Despite the ever-present fear that “it could happen again,” there are at least three differences that make a repeat of the 1929 crash very unlikely. First, there was a lot of borrowed money in the market in 1929, when you only had to put up 10% of the purchase price, compared to 50% now. In other words, in 1929, you could borrow $90 to make a $100 investment then, but you can only borrow $50 now. That’s called “leverage,” which helps you when the market goes up but kills you when the market goes down.
Second, the average investor was playing the game or exposed to the stock market in 1929. However, following the mini-crash of 2008, many people are still too afraid to go back into the market. They are known on Wall Street as the “dumb money.” There is also much discussion on Wall Street about the anemic level of volume in shares traded. Those broker-dealer firms depend on volume to make money, and people are simply sitting out the rally, immobilized by fear. So are businesses! The biggest players today are hedge funds and mutual funds, aka the “smart money”.
Third, a lot of the “frothiness” of 1929 was the result of actions that are flatly illegal today. An example would be the classic “pump & dump,” whereby a group of wealthy investors would join forces to bid up the price of a stock until the average investor noticed the run-up in price and starting buying the stock, at which time the wealthy investors would sell their stock, which then plummeted in price, cheating the average investor. Despite greater legal protection for average investors today, they are still too fearful to return.
The only spooky similarity between 1929 and the present was the discussion about “the new era,” referring to the eight years of economic prosperity that preceded the crash of 1929. (There was even a signature song about “blue skies are all I see.”) That relentlessly, sunny, overly-optimistic outlook certainly does not exist today. However, I can remember Ben Bernanke in 2007 arguing there is a “great moderation” wherein the economy was now administered so well that booms and busts were no longer possible. And, he is a very serious student of the Great Depression!
It is clear we cannot have another crash like that of 1929 . . . from the same causes anyway. It is also clear to me that we could still have a crash of similar devastation but from different causes. I worry about the “dark pools” of money, where virtually nothing is known about the investors, their techniques, or their investment objectives. I worry about the un-regulated derivatives market, which prevents transparency for a reason. I worry about the absolutely soul-crushing reliance on technology and the ever-increasingly complex nature of investing. (Think Flash Crash.) And, I even still worry a little about the sovereign funds, which could use their vast wealth for political purposes. (Think Mutually-Assured-Destruction or MAD.)
Last night, I got a reminder of how it is more important than ever to have a “Sell Discipline” or a pre-determined signal of when to start increasing cash . . . but, that was just before my wife reminded me I should be taking her out for dinner instead. After all, it was Friday night!