Time Machine:1929 Black Swan, this done to show how similar the situaion is now.(and how it does not compare to the year 2000. The ourageous P/Es for one made that obvious: i know way a Black Swan.1929 did not have outrageous P/Es. for instance.
excerpted from The Spear Report
<<Let's play pretend. Let's pretend it is the evening of October 22, 2007 and you are a broker working at Goldman Sachs who lives on the Upper Westside of New York. You own an apartment in a classic older high-rise overlooking Central Park. As you lie in bed one night, you are feeling pretty good about things. Although the company and the market are having some problems, you think things will work out. Even if worse came to worst, you say to yourself, you know that Goldman survived the '29 crash and it is stronger now than ever. With that thought you drift off into dreamland.
When you wake up, you peruse the quote pages of the Wall Street Journal, as you do every morning. You own a few thousand shares of GS stock so you check the closing price but it doesn't make sense. The paper says shares of the Goldman Sachs Trading Group are at $96. You think Goldman closed over $160 yesterday and it's not called a "trading group," either. Did the stock split and the name change overnight? What gives? The paper shows Chrysler at $130 a share? No, that can't be true, it's been taken private.
Then you read that the Dow supposedly closed yesterday at 326.50 and you notice the date on the paper: Wednesday, October 23, 1929. What? 1929? Some kinda prank, you think. It's October 23rd, 2007. Still, you feel a bit strange when you look around the room and notice a large radio on the table, but no T.V. You look outside the window down to Central Park West and all the cars are black. Suddenly you realize you have been sent back in time and you don't know how you got there or whether you can ever return to your own time.
Of course, after the shock of possibly never seeing your family and friends again abates a bit, you wonder about feeding yourself, so you check your wallet and find no credit cards and just $20 in cash. The bills look funny, though. You check your jacket pocket and find a checkbook. Whew! You have $1,000 in that account and $30,000 in a savings account at JP Morgan's bank. You also find a brokerage statement that shows you own 2000 shares of Goldman. OK. You are not going to starve. But what do you do next?
A Day at the Office
You know from your study of financial history that today the Dow is going to drop over 4% and tomorrow is the start of the "crash." You take the trolley down to the brokerage office and people seem to recognize you, but you don't recognize them. You make small talk and go hide in your office, dumfounded.
Before the market opens, you attend the morning meeting. There is some concern as it has been a rocky month. From 1925 to the third quarter of 1929 stocks have risen by 120%, a compound annual growth of 21.8%. Everyone is wondering how long the party can continue. You think to yourself, well, the S&P 500 is up 103% in the last four years since the 2002 low, but you don't say anything. Some outsiders are describing the market as an "orgy of specula-tion," but short interest is the highest in history, so most people at your firm consider the bubble talk a contrary indicator.
At the morning meeting, a technically oriented guy points out that between October 3rd and 4th the market dropped suddenly by 5% to the 200-day moving average. He says his group was right to predict a bounce off that support level, which did happen, but this past Monday the market took out those October lows. The small group of technical analysts are obviously concerned. You yourself don't pay much attention to that sort of thing.
The View from the Quants
The rest of the analysts are quantitatively oriented and are totally sanguine...bullish even. They point out that P/E ratios, dividends, earnings and earnings guidance all suggest this is a buy-able dip and if the market goes lower, buy more. Then they give the data backing up their point of view.
One fellow gets up and points out that last year (1928) the P/E ratio for the 45 leading industrial stocks rose from 12 to 14 and is at 15 now. No big deal, he says. This is not a bubble even though the overall market P/E is around 21 based on reported earnings for the 500 largest companies.
You chuckle when a man who looks a lot like Abbey Joseph Cohen steps up and points out that Treasuries are yielding 3.4% and investment grade corporate bonds are yielding 5.1%, which translates into a commensurate stock market P/E "speed limit" of 19.6 or even higher. He predicts Dow 500 by late next year.
Another person flips through a chart showing that the list of in-dustries that are doing well is quite large and diverse, including avia-tion, agricultural equipment, chemicals, retail department stores, steel, utilities, communications, electrical equipment, oil and gas, paper and, of course, radio. You remember that Radio Corporation of America (RCA) was the darling tech stock of the day. You think to yourself, how quaint.
This fellow has a graph that shows that manufacturing output and efficiency has been steadily increasing at better than 3% a year over the decade, due to the widespread use of electricity and new types of machinery. Factory payrolls were at an all time high last month, real income has been rising 3.4% per year over the last five years, while wholesale prices declined 0.9% per year, boosting spending power. He points out that freight car loadings hit an all-time high last month. Annual productivity growth in the manufactur-ing sector for 1919-1929 has been clocking at an incredible 5.3%.
