I have been recognized as an academic star of finance by CFO magazine and a top economic theorist to have influenced empirical work by American Economic Review.
During the Depression, investor psychology was absolutely whipsawed by earnings growth. Even in 1932, at the depths of the depression, they wanted to shrink government spending by 25%.
Nevertheless, for readers wondering what if — what if the the current contraction of the U.S. economy ends up being similar to the Depression — Figures 10 and 11 below offer a glimpse of what the first three decades of the twenty first century might look like in respect to GDP, earnings, and stock prices.
The Dow lost 89% of its value from 1929 through 1932. In this regard, some of the key assumptions about the severity of the pandemic that are built into the model developed by Eichenbaum, Rebelo, and Trabandt differ from comparable assumptions used in the epidemic models upon which U.S. policy makers rely.
The Great …
Therefore, the question in my mind is where in the range 35% to 85% it will fall.
Figure 10 below displays the time path of real GDP, with past actual historical values in solid blue and subsequent future values displayed in dotted blue. I manage portfolios for institutions and individuals at Ritholtz Wealth Management LLC. The follow on shocks to aggregate demand are likely to amplify these effects, extending the duration of the downturn. These patterns pertain to the time paths of earnings, stock prices, and market sentiment as reflected in P/E.
In line with the discussion in in Part II about the psychology of booms and busts, our analysis led us to conclude that the market’s judgement about expected returns was pessimistic by 2% during the recession of 2001, and about 5% during the Great Recession. You may opt-out by. Figure 4: The time series of real GDP during the period 1929 through 1940.
2020 Crash Pared With 1929 1987 2000 And 2008 2009 Nysearca. During the period 1909-1929, inflation was also modest, except for World War I when it was high.
With the above comparisons in mind, consider the extent to which the relationships among earnings, stock prices, and sentiment that play out over the next few years will be similar to those experienced during the Depression.
I don’t know how things will play out because they weren’t dealing with a global pandemic back then.1. The Great Depression was the most severe stock market crisis to date, with the Dow tanking 89% from its pre-crisis peak. For disclosure information please see here.
My sense is that the risk is low that the current contraction will turn out to be comparable in both magnitude and duration to the Depression.
You can see in Figure 1 that both recessions correspond to a flattening of the curve, occurring at the points with small dips. 1. Recession of 1937-38. Great Depression Stock Chart Vs Today. Books I have written include Beyond Greed and Fear, A Behavioral Approach to Asset Pricing, Behavioral Corporate Finance, Ending the Management Illusion, Behavioralizing Finance, and Behavioral Risk Management. EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit — And Pushing For Change, how the performance of the U.S. economy over the next few years will depend on the strength of the country’s containment response to the COVID-19 pandemic, 16 million people have filed for unemployment insurance, hold the potential to prolong the downturn, https://www.washingtonpost.com/business/2020/04/09/66-million-americans-filed-unemployed-last-week-bringing-pandemic-total-over-17-million/?utm_campaign=wp_to_your_health&utm_medium=email&utm_source=newsletter&wpisrc=nl_tyh&wpmk=1. The range of potential outcomes is wide, and much depends on containment policy and economic policy. Consider the twenty year experience of the economy and the stock market prior to the onset of the pandemic. Figures 10 and 11 make clear that a repeat of the Depression would be much more severe than the Great Recession. If anything stands out in this figure, it is the accentuated path of earnings relative to stocks, especially during the Great Recession.
https://ritholtzwealth.com/blog-disclosures/. , which focuses on the stock market’s reaction to theses shocks. The lack of a social safety net is one of the reasons a generation of Depression Babies changed their saving and spending habits following the crash for years to come.
During the Great Recession, the S&P 500 fell almost 51% from its peak in October 2007. Things have been that crazy. In the case of the Great Recession, the trajectory of real GDP lies below a line extrapolating the GDP-trajectory during the expansion between 2002 and 2007, with a slower pace of growth.
Figure 1 below displays a graph of real GDP from 1999-2019.1 The graph provides a quick sense of how the U.S. economy performed over the last two decades. In the current crisis, the Fed has acted fast and they’ve gone big. The decline occurred over a period of about 34 months.
Some people will look at these numbers and assume we’re heading down a similar path as the depression. If the trajectory suggested by Eichenbaurm, Rebelo, and Trabandt were to occur, then the dotted portion of the GDP curve in Figure 10 will turn out to be more compressed at the right end, with the duration of the U-shaped portion being perhaps between 15 and 18 months, with the peak-to-trough decline being comparable if not larger than that depicted in Figure 10. Currently serving as the Mario L. Belotti Professor of Finance at Santa Clara University, I earned my Bachelor of Science Degree from the University of Manitoba, was awarded a Masters Degree in Mathematics from the University of Waterloo and have a Ph.D. from the London School of Economics. I would note that such a decline is larger than that which occurred during the Depression. The average GDP decline since 1948 is -2.3%, with the worst print coming during the 2007-2009 contraction.
