Are we Hearing Voices from the Past?

Part - 1

July 19, 1999

The following excerpted material is important for understanding the way many view U.S. stocks today:

"Whereupon stocks not only ceased their precipitous fall, but cheerfully recovered. The lesson was plain: the public simply would not be shaken out of the market by anything short of a major disaster. But the speculative memory is short. As the people that summer looked back for precedents, they were comforted by the recollection that every crash of the past few years had ultimately brought prices to a new high point. Two steps up, one step down, two steps up again -- that was how the market went. If you sold, you had only to wait for the next crash (they came every few months) and buy in again. And there was really no reason to sell at all: you were bound to win in the end if your stock was sound. The really wise man, it appeared, was he who 'bought and held on.' Time and again the economists and forecasts had cried wolf, wolf, and the wolf had made only the most fleeting of visits. Time and again the Federal Reserve had expressed fear of inflation, and inflation had failed to bring hard times. Business in danger? Why, nonsense! Factories were running at full blast and the statistical indices registered first-class industrial health. Was there a threat of overproduction? Nonsense again! Were not business concerns committed to hand-to-mouth buying, were not commodity prices holding to reasonable levels? Where were the overloaded shelves of goods, the heavy inventories, which business analysts universally accepted as storm signals? And look at the character of the stocks which were now leading the advance! At a moment when many of the high-flyers of earlier months were losing ground, the really solid and conservatively managed companies were precisely those which the most cautious investor would select with an eye to the long future. Their advance, it appeared, was simply a sign that they were beginning to have scarcity value. What the bull operators had long been saying must be true, after all. This was a new era. Prosperity was coming to a full and perfect flower. Still there remained doubters. Yet so cogent were the arguments against them that at last the great majority of even the sober financial leaders of the country were won over in some degree. They recognized that inflation might ultimately be a menace, but the fears of immediate and serious trouble, which had gripped them during the preceding winter were being dissipated. This bull market had survived some terrific shocks; perhaps it was destined for a long life, after all. On every side one heard the new wisdom sagely expressed. 'Prosperity due for a decline? Why, man, we've scarcely started!' 'Be a Bull on America. Never sell the United States short.'"

After reading this, one might think the article is being pulled from today's Wall Street Journal. When in fact, it is not as the rest of the excerpt shows:

"By the summer of 1929, prices had soared far above the stormy levels of the preceding winter into the blue and cloudless empyrean. All the old markers by which the price of a promising common stock could be measured had long since passed; if a stock once valued at 100 went to 300, what on earth was to prevent it from sailing on to 400? And why not ride with it for fifty or a hundred points, with Easy Street at the end of the journey?"

Excerpted from "Only Yesterday," by Frederick Lewis Allen. Chapter XII: The Big Bull Market. Regarding September 3, 1929, the peak of the Bull Run of the 1920's. (Perennial Library; Harper & Row Publishers.) Copyrighted 1931.

1929 vs 1999 A Comparison of Financial Mania's, Are we hearing voices from the past?

A mania is defined as excessive or unreasonable enthusiasm. It is well accepted that the U.S. stock market bubble of 1929 (see Figure A) was a speculative mania as was Japan's in the 1980's (see Figure B). If one goes back further in history, such famous financial manias as the South Sea Bubble or the great Tulip Mania come to mind. The folly of thinking during these events is obvious today, but it is important to note that while a mania is in process it appears rationally justified as viewed by the participants. It is only after the eventual collapse that the event is recognized for what it was. Thus is the nature of today's financial mania in U.S. stocks. Financial manias are very rare, but when they do appear they always do irreparable damage to an economy as the degree of the bust truly fits the boom. Financial mania's can be especially damaging when they coincide with world-wide deflation as they did in 1929. That same deflation is present again today and is slowly engulfing the entire planet. When viewed through the cold hard eyes of history, the similarities between today's mania and the mania of the 1920's are truly startling.

Sentiment and other similarities:

The 1920's brought a new feeling of optimism in the United States. The War to End All Wars (at least that's what they called it until WWII started) had ended the decade before and invention (we call it technology today) was changing the way people lived. There was a general feeling that the United States had entered a "new era" of prosperity. Inventions such as the automobile, airplane, electricity, indoor plumbing, and the mass production system had rapidly increased productivity of American businesses since the early 1900's and were changing the way people lived on an unprecedented scale. Investors seemed to think stocks would always go up with the exception of a small correction every now and then. After all, you couldn't time the market. Just buy in and hold on, you were sure to make money if you just held for "the long term." Men had accumulated vast fortunes due to the industrial and technological boom experienced during the period both in the stock market and through ownership of those businesses.

