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Understanding the 1929 and 2008 Stock Market Crashes

Last update on: Mar 15 2020

This is another long one from The Philosophical Economist, but it is worth the time. The basic argument is that people generally misunderstand why stocks declined so much in 1929 and also why they fell in 2008. The writer believes that it wasn’t valuations, and that’s an important lesson for today when many people point to the Shiller P/E and other measures to argue that stocks are highly overvalued today.

In hindsight, valuation wasn’t the real problem in 1929, just as it wasn’t the real problem in 2007.  The real problem was downward economic momentum and a reflexive, self-feeding financial panic.  The panic was successfully arrested in the fall of 2008 by the Fed’s efforts to stabilize the banking system, and exacerbated in the fall of 1930 by the Fed’s decision to walk away and let the banking system implode on itself.

For all of the maligning of the market’s valuation in 1929, the subsequent long-term total return that it produced was actually surprisingly strong.  The habit is to evaluate market performance in terms of the subsequent 10 year return, which, for 1929, was a lousy -1% real.  But the choice of 10 years as a time horizon is arbitrary and unfair.  Growth in the 1930s was marred by economic mismanagement, and the terminal point for the period, 1939, coincided with Hitler’s invasion of Poland and the official outbreak of World War 2–a weak period for global equity market valuations.  A better time horizon to use is 30 years, which dilutes the depressed growth performance of 1929-1939 with two other decades of data and puts the terminal point for the period at 1959, a period characterized by a more favorable valuation environment.



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