As of last Thursday, the stock market was not in a bear market. However, historical trends suggest that stock prices strongly track earnings during a deep contraction; and earnings announcements of U.S. firms for the period since the pandemic began are yet to come! All Rights Reserved, This is a BETA experience. Figure 2: Time series of S&P 500 and associated earnings during the period 1999-2019. The Dow chart shows the roaring twenties (A-B), the 1929 peak (B), the crash of 1929 (B-C), the sucker rally of 1930 (C-D), and the prolonged stock market collapse that continued until 1932 (D-E).
I propose Figures 10 and 11 as plausible scenarios to help guide our intuition about stock market risk, in respect to how the future might unfold; however, I do not propose them as forecasts. 4.
Figure 4 below shows the time path of real GDP.
Historical Trends in the Last Twenty Years.
about psychology, optimism, confidence, and market sentiment. Stocks then rose, with earnings, and earnings generally rose until the recession of 1937-38. When earnings rose during an expansion, P/E rose. The St. Louis Fed’s back of the envelope calculation says the unemployment rate could get as high as 32% next quarter.
One way to get a handle on market sentiment during the last twenty years is to consider the time path of price-to-earnings (P/E) relative to that of earnings.
Back then there were no 401ks or IRAs or periodic contributions into the market. As can be seen in Figure 9, at the outset of the Depression the price level did fall; and it continued to fall until 1932 even though GDP and earnings were still declining. By comparing Figures 3 and 8, we can see that for the most part, sentiment (measured by CAPE) also tracked earnings, although not during the part of World War I that preceded the U.S. entry into the war.
© 2020 Forbes Media LLC. With these observations in mind, consider how stocks might move as the current contraction unfolds, as economic activity reaches bottom out and then rebounds.
In some ways, the economic backdrop of the coming months will be similar to the Great Depression. More about me here. The frightening patterns were first identified in November by market analyst Tom DeMark and since then the 1929 chart has been the subject of intense debate on stock market blogs. If historical patterns repeat, then stock investors will continue to experience a rough ride accentuated by swings in sentiment, as earnings decline sharply and rebound, and market sentiment moves from excessive optimism to excessive pessimism and back again. During the dot.com bubble, P/E peaked over 40, reflecting a degree of optimism that former Fed chair Alan Greenspan and economist Robert Shiller characterized as “irrational exuberance.”. Because of these differences, there is reason to anticipate that the current contraction will not be as prolonged as was the Depression. 2. Great Depression Stock Chart. Anything is possible. Leading up to the 1929 crash, only around 1% of the population was invested in stocks, mostly on margin, and traded them in bucket shops (which were glorified casinos).
Earnings numbers fell more from 2007-2009 but this figure is difficult to compare over different historical periods because the rules on how companies account for earnings have changed over time. But it’s possible the fall in quarterly earnings could rival some of history’s worst drawdowns too. At the worst point during this drawdown, U.S. stocks were down roughly 34%. This is one of the reasons there a bonafide recovery didn’t take place in the years following this downturn. In other ways, we are far better off. With luck, the compressed time frame in Figure 11 will also feature reduced amplitude; but, with the recent rise in algorithmic trading, the probabilities associated with high volatility and flash crashes are higher than they were in the past. Central banks around the globe have pumped liquidity into the system to make sure the plumbing of the financial markets continues to function. My academic work studying the period between these two recessions, with colleagues Giovanni Barone-Adesi and Loriano Mancini, quantifies the degree of excessive optimism and overconfidence over time. However, historical trends suggest that stock prices strongly track earnings during a deep contraction; and earnings announcements of U.S. firms for the period since the pandemic began are yet to come! Markets.
Job losses are already twice the size that they were during the Great Recession, and are echoing the job loss trajectory from the Depression. For the rest of the decade, GDP rose, except for a recession in 1937. The range of economic and financial outcomes is wide. When the medical system lacks adequate capacity, as above, they suggest that with weak containment, the economy would experience a much smaller decline peak-to-trough, between 15 and 20%, with a recovery period that is about fifteen months. For everyone else, here we go, beginning with a look back at the last twenty years, with which we are familiar, and then taking a similar look at the years marking the Great Depression.
Largest single-day decline: …
The unemployment rate was still 20% in 1938, a full six years after the Great Depression had ended. Figure 5: The time paths of the S&P 500 and associated earnings during the period 1929 though 1939. You'll also receive an extensive curriculum (books, articles, papers, videos) in PDF form right away.
During the Depression, the U.S. stock market was extremely volatile. Being on the same table as 1987 and 1929 data is typically not a good thing. The largest decline was from 1931 to 1932, when GDP fell by almost 13%.
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