 1900 highs. From a longer term perspective, this recovery is less impressive. The Global Financial Index of British stocks, which uses the Financial Times-Actuaries base of April 10, 1962 = 100, recorded a high of 155.61 during the South Sea Bubble in June 1720. It wasn't until July 1968 that the All-Share index finally broke through the old high of 1720. In other words, someone who had bought stocks at the top of the South Sea Bubble would have had to wait 250 years to get their principal back and not suffer a capital loss. Of course, dividends, not capital gains, would have returned shareholders' investment long before 1968, but this should remind investors that stocks do not always go up.

Finally, there is South Africa and Australia. Both countries' stock markets suffered declines of 40% to 50% during the 1929-1932 bear market, and then recovered quickly. For these two countries, the decline which followed 1929, though sharp, was more of a correction within a continuing bull market than a secular bear. South Africa's stock market had recovered its 1929 highs by 1933 and Australia by 1934.

The 1929-1932 Bear Market

So how bad was it? Very bad unless you were short. In fact, the only other world-wide bear markets comparable to the 1929-1932 bear in this century were the 1920-1922 and the 1973-1974 bear markets. To show you the impact of the 1929-1932 bear market, the table on the next page summarizes the impact of Ursa Major on 20 different countries, listing the world's stock markets from the market with the largest decline to the smallest. We have shown the month of the market's top, the month of the market's bottom, the percent that the market declined, and the recovery date, which tells you how long investors who bought at the top of the bull market would have had to wait until they got their principal back.

This table should leave no doubt as to why 1929 leaves such a bad memory in American investors' psyches. Of all the world's stock markets, the United States had the largest decline. It wasn't just the crash of October 1929 which did investors in, but the long, continuous decline that occurred from mid-1930 until the summer of 1932. It should come as no surprise that the markets which had the largest bull markets in the 1920s also had the largest declines in the bear markets which ensued. The United States, Belgium, Canada and Poland all had bull market runs of over 300%, and subsequently declined by over 80%. Many markets had their worst declines in history and shook investors' faith in markets for decades.

This evidence shows that mega-bulls produce mega-bears. The best performers in the 1920s became the worst performers in the bear market of 1929-1932. Investors in both the United States and Canada had to wait until 1954 before their indices recovered their 1929 highs. Neither the United States nor Canada has ever had a bear market as bad as this one.

In fact, although the table shows that some markets overtook their 1929 highs by the early 1940s, the truth is quite different. War brings inflation, and inflation deflates the real value of financial assets. Measured in real terms, the French stock market index is still struggling to overtake its all-time high in 1912. Even though the French stock market index as calculated by the INSEE rose by 65% in nominal terms between 1943 and 1951, it fell by 85% in real terms. Now you know why the stock market declines every time inflation fears rise: the stock market has memories which many investors do not.

The Germany-related stock markets, which were already in downtrends in the 1920s, had smaller declines than the markets which led the 1920s bull market, but their overall decline from their 1920 highs remained substantial. The only markets which came out of the 1929-1932 bear market relatively unscathed were South Africa and Australia. Not only did these markets have smaller declines, but they were among the first to recover their 1929 highs. South Africa Gold shares moved counter-cyclically to the bear market, topping two-and-a-half years before New York did, and bottoming only six months after the crash. By 1934, South Africa, Australia and Japan had all recovered their highs of the 1920s.

Although the tops in different countries' stock markets was spread out over 1928 and 1929, the bottom in the bear market can be pinpointed rather closely: May and June of 1932. Only Belgium, France (after the election of the Popular Front in 1936) and Spain (due to the civil war) were to sell off to lower lows after the 1932 bottom.

The Five Criteria

There are five factors which can cause Ursa Majors, economic declines and political chaos, speculative blow-offs, high inflation or hyperinflations, and the culmination of secular tops which build up in the world's stock markets over time. When these factors occur together, the impact on stock market values can be devastating, as history has shown.

The 1920-1922 bear was a combination of economic decline, political chaos and inflation exploding in the countries which had participated in World War I. Germany saw its stock market decline by over 97% in this bear market. Most stock markets in northern Europe never recovered their 1920 market highs until the 1940s. Both 1920 and 1929 were the beginnings of severe economic depressions which led to double-digit levels of unemployment in most countries. The hyperinflations which accompanied the economic collapse of Europe only worsened matters.

One important point which this newsletter has tried to make, and which few people have recognized, is that although the 1929 bull market rally was a bubble in the United States which ultimately burst, this was not true of stock markets in the rest of the world. If anything, 1929 was the final rally within a secular top which had been building in world stock markets since the beginning of World War I.

The decades between World War I and World War II were fraught with economic and political crises, making any sustained market recoveries almost impossible. Nations could not agree on their political differences, the United States preferred isolationism, and no world-wide economic system was created to replace the Gold Standard which had fallen apart during Bretton Woods. It wasn't until the establishment of Bretton Woods, and the stabilization of currencies in 1948-1949 that the foundations were laid for a stable economic environment in which economies could grow and stock markets could once again rise in value.

A similar, though less dramatic situation occurred in the 1960s. As inflation began building up in the world's economies, and the Bretton Woods system began breaking down, a long secular top began building in the world's stock markets between 1962 and 1973. Stock markets in France, Switzerland and Austria failed to overtake their 1962 highs until the 1980s, and the United States hit its high in 1966, and began to falter for the next 16 years, declining in real terms during this period by 75%.

