You Look Familiar: A History of Market Highs and Lows
by Danielle Woods, daniellewoods@propel-fa.com
It may be true that history repeats itself, but future versions tend to get better at disguising themselves from their predecessors. At Propel, we’ve been through the ups and downs of the market roller coaster quite a few times. For that reason, we are good at maintaining a level head when the markets seem awful, but we also know to be skeptical when markets seem too good to be true. Our job is to hang out somewhere in the middle, not overreacting one way or the other.
The purpose of this blogpost is two-fold: 1) to remind our more experienced clients of the similarities and differences between the current environment and market cycles of yesteryear, and 2) to cultivate our newer investor generation’s critical eye toward market behavior.
Since March 2009 (bottom of the Great Recession)
The truth is we have been experiencing a bull market for the better part of nearly thirteen years. The S&P 500 Index, for instance, has increased in value by nearly 780% from March 5, 2009, to November 17, 2021. If you were born after 1990, your entire adult life has been spent in this environment. Even for me (and I was born sometime before 1990!) more than half of my time as an investment advisor has taken place during this incredible period of economic growth and prosperity.
On the one hand, we can revel in our good fortune. Our retirement accounts are growing, our home values are skyrocketing, and it seems nearly impossible to lose money. On the other hand, such a long period of positive economic output promotes risky behavior. After all, what do you have to lose?
“Don’t confuse brains with a bull market.” Liz Ann Sonders, Managing Director and Chief Financial Strategist at Charles Schwab, recently reiterated this age-old wisdom on the Prof G Podcast. (Prof G Podcast, November 11, 2021, “Markets, Meme Stocks, and Inflation”). We wholeheartedly agree.
Investopedia defines a bull market as “the condition of a financial market in which prices are rising or are expected to rise.” But markets don’t always rise. The flip side is called a bear market, defined by Investopedia as “when a market experiences prolonged price declines.” It is important to note that all of us will experience both markets, possibly many times over, in our lifetimes. That is because the market runs in cycles. It goes up, and it goes down. Sometimes it crashes.
A Tale of Two Markets: 1929
The most famous market crash, of course, is Black Thursday, which kicked off the Great Depression of the 1930s. On October 24, 1929, the market opened more than 10% lower than it closed the night before. Small measures were taken by large institutions to ease the fear, but it couldn’t undo what was coming. From the market peak in September 1929, to the market bottom in July 1932, the Dow Jones Industrial Average (DJIA), the primary index at that time, lost more than 89% of its value. In fact, the Dow did not return to its September 1929 peak until late 1954 (25 years later!).
While our current federal government has shown that it has far more tools in its economic arsenal now than was available back in 1929, some very disturbing similarities remain. The 1920’s, also known as “The Roaring Twenties,” is well known to be a period of great economic growth and excess. According to Investopedia, “The economic growth created an environment in which speculating in stocks became almost a hobby, with the general population wanting a piece of the market.” (Investopedia.com/what-caused-stock-market-crash-1929-preceded-great-depression.asp, 11/18/21)
Sound familiar?
But what caused the Great Depression?
- Overconfident investors were buying stocks on credit (margin);
- Overproduction in industry such as manufacturing and agriculture led to losses and, thus, reduced corporate stock prices;
- The Fed’s sudden increase in interest rates from 5-6%;
- Agricultural recession; and
- Bank runs. Panicked citizens withdrew large sums of money from banks all at once.
In conclusion, “A soaring, overheated economy that was destined to one day fall likely played a large role.”
My 11-year-old son recently completed his unit on the Great Depression. One of the standouts to me while helping him study was that the 1920s was a period of great technological advancement. Perhaps because it was on the heels of the industrial and military efforts of World War I, but home appliances and cars were brand new and taking the country by storm. When your day-to-day life is easier, it puts you in a good mood and makes you spend money. Never underestimate the power of the collective psyche.
Another Decade, Another Crash: 1987
Let’s fast forward to 1987. The year of Dirty Dancing and The Bangles’ “Walk Like an Egyptian” also brought us an October market crash.
In the five years leading up to the crash, the Dow Jones Industrial Average (DJIA) had more than tripled without a significant correction; computer models were becoming much more common on Wall Street for trading; and the U.S. had come to an agreement called the Plaza Accord with France, Germany, the UK, and Japan to:
depreciate the U.S. dollar in international currency markets in order to control mounting U.S. trade deficits…In the U.S., the Federal Reserve tightened monetary policy under the new Louvre Accord [replaced the Plaza Accord] to halt the downward pressure on the dollar in the time period leading up to the crash. As a result of this contractionary monetary policy, growth in the U.S. money supply plummeted from January to September, interest rates rose, and stock prices began to fall by the end of the third quarter of 1987.
Much of the crash is blamed on the new computer trading models. At the time, there were no fail-safes in place. The computers were programmed to buy as prices rose, and sell as prices fell. What?! You can see how that would be a problem and create inflated or deflated prices. It still happens today, but we often see quick corrections and perhaps don’t worry about it as much as we used to.
Bursting Bubbles: 1999
Less than 10 years after the 1987 market crash, the creation of the internet resulted in a whole new breed of start-up company called the “dotcom.” These companies were created out of thin air and managed to command large amounts of capital from speculative investors. Why? Interest rates were low, people were making money, and we were enjoying a bull market. Sound familiar?
I think it’s safe to use the word “frenzy” when describing the money flying around during that time. I was a new advisor then, and I remember my mentors scratching their heads at this new phenomenon. It made no sense! Why were people so willing to throw money at an idea that was brand new, with no financials, and no real market?
