What Next? History Provides Conflicting Answers
By Steven Mufson
Washington Post Staff Writer
Tuesday, September 1, 1998; Page A06
In October 1929, a two-day, 25 percent plunge in the stock market sparked the Great Depression; the Dow Jones industrial average didn't match 1929 levels until the early 1950s. In October 1987, a one-day, 25 percent plunge in the stock market was shrugged off within a few months with barely a ripple in the U.S. economy; stocks recovered within a few months.
Which will it be this time? Over the past six weeks, the slide in stock markets have left share prices 19 percent below their peak and have left investors, consumers and business executives wondering whether the end of the longest bull market will also mean the end of the longest economic expansion.
With history as a guide, the outlook is unclear. Stock market crashes in 1929 and 1987, as well as the long swoon in stock prices in the early 1970s, bear some sobering similarities with the current decline as well as some crucial differences.
1929
Before Oct. 28, 1929, stock prices were selling at stratospheric prices. In the euphoria of the Roaring '20s, just as in the euphoria of the '90s, many people argued that the high prices for company share prices relative to their earnings was justified by a technological revolution that would change the nature of society and drive profits and share prices higher. Today the technological revolution is computers and electronics. Then it was appliances and automobiles.
"Back then, a lot of people were saying, 'This time, it's different because we're on edge of a new technological era,'" said James Angel, a professor of finance at Georgetown University. "A lot of people are saying the same thing now. Electronics are going to change everything, but that doesn't change the cyclicality of markets. Markets are based on fear and greed."
Other similarities between the mood of early 1998 and early 1929 include low inflation rates, a confidence that the United States could continue to grow even while the rest of the developing world remained mired in recession, and a Federal Reserve that left interest rates locked in place while warning that stock prices were reaching unsustainable heights.
Once the market crashed in 1929, consumer confidence worsened and spending dried up. Eventually a quarter of the labor force was out of work.
But economists note that there are important differences between the current slump in the stock market and the crash of 1929.
"The economic outlook is not as bad as in 1929," said Tim Hayes, senior equities strategist for Ned Davis Research. "We have deflationary pressures, but no evidence of real deflation yet. The danger is that the market decline could worsen deflationary pressures."
In addition, because of securities law reforms, fewer people buy stock on margin, with borrowed money..
The Federal Reserve in 1929 also erred in failing to shore up the nation's banks. Instead of providing liquidity to the economy, the Fed let money supply drop by about a third in the couple of years after the crash. The economy actually didn't feel the full impact of a downturn until mid-1930.
EARLY 1970'S
In September and October of 1974, the market dropped about 13 percent over a four-week period, the sharpest point in a several month decline in stock prices. Like now, the president was weakened by scandal, hampering his ability to rally support for domestic programs. And like now, a drop in a small number of high-flying stocks brought the benchmark stock index in line with the larger number of slumping corporate shares.
But then the sell-off in the stock market was prompted by the spiraling cost of crude oil, prompted by cutbacks in production by the Organization of Petroleum Exporting Countries and panic hoarding by oil consuming nations. That in turn caused an increase in inflation and an outflow of money from the United States to foreign oil producing nations.
Hayes said that though there were some similarities in the way the late 1974 market decline ended the divergence between high-flying stocks and the broader market, there are key differences.
In 1974, he said, there were real problems in the domestic economy, including the twin inflationary pressures from labor demands and higher oil prices. By contrast today, low oil prices have helped keep inflation tame.
1987
In 1987, like today, stock prices hit high levels relative to earnings, and when big investors became nervous, prices tumbled. Unlike 1929, the Fed moved to provide liquidity to financial markets and prevent the stock market crash from substantially hurting the economy. Unlike 1974, there weren't any outside shocks to the American economy.
Monthly closes of the Dow Jones industrial average
1929: Stock market crashes; depression begins.
December 1972 to December 1974: Dow drops 39.6 percent from 1020 to 616.
Oct. 19, 1987: Dow dives 508 points to 1738.74, down 34 percent from its record of 2722.42 set two months earlier.
Yesterday: Dow closes at 7539.07
SOURCE: Department of Commerce, Bloomberg News
c Copyright 1998 The Washington Post Company
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