You think to yourself, wow, that's twice the rate of the period after WWII, but of course you don't say anything. Farming productiv-ity is strong, as well, because mechanized equipment is beginning to enhance yield.
Someone else chimes in that in the first nine months of this year, over 1,400 firms have announced dividend increases, more than a 50% increase over 1928 and double 1927 levels. Earnings were up 27% for over 900 companies through Q3 of 1929. Earnings in Q3 of '29 were up an average of 14% over year earlier levels for 600 leading companies. That's pretty darn good, you think. It's hard to make sense of all this. Why did the market crash if things were going so well?
On the way back to your office, still mostly in shock, a fellow who seems to know you very well joins you and you invite him in for a confidential chat. You say, "Look, buddy, the market is in trouble and so are we. The Dow is going to lose 79% of its value by 1932 and our personal shares of Goldman Trading Group are going to fall from their peak of $104 down to $3. Are you prepared for that?" The guy looks at you as though you were mad and walks out the door.
It doesn't feel right to short the market, knowing how much pain people will go through, but you do make the call to the trading floor and sell your shares. Later, you hear he was one of those who jumped.
The Black Swan of 1929
No Wall Street brokerages went bankrupt during the 1929-1932 bear market, as none were highly leveraged. Investors in one particular sector of the market...utilities... were leveraged to the hilt, however, and that made all the difference.
In September 1929 the utility industry had a market cap of $14 billion or 18% of the value of the NYSE. The utility sector ran up 48% during the first nine months of 1929, more than twice the ap-preciation of the industrials or the rails. As a result, by October many were selling at over 3 times book. The utilities were the mas-ter enablers of commerce, providing new and exciting services that no one could live without. The U.S. has had a long love affair with technology, starting with the telegraph in the mid-19th century. In the 1920's, the utility industry was growing rapidly and investors had formed non-operating holding companies that owned numerous smaller operating units. These holding companies also traded on the Exchanges and fetched more than 4 times book value.
At the same time there was a surge in a type of closed-end in-vestment fund called an investment trust that also traded on the exchanges. These trusts were actively managed and yet did not disclose much about their holdings, but we can deduce that many were concentrated in the utility sector, because that's where the action was. As actively managed funds, they also were trading as much as 50-100% above net asset value (NAV). Nevertheless, Ir-ving Fisher, the famous Yale economist of the day, endorsed the trusts, writing that they provided increased diversification and reduc-tion of risk. Fisher is also known for the statement he made shortly before the crash, "Stock prices have reached what looks like a permanently high plateau."
2:1 margin was commonly available in 1929, which these funds and individual investors used liberally. Therefore, one had at one's fingertips quite a number of multipliers that enhanced lever-age when investing in the utilities. It was not too difficult for an ag-gressive investor to gain more than 50 times leverage on a cash investment. That, of course, meant that any decline in a public util-ity's value would be similarly magnified in the downward direction. Sound familiar?
The utility bubble began to pop in mid-October when a regula-tory body denied the Edison Electric Illuminating Company of Bos-ton permission to split their stock (then trading at $440/share) and announced an investigation into rates. The next day, October 16th, the Boston City Council recommended legislation to force the utility into public ownership and the Governor of Massachusetts was on-board with the plan. Uh oh.
Over the next two months, the utilities led the market to the downside, dropping 55% by the end of November.
Conclusion
An individual sector of the market, if large enough and highly leveraged into a bubble, can kindle a wildfire in the broader market, even if the overall market is not grossly overvalued and even if the economy is not in a recession. In fact, the collapse of equities itself can produce a recession, even a depression. In 1929, it was the public utilities; in the year 2000 it was high tech and dot coms; today the culprits are the financials.
The decline of 500 dot coms to zero erased a few trillion dol-lars from the equity markets, but like a fire in the forest that clears the underbrush, it did not hurt the economy overall. The recession of 2001-2002 was one of the mildest on record. The situation was dif-ferent in 1929, and it is likely to be different going forward. We will talk more about this next week.
The question we would leave you with is as follows: If you could go back to October 1929 with the knowledge you have today, what would you do as an investor over the next few years? Would you get excited at the idea that you would be able to buy the best companies in the U.S. at a 75% discount just by waiting a few short years for a bubble to unwind? Could you raise cash and hold it pa-tiently? Some did.
>b>If the coming correction is anything like the 1929-1932 bust, then the best stocks in the world will be on sale at a time when al-most no one wants them.,/b> If the final bottom is like the 2002 bottom, then these stocks will easily double during the first year of the global recovery. We don't have a time machine; all we have is timing. Make it work for you.>> |
