(Manic) Depression In The Stock Market

For a good part of the 1990s, investors basked in manic euphoria. Gurus of the TTID (“This Time It’s Different”) School of Economics promised us a New Economy producing extraordinary growth, sharp gains in productivity, full employment, zero inflation and, of course, limitless stock market gains.

Now, after losses of 45% on the S&P 500 index and $7 trillion (over $2 trillion this year alone) on the Wilshire 5000 index of stock market value, 2000-2002 has matched the worst bear market of the post-war period, in 1974-1975. Not surprisingly in the wake of the staggering recent losses, we are hearing a growing number of predictions that the economy is about to fall into “depression”.

Except as it describes their own state of mind, however, few investors know what the “D” word really means. More importantly, they forget that, while the Great Depression arguably lasted until 1939, the great stock market decline itself lasted less than three years: following an 83.5% decline between 1929 and 1932, it bounced 52.9% in 1933 and, after a pause (-2.4% in 1934), gained another 46.8% in 1935 and 32.5% in 1936. (For more details and data, see Global Financial Data at www.globalfindata.com).

“The” Great Depression of the 1930s forever changed the whole discourse on depressions. But the very reason why this episode rates the article “the”, as well as a capital G and D, is that it was and remains unique. Reading studies written before the 1930s about depressions highlights three interesting facts:

- Depressions were considered a normal economic occurrence that could be expected at more or less regular intervals. They were part of the “creative destruction” that Schumpeter later associated with long-term economic cycles.

- In most depressions, all people did not suffer equally. Some activities or segments of the economy pulled through relatively unscathed, while others actually prospered.

- The word’s definition itself contained nothing exceptional: depressions were merely recessions that were occasionally deeper than normal recessions, but most of the time simply longer. (For more on this, one can read Financial Crises by Theodore E. Burton, first published in 1902).

What made the Great Depression unique, besides its depth and length, was publicity: more statistics; more records of policy debates; more chronicles of individual hardships were available than ever before. Also, adding to its aura, that depression was both predicted (by Nikolai Kondratieff in the 1920s) and resolved (not so much by Roosevelt’s cushioning measures as by the “Keynesian” stimulus of the WWII build up).

Kondratieff’s work, as well as those by later students of the Long Wave, has served as the basis for outrageous and poorly documented forecasts of a repeat of the Great Depression ever since the mid-1960s. In fact, one can say that, unwillingly, Kondratieff has become the economists’ Nostradamus. Prior to the 1930s, few historical statistics were available to measure the characteristics of depressions, so that most of Kondratieff’s work was based on statistics of commodities prices, the only ones going back in time long enough to discern long term cyclical patterns. Kondratieff documented that some long-term cycles could, indeed, be detected in commodities prices. The rest is a genial work of rationalization, but one of little predictive nature.

Also, through the nineteenth century, depressions mostly originated in Europe and tended to be regionally contained. The only true global depression (the “Great” one) occurred in the twentieth century and originated in the United States. Since then, however, especially after WWII, leading economies have been cushioned by large (less volatile) government sectors, social safety nets, and more proactive and counter-cyclical fiscal and monetary policies. All of these have served to reduce the pain and length of episodes that could otherwise have qualified as depressions, such as the global recession of the mid-1970s.

More importantly, the statistics used by Kondratieff were for wholesale, or crude commodities prices. On that sole basis, it could be argued that the world has been in depression since the beginning of the 1990s, if not the early 1980s. The Department of Commerce price index for crude materials reached 102.5 in 1983. After a brief decline, it recovered to 110.5 in 1990. Since then, after a very brief, oil-related spike to 140.3 in 2000, the trend has been down and the index closed the year 2001 at 94.7.

Finally, since the late 1980s, Japan has been in what surely would have qualified as a depression to Kondratieff and other students of the Long Wave. Economic growth has been negligible and prices have been in a downward spiral, predictably hurting corporate profits as well. Yet, by all accounts, this has been a very comfortable depression. Wages stagnated or even declined moderately for some, but this was generally offset by lower retail prices, so that Japan’s living standard has deteriorated little. More importantly, traditional economic cycles have continued to be superimposed onto the longer-term deflationary trend, with subdued but real recoveries in the economy and the stock market every few years.

The United States may very well experience a depression of the Schumpeterian type that often follows a technological revolution. But we would argue that some of that already has happened. Bankruptcies may continue to rise as a result of the innovation cycle’s “creative destruction” and, as we have hinted before, economic growth may be subdued in the aggregate. But some segments of the “old” economy already appear on the mend and global activity appears on the mend – at least cyclically.

As a crowd, investors tend to be manic depressive, with euphoric “highs” and devastating “downs”. As individuals, we should try to keep as cool a head in the current “down” as we did during the stock market’s euphoric “high” of the late 1990s.