Like earthquakes, financial crises seem to be accompanied by aftershocks, like the one we’ve been living through this week. They can feel every bit as bad as the crisis itself. But economic history and academic research suggest they can set the stage for a sustainable recovery ”” and eventual sharp stock market gains.
The events of the last few weeks ”” gridlock in Washington, brinksmanship over raising the debt ceiling, Standard & Poor’s downgrade of long-term Treasuries, renewed fears about European debt and a dizzying plunge in the stock market ”” bear an intriguing resemblance to some of the events of 1937-38, the so-called recession within the Depression, with a major caveat: it was a lot worse back then. The Dow Jones industrial average dropped 49 percent from its peak in 1937. Manufacturing output fell by 37 percent, a steeper decline than in 1929-33. Unemployment, which had been slowly declining, to 14 percent from 25 percent, surged to 19 percent. Price declines led to deflation.
“The parallels to what is happening now are very strong,” Robert McElvaine, author of “The Great Depression: America, 1929-1941” and a professor of history at Millsaps College, said this week. Then as now, policy makers were struggling with how and when to turn off the fiscal stimulus and monetary easing that had been used to combat the initial crisis.
Andrew Smithers in the FT July 18:
“There are two, and only two, ways of valuing the US stock market that are robust when tested. These are the q ratio, which is the ratio of the market value of non-financial companies to their net worth, adjusted for inflation; and CAPE, which is the cyclically adjusted price to earnings ratio. These measures show the US stock market to be about 60 per cent overpriced. This is a long way below the peaks of 1929 and 2000, but similar to the peaks of 1906, 1937 and 1968 – which were followed by falling markets and recessions.”
http://www.ft.com/intl/cms/s/0/f1ff9be8-a3e5-11e0-9f5c-00144feabdc0.html