[Note: The following is part two of a multi-part installment series expounding Robert T. Pattersons' notable work on the stock market crash of 1929, "The Great Boom and Panic," and its application to our present market environment.]
"It was easy to say how that in early September, 1929, the market was 'ripe' for a fall," writes Patterson. But on the surface of things, while prices advanced, it certainly did not seem so. With respect to what were called 'technical factors,' however, the market was vulnerable.
"A great deal of stock was in comparatively weak hands, notwithstanding the effect of the year's deeper reactions in eliminating thinly margined accounts. In the final four weeks of the boom, as prices rose far above their previous highest levels, the number of new 'shoestring' speculators, and of those who had extended their commitments to the limit of their credit with the brokers, must have increased considerably. Just a 'normal' compensatory reaction would have been sufficient to force some of them to sell, and if an extended downswing were to carry prices below the low points of the August 9 setback, it would cause selling from accounts that had barely survived at that time. Also, at the prevailing high prices, and because of the rapidity of the advance, a considerable amount of profit-taking by the more cautious and less credulous seemed overdue."
Robertson explains that the fuse was lit for the October explosion (or rather, implosion) on Wall Street with the Federal Reserve Board's decision to raise the rediscount rate a month earlier, in August of 1929. Says Roberts, "Why the panic did not begin in August, set off by that traumatic event, which to the knowing was only further evidence of a determined restrictive credit policy, instead of a month later at a higher level of prices, is one of the great mysteries of the boom." The year 1929 was only one of many in which has borne witness to the fact that a lingering tightening bias with respect to central banking policy inevitably leads to a credit crunch, typically spilling over into the equities markets. Indeed, 1999 and 2000 have seen a similar tightening policy from the Fed, with interest rates rising successively beginning with last Autumn. That policy is expected to continue throughout the remainder of this year. Under the venerable "three jumps and a tumble" rule of interest rate hikes, we can with utmost certainty expect a similar stock market decline this Fall, especially since this time harbingers a concurrent topping of major financial cycles.
Patterson further notes, "Although interest rates were high, the amount of credit used to carry stocks on margin was the largest on record." This corresponds closely with our present rate of margin debt. According to the Wall Street Journal of Feb. 15, 2000, levels of margin debt on the NYSE had approached the record levels of 1987, prior to the crash in October of that same year. As of this writing, margin debt on the stock exchanges is at record levels. The implication is that the equities bubble is being fueled by a relentless run-up of debt; i.e., the relentless piling of debt upon debt in an inverted pyramid waiting to collapse of its own weight.
"At about this time," observes Robertson, referring to the months preceding the crash of '29, "some stock transfer clerks were said to have remarked on the many old, high-denomination certificates that passed through their hands, the implication being that an extraordinary number of staid, wealthy people who owned securities outright were moving out of stocks." In many blue-chip NYSE stocks, we are beginning to witness this same phenomenon.
At some point in 1929—it is difficult in retrospect to determine just how or when—the spigots which flowed freely with liquidity were shut off. "The mania for speculation," notes Robertson, "was no longer fortified by an increasing amount of inflationary bank credit." For millions of people who had their livelihoods tied up in the great financial edifice of Wall Street, the beginning of the end had arrived.
Robertson tabs the official "end of the line" for the great '20s bull market at Tuesday, September 3, 1929, at which time the boom reached its peak. The Dow-Jones average of industrial stock prices was 381.17, and that of the railroad stock prices (later known as the Transportation average) 189.11 at the close. "In retrospect," says Robertson, "the market was plainly a 'sick' one after September 3, although between the thirteenth and the nineteenth it rallied and for a few days seemed to have stabilized, with some issues making new highs."
Flash forward to October, 1929: According to Robertson, a leading financial columnist for the Wall Street Journal at that time who was free to express his individual opinion on the market (much like today's smiley-faced WSJ guru, Jonathan Clements) was casting an optimistic frame over the worsening situation on Wall Street, writing: "Every time the market has a bad slump the bears start inflation talk…In years to come you will hear inflation talk when some stocks are selling for ten times their present worth and brokers' loans are many billions higher than they are now…" Others, however, were beginning to take a more precautionary tone—even a bearish one—most notably (strangely enough) the editorial writers for the New York Times.