If this sounds familiar to the current environment today, that's because it is. The Cold War's de facto ending occurred with the fall of the Berlin Wall in 1989. The remnants of the Soviet Union are in the same sad state as Germany was after WWI. Germany's ultra-sick economic state allowed a lunatic like Hitler to gain power. Similarly today, since the microchip was invented a little over three decades ago we have experienced vast gains in productivity. Technology is repeatedly pointed to today as the reason for U.S. businesses never ending growth and prosperity. The internet is the latest technology to be touted as bringing us into a yet even greater "new era." Men like Bill Gates and Michael Dell have accumulated vast fortunes through their technology companies' soaring stock prices. They are household names just as Rockefeller and Vanderbilt were in their day.

Many in 1929 felt that a crash could simply not happen because of the great lengths the government would go to keep the market up and healthy. For example, the newly elected President of the United States, Herbert Hoover, publicly stated that stocks were overvalued and that speculation hurt the economy. Hoover's statement suggested to the public the lengths he was willing to go to control the stock market. These kinds of statements encouraged investors to believe that the market would continue to be strong, which could be one of the causes of the Crash. Similarly, today Alan Greenspan made his now infamous "irrational exuberance" speech in December of 1996 and many investors point to the rise we've had since then as a sign of the strength of the market. Even more recently were the Fed Chairman's 3 reckless, rapid rate cuts which only further convinced the public and financial analysts alike that Greenspan would never "allow" the stock market or the economy to falter. For example, an article entitled "Betting on Greenspan" appeared in the December issue of Money magazine which stated "Forget deflation fears, rickety emerging markets and Japan's woes, Michael Sivy argues that the Fed chief's deft handling of rates will help lift U.S. stocks to new highs." Mr. Sivy is not alone in his belief in the almighty Greenspan, but is this a rational belief? The following quote is noteworthy in judging the current absolute faith and worship of the infallible Alan Greenspan by both the public and the financial community:

"It's very rare that you can be as unqualifiedly bullish as you can be now."

That was Alan Greenspan quoted in the Wall Street Journal on January 7, 1973, two days after the stock market peaked on its way to declining 50% over two years and the U.S. endured the worst recession since the depression. Unfortunately, Greenspan is a man and thus prone to commit mistakes. His mistakes in fact heavily contributed to the formation of the current bubble. His and Robert Rubin's reckless printing of money and continual financial bailouts (whether it was the crash of '87, Mexico in 1995, Asia in 1997, or Russia in 1998) have doomed our currency to sit along side the Rea'l and other worthless paper. History will show these clowns for who they are, but their mistakes will be discussed later in this piece.

Further buoying sentiment, many in the public foolishly believe such simple devices as the circuit breakers will prevent large declines by halting trading. Another argument is that the huge hordes of cash held at mutual funds and retirement contributions by the "baby boomers" will support the market indefinitely until they decide to retire. Unfortunately, mutual fund cash levels, per AMG Data as of 1/20/99, have dwindled to just 5.5%. While this is up from their July low of 2.98%, they are still at historically unprecedented, dangerous levels. History has shown that reality suspension props such as those discussed earlier are necessary in order to truly get a bubble or "mania." In Japan, it was the belief in the "Japanese way" being superior to the rest of the world. In the oil boom of the 1980's, it was as simple as "oil is a nonrenewable resource, therefore the price should always rise." And of course, in 1929, it was the belief that America was entering a new era because of invention and that all of the old rules about valuation could be discarded with the horse and buggy. Such beliefs turned out in retrospect to be foolish at best. The words of Professor Irving Fisher of Yale (arguably the Abby Joseph Cohen of the time) offer another haunting reminder of the folly in believing that "this time it is different." He was quoted in the NY Times on 9/5/29:

"Stock prices are not too high and Wall Street will not experience anything in the nature of a crash.......increasing prosperity .....is due in large measure to...inventions such as the world never before has witnessed...the result of the tremendous research laboratories of our great [corporations]....This is a new and tremendously powerful factor in the [business] world and one which never before existed."

Small amounts of natural gold were found in Spanish caves used by the Paleolithic Man about 40,000 B.C.

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