From 1995-2000, the technology-dominated NASDAQ Index rose from about 1,000 to more than 5,000 because of overinflated equity valuations. The bubble burst in 2001 as capital infusion stopped. It became clear that there were companies spending money on nothing but advertising with no actual technology or product to show for it. By October of 2002, the NASDAQ had retreated to about 1100, and more than 50% of the dotcom companies were shuttered.
The Economist said of the dotcom crash, “behind the general jitters in stock markets lies the biggest and fastest rise and fall in business history.” (“The great telecoms crash,” The Economist, July 18, 2002.)
Unfortunately, the influx of capital to these dotcoms caused all valuations to climb and impacted established companies as well. But one company that survived is a household name now – Amazon.
Housing Rockets and the Great Recession: 2008-2009
The bear market and the low bond yields that resulted from the dotcom bubble persisted for a handful of years before the stock market rose again in the mid to late 2000s. Unfortunately, the gains were short-lived as the decade ended with the Great Recession of 2008 and 2009. For this reason, the first decade of the new century is often called “the lost decade” because major stock market indices actually lost money for the 10-year-period.
This time, the cause was the Subprime Mortgage crisis, often referred to as “the Housing Bubble.” With interest rates so low (a tool used by the Federal Reserve to assist markets after the dotcom bubble burst), there began an excess of subprime lending without appreciation for the risks that it presented, both from borrowers AND lenders. Almost anyone could get a mortgage or three. Lax lending requirements and risky business practices at Freddie Mac and Fannie Mae (government-sponsored agencies responsible for buying qualified mortgages) meant that people who could not afford their payments were buying houses with little to no money down. The tried and true 20% down requirement seemed to just disappear as the agencies competed to get their stock prices higher while their capital reserves dwindled.
As the housing craze continued, prices skyrocketed, leading many to believe that they would always have equity ahead of their debt. That led to even more borrowing, until homeowners were upside down. The market bottomed in March 2009, resulting in large bank bailouts, an increased unemployment rate, and dwindling retirement accounts. It terrified a lot of investors who pulled out of the market completely, some lost all their retirement or college savings during this period.
Hindsight in the 2020’s
While all these market crashes happened in different decades with seemingly different catalysts, they all have one thing in common: Investors were pouring money into assets with the belief that they could not lose money, (I would say with an insufficient appreciation of the risk) no matter how expensive the asset became and no matter how unrealistic it was that it could be sustained. Then the capital dried up.
Below is a graph that fellow Propel advisor Amanda Vaught found on LinkedIn recently. It illustrates the confidence that individual investors – notice that it does not include institutional or professional investors - have had in the market over the past 7 years. The average expectation above inflation from 2014 through 2019 was 9.85%. (I expect 2020 was skipped because of the general pessimism in the market after the COVID bottom on 3/23/20.) Now look at 2021. Individuals believe that the market will return 13% ABOVE inflation. The new 12-month inflation number when measured by CPI is greater than 6%. That means individual investors are expecting returns of 20% for 2021. As of 11/22/21, the Schwab S&P 500 fund (SWPPX) has returned more than 28% for the year. Is it possible that there will be a correction before year end? Absolutely.
Profitability vs Popularity
As an attorney, I’m required to engage in continuing education each year that is monitored by my licensing regulators. I recently attended a class titled “Ethics for Lawyers and Tax Practitioners” taught by Peter Lennon of McEldrew Young. That firm, based in Philadelphia, specializes in catastrophic injury and whistleblower litigation according to its website. Rather than another boring lecture on ethics rules, I was surprised to hear Mr. Lennon discussing the corporate and regulator excesses and ethical sidestepping that has taken place over the course of the same periods I discussed in this blogpost. It’s worth noting that most “education” you hear is really advertising. There is a difference between profitable companies and popular companies. It is important to constantly look for the difference when investing your money. Keep that in mind as we look a little closer at the most recent bull market.
The Great Bull Market of the 2010s
Even though we’ve experienced 3 significant market crashes over the past 35 years, our memories are short. Nothing will help us forget a bear market like a bull market, eh? Since the Great Recession bottom in March 2009, we have enjoyed a bull market. It’s been so strong, in fact, that the COVID-related market corrections over the past 18 months hardly seem that painful for many of us. (Imagine what might have happened if we’d been in a bear market when COVID hit?)
During this bull market, we’ve experienced unbelievable market valuation growth. Below is a graph of Schwab’s S&P 500 Index Fund (SWPPX) from December 31, 1999, to December 31, 2021. The Great Recession hardly looks like a dip when compared with the growth that occurred after.
It has been a good time for companies as well as individual workers and investors. However, it’s starting to remind this advisor of previous markets when a flurry of investor capital is the reason for higher valuations and not the companies or products themselves.
For some, this stock market just isn’t good enough! They want to beat it with something new and different. Worse, they believe they cannot lose, thus causing more and more risky investments to become attractive. On the flip side, we have a bond market that is producing almost no income for pensions and retirees, leading some investors to look for something different because they fear the stock market.
The speculative fervor surrounding Crypto and the Meme Stocks was covered by my colleague Amanda Vaught in a recent blogpost (“Crypto, Meme Stocks, and Other Shiny Objects”); but some of that activity is highly reminiscent of the behavior that led to market crashes in the past.
Our advice is to be boring. There is plenty of money to be made by simply saving and investing in a variety of assets for the long-term. Yes, you could make a lot of money by taking risk; but you could also lose it all. I’ve seen it happen twice in my 23 years, and it will happen again. We hope you will continue saving and watching your investments with a skeptical eye. It will keep you in the black.