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A Tale of Two Crises.

In Investment Returns on November 19, 2011 by CQCA

We like to compare the 2007 crisis to the Great Depression, but the real Great Depression II started in the year 2000. The graph above compares the run-up and wind-down of the stock market peaks in 1929 and 2000.

On the X-axis, zero is when each stock market topped out on a monthly basis (September 1929 and August 2000). The high point of both has been indexed to one. It also shows the ten years (120 months) prior to and after the peak. The blue line (1929) and the red line (2000) trace the value of the stock markets if they were priced in gold.

Even though the lines are similar, there is one difference that we need to understand better. Between the +20 month and the +90 month, the lines separated. The 2000 market stabilized for about three years before continuing to fall. In the end, the 2000 stock market performed worse than the 1929 stock market. What was different about those years?

The above graph shows the indexed rate for the Federal Reserve bank rate over the same 10 year period. Interest rates were, on average, lower before for the 2000 peak than before the 1929 peak, which explains why the rally was also higher. But the immediate reaction was also different. After 2000, the Federal Reserve cut interest rates by more than 80%, from 6.5% to .98%. After the 1929 crash, the interest rate was only cut by 50% before being brought back up slightly. This extra stimulus from low interest rates allowed the stock market to level out for a few years.

However, that short-term gain eventually led to long-term pain, which is what we’re facing now. Not only did the stock market end at a comparatively lower point than in 1929, economic activity also took a much harder hit.

After getting a boost from low interest rates, indexed corporate earnings, which began to recover between +20 and +60 months after the crisis, eventually hit a lower point than at any time during the Great Depression I. In August 2010, ten years after the 2000 crash, we were at the same point that we were in September 1939, ten years after the 1929 crash.

At least Germany hasn’t invaded Poland, again.

Sources: Data on S&P 500 price and earnings are from R. Shiller. Gold prices are from Kitco. Interest rate data is from FRED.

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