As you probably know, I believe that a 40%+ bear market will follow this bull market in stocks. The Medium-Long Term Model supports this case. The most bearish of traders think that this will lead to a 1929-1932 like stock market crash, in which the Dow fell more than 80%!
I don’t think this is likely. There are many reasons why a repeat of the 1929 stock market crash is unlikely. Moreover, I’m not even sure the next bear market will be as severe as the 2007-2009 bear market. This next bear market might be more similar to the 2000-2002 bear market.
Why a repeat of the 1929 stock market crash is unlikely
The world, economy, and social structure are very different today than they were in 1929. These differences make a repeat of 1929 unlikely.
1929 was an exceptionally massive bear market because it was exacerbated by multiple factors:
- A massive, across the board trade war between every major economy.
- No social safety net in place.
- A government and national culture that believed in “small government”.
- Multiple policy mistakes (contractionary public policy when the economy was already going down).
None of these 4 factors are present today. Humans have learned a little from the past.
People compare Trump’s tariffs to the June 1930 Smoot-Hawley Act. The magnitude of these trade wars is completely different:
- Smoot-Hawley was passed by Congress. It wasn’t enacted singlehandedly by the President at the time (Hoover).
- This was a tariff on 28k products.
- By 1934, global trade had fallen 66% from 1929 levels.
Humans and politicians have generally learned that full-blown trade wars are very bad for the economy and stock market. That’s why even when Trump is talking about a trade wars, he’s using this as a threat in negotiations. He doesn’t actually want a full blown trade war. If he wanted a full blown trade war, he would have started one already. And it’s hard to imagine that Congress would sit by idly while watching the President singlehandedly destroy the economy.
Global trade wars significantly exacerbated the 1929 crash. What could have been a normal recession and bear market turned into the Great Depression.
The repeat of such a global trade war is unlikely.
Social safety net
Many great programs came out of Great Depression, such as employment insurance and social security. Recessions are dangerous because people losing their jobs = less spending = less revenue for companies = more people losing their jobs. It becomes a self-fulfilling destructive cycle.
Many great social security programs were introduced after the 1929-1932 stock market crash and recession. These counter-cyclical programs work to soften the impact of a recession and prevent a death-spiral.
These programs have their roots in the 1935 Social Security Act. An example is Employment Insurance: designed to provide income security during temporary unemployment. This means that people don’t need to drastically and immediately cut their spending when a recession causes job losses.
Some bearish investors argue that the government might “run out of money” and be unable to fund social security in the future.
- The government won’t completely run out of money. It will slowly cut back on Social Security programs. It won’t cut them all off completely in the blink of an eye. This is a slow and steady process, which doesn’t match the timeline of a crisis. Crisis are rather short, usually only lasting a few years.
- Social security was almost nonexistent before the Great Depression. Some social security is always better than none.
A government and national culture that believed in “small government”
The political spectrum has shifted significantly towards the left over the past 100 years. What is “conservative” nowadays used to be considered “liberal”.
I’m not saying whether this is good or bad. I’m not trying to make a political point here. The point is that the Hoover administration did too little, too late. The general belief was that “the world will figure itself out, the economy will recover on its own”. Clearly it did not. This national belief (culture) in small government prevented politicians from acting faster. It was a mindset problem.
But most importantly, it was the policy mistakes during the 1929-1932 economic contraction that made the crash so severe.
It’s well known that the Hoover administration didn’t put a lot of effort into fiscal stimulus. By the time the Hoover administration realized that it had made a mistake, it was already too late.
Every single administration after Hoover has learned from his mistake. Government’s role nowadays is seen as a balancing factor. Every single government tries to juice-up the economy when the economy goes down. No government today is going to let the economy tank while doing nothing. Nobody in power really believes in “let the world figure itself out, things will get better on their own”.
But what’s lesser known is that the Federal Reserve made a massive policy mistake in 1931. This is what turned a normal recession and bear market into a full blown depression and mega-crash.
From 1929-1930 there was the first bank crisis, during which the stock market fell -59%. This was similar to the 2008 financial crisis, in which the stock market fell a similar magnitude.
It was the second bank crisis in 1931 that killed the stock market and economy. People thought that the Fed would step in to save the banks because in the Saturday Evening Post of April 14 1928, the New York Federal Reserve said the Fed will step in to save markets if need be. The Fed ended up doing almost nothing. The second bank crisis unfolded in a death spiral.
Hence it was a good thing that Bernake saved the banks after 2008. Yes, it caused morale hazard (i.e. “how dare those evil bankers mess up the financial system and get bailed out”). But Bernake had no choice. If he didn’t save the banks, 2008 would have been a repeat of the Great Depression. Bernake chose the lesser of 2 evils.
This proves that modern day economists and policy makers have at least partially learned from the Great Depressions’ mistakes.
In another error, the Federal Reserve HIKED interest rates in the second half of 1931, thereby exacerbating the second financial crisis. This is because gold started to leave the U.S. as foreigners lost faith in the U.S. Dollar. The USD was pegged to the gold standard at the time. The Fed chose to maintain the integrity of the gold standard instead of saving the economy. The Fed hiked rates from 1.5% to 3.5% in hopes of halting the flight of gold from the U.S.
This is clearly not a threat today because the USD is no longer tied to the gold standard. More importantly, the Fed will not do nothing during a recession and bear market.
The 1929 stock market crash did not have to be as severe as it was. Multiple problems exacerbated it. Those problems are mainly absent today. The world has changed.
Could another stock market crash like 1929 happen? Yes. Everything is a possibility in this world. But what’s the probability? Low. Very low. We cannot trade and invest by considering every single scenario, otherwise we’d stay in cash all the time and hid under a rock because “the world can end at any time”. We can only make decisions based on probability.
The point is, you shouldn’t try to predict 10 steps into the future because the world, economy, and markets are constantly changing. Predicting the next 1-2 steps in the future is much easier.
And right now, those 1-2 steps state:
- This is probably still a bull market.
- After that bull market we will probably have a 40%+ bear market.
- How big will the bear market be? 40%? 60%? 90% (like from 1929-1932)? No one knows. That’s too far in the future to make any meaningful predictions.