During the week of October 14, "'crosscurrents' of buying and selling caused a confusion of price changes and a generally downward appearance for the market as a whole," as Robertson noted. This confluence of buying and selling is historically seen at major market tops, and is presently characterizing our own market. Notes Robertson: "Already, however, there was a substantial short interest, and the demand to borrow half a dozen or more important stocks for short-selling purposes was said to be very large." This statement contradicts the conventional wisdom that a large short interest acts as a safeguard against a substantial market decline since, presumably, a large short interest entails the buying back of stock once prices start declining. The testimony of 1929, however, refutes this wisdom. "Highly significant was the comment of one large operator who, noting the risk of obtaining a poor price if one sold stock 'at the market,' observed that stocks were 'easy to buy' and 'difficult to sell.' Even more significant to experienced and objective traders during this period of comparative calm was the relatively small volume of transactions…At times the ticker simply halted while its operators waited for reports of transactions to be brought from the trading posts." This dullness of trading contrasted sharply with the many times during the final phase of the boom during which the ticker was unable to keep pace with the rapid clip of transactions that were taking place and frequently was behind by several hours.
Robertson relates that during this period of time, a Colonel Leonard P. Ayers, a well-known economist, in the Business Bulletin of the Cleveland Trust Company, "undertook to show that during 1929 the apparent strength of the stock market had been deceptive in some important respects, and that the decline extending through the first week of October was, when viewed historically, of major significance:
"'In a real sense there has been underway during most of the year a sort of creeping bear market that has been hidden by the fact that many of the utility stocks, and some of the rails, and certain other issues, have advanced so much as to carry the figures of most of the well-recognized stock averages upward to new high levels from month to month until the sharp decline of September began.
"'This has been a highly selective market. It has made new high records for volume of trading, and most of the stock averages have moved up during considerable periods of time with a rapidity never before equaled. Nevertheless a majority of the issues have been drifting downward for a long time before the recent break began. Many of these have been the preferred stocks which have suffered along with bonds because the public did not prefer them.
"Important declines in stock prices have occurred during the Autumn months in 28 of the past 30 years, usually in September and October. In these typical Autumn recessions the average decline in the Dow Jones industrial averages has been something more than nine percent. The decline from the first of September through the first week of October this year has amounted to 14 percent. In the panic of 1903 the fall decline was 23 percent, in that of 1907 it amounted to 28 percent, and in the post-war reaction of 1919 it was 16 percent. In all other years it has been less than this year.'" The parallels between our present market environment and that mentioned by Ayers in 1929 are too obvious to mention.
For those who seek financial protection during such a time, Robertson relates to us a much sought-after safe haven in late 1929 which could again this year witness a considerable influx of flight capital: "While the stock market was falling, two other important financial markets were on the rise. Bonds were in great demand, especially those of the government and the higher grade bonds of corporations and municipalities. The dollar exchange rates for various European currencies also had increased, the rate for British pounds reaching its highest level in more than a year. Some investors were switching their funds to the safest possible securities, and foreign capital that had been lured to New York by high interest rates was being called home." During this time, gold also was viewed as a safe haven and witnessed a similar flight to quality by many investors.
"At long last," writes Robertson, "a major bear market was conclusively established" on October 21, under the tenets of the venerable Dow Theory. "The downward penetration of an important [support] by the railroad average 'confirmed' a similar breakthrough by the industrial average that had occurred on October 21. Of this the Wall Street Journal said:
"'On the late Charles H. Dow's well known method of reading the stock market movement from the Dow-Jones averages, the twenty railroad stocks on Wednesday, October 23, confirmed a bearish indication given by the industrials two days before. Together the averages gave the signal for a bear market in stocks after a major bull market with the unprocessed duration of almost six years.'"
This would be only a precursor to the harrowing trading sessions beginning with Oct. 24 through November. We will pick up Robertson's account of this in his sixth chapter, entitled, "The Panic Begins," in our next installment.
Clif Droke is editor of the weekly Leading Indicators newsletter, covering the U.S. equities market outlook from a technical perspective as well as the general economic outlook. He is the author of the recently published book, Technical Analysis Simplified. For a free sample issue of Leading Indicators, send name and mailing address to email@example.com or mail to: Leading Indicators, 816 Easely St., #411, Silver Spring, MD 20910.
Be sure and visit our Web site at www.tapetellsall.com
Also by Clif Droke
Back to the Bears Lair
Copyright © 1997 - 2000 vronsky and westerman