Does 2009 Bear an Uncanny Resemblance to 1938?

When last we checked in with technical analyst supreme Louise Yamada, we were 4 weeks into a monstrous bounce... she was cautious [Apr 9, 2009: Did this Rally Turn Louise Yamada Into a Bull?] and not changing her tune. It's been 6 weeks, and thousands of green shoots later, and we've only suffered one serious weekly setback. Barron's has a piece with her latest thoughts. If you are not familiar with her, in November 2008 [Nov 21, 2008: Fear Louise Yamada] she suggested S&P 600 (with downside to 400). We were at S&P 800 at the time, and the index fell to 750 in the days to come, before rallying for about 7 weeks on Obama / Geithner green shoots... to S&P 950. Then proceeded to crash to S&P 666. She did not back off from those calls when we last looked in early March [Mar 2, 2009: Louise Yamada - Sheeeee's Back]

The latest...

• So, why the attraction of green shoots? One can only speculate that they must be in some ways intoxicating. Perhaps not the shoots exactly, or the stems or seeds, but the leaves of a certain plant. Those might be smoked or otherwise ingested to bring about a euphoric effect. From what I've read, the current crop is far more potent than the commodity available in years past. How else to explain the mind-bending notion that an economy that is declining less quickly is somehow improving?
• Market historians have been pointing to 1938 as an antecedent for this year's action, as Mike