For some stock markets, 1971-1973 was the final blow-off with Japan and Hong Kong rising the most spectacularly. In Hong Kong, the Hang Seng index rose 880% between 1971 and February of 1973, only to collapse 91.5% by the end of 1974. Even though the Japanese stock market rallied strongly, few people realize how much Japanese stock market equity had been devastated by the post-World War II inflation. Measured in real terms, the Japanese stock market has never overtaken its top in November 1916, even during the blow-off which occurred in 1990!

Both the 1929-1932 and the 1973-1974 bear markets ended secular tops which had been building in the world's stock markets for a decade. The 1971-1972 rallies which occurred in Japan and Hong Kong were just as dramatic as the 1929 bull market rally had been on Wall Street, and also, just as good of indication that the end of the bull market which had begun back in the 1940s was finally coming to an end.

What would cause another bear market similar to the one in the 1930s?

Are we facing another 1929 in the near future. We should remember that no one can accurately predict the future. Very few economists or Wall Street pundits can even explain what happened in the past, so how can you expect them to predict what is going to happen in the future? Predictions are based upon probabilities, not facts, so the question might be rephrased, does the market's current behavior portend a large decline in the market with a high probability in the near future? Based upon the analysis of the 1929-1932 bear market, there are several questions which I think are important.

First, is the world currently in the throes of economic depression or recession?

Although it is impossible to predict the future, it would be difficult to argue that the current situation bears any resemblance to the chaos of the 1920s and 1930s, or the inflationary explosions of the 1970s. In most countries, inflation rates are falling, not rising, and the world's economies are opening themselves up to trade, not setting up new barriers. Although the transition to a world without socialism may be difficult, signs of economic collapse are few. Although the world's economies could sink into a recession in the near future, it seems unlikely it would be as sharp as the recession/depressions which began in 1920, 1929 and 1973.

Second, is the world falling into a period of political chaos?

The answer to this would be a decided no. Although there is a threat that political changes in Russia or China could create economic or political disruptions, nothing comparable to the chaos of inter-war Europe, or the stranglehold imposed upon the developed countries by OPEC yet exists. Although GATT and NAFTA and the European Economic Community may not work as well as their participants may want, they provide a stark contrast to the League of Nations in the 1920s and the United Nations during the Cold War.

Third, are the world's stock markets in a speculative blow off?

Although the United States has certainly had a spectacular run since 1994, and the Japanese market has yet to recover from its blow-off in 1990, whether world stock markets are in a blow-off stage right now is debatable. As we have seen, stocks blow off every year, emerging markets in 1994, Bangladesh in 1996, Asian markets in 1997. These blow-offs have led to sharp corrections and crashes, but a sustained bear market requires bad news developing over a period of time. That could happen in the future, but does not look inevitable right now.

Fourth, is inflation building up within the world's economies?

One difference between the bear markets of 1920-1922 and 1973-1974 and the bear market of 1929-1932 was that the first two were accompanied by inflation while the 1930s bear was accompanied by deflation. Although inflation can trigger bear markets, it is not a necessary condition. Although there are signs that inflation is building up within the United States, there are no signs of the advent of the hyperinflations which occurred in the 1920s and 1940s in Europe, the double-digit inflations of the 1970s, or the hyperinflations which occurred in developing countries in the 1980s. Even the economies which collapsed when the Soviet Empire fell have all recovered from the hyperinflations which struck their economies in the early 1990s. In fact, there is a more a fear of deflation than inflation among some economists.

Fifth, are the world's stock markets near the end of a long, secular top as occurred in the 1920s and 1960s?

It is true that some of the world's stock markets have failed to overtake their highs of 1987 and 1990. Portugal remains below its 1987 high, both Japan and Taiwan remain well below their blow-off tops of 1990, and Australia is just now reaching its 1987 high. But these countries are the exceptions, not the rule. Most of the world's stock markets continue to hit all-time highs.

One reason why 1987 did not lead to an Ursa Major of the 1929-1932 variety, despite the similarities between 1987 and 1929, is that none of the five factors discussed above was present in the world's stock markets in 1987. There was no political or economic crisis which would undo confidence in financial markets, no inflation that was building up, and if anything the world's stock markets were at the beginning of a bull market, not the end. Although Wall Street pundits were quick to draw the analogies between October 1987 and October 1929, to my knowledge no one put world stock markets in their historical perspective. If they had, they would have realized how different 1987 was from 1929, not only in fundamental economic terms, but in terms of the world's stock markets as well. By no stretch of the imagination was 1987 at the conclusion of a secular top which had been building in the world's stock markets for a decade. If anything, 1987 was more akin to 1920 and 1962 than to 1929.

Conclusion

Even if the evidence points against an Ursa Major in the near future, this does not preclude a bear market of the more normal variety. Market corrections of 20% or more can occur whenever economic and political uncertainty exist, major recessions occur, inflation reaches double-digit or hyperinflation levels, markets blow off, or tops have built up within a markets. Until several of the five factors which were discussed here occur in tandem and in strong doses, the probability that another 1929-1932 bear market will occur is low.

Bryan Taylor II, President
Global Financial Data, Inc.
784 Fremont Villas
Los Angeles, CA 90042
Phone: (877) 328-2999
E-mail: btaylor@globalfindata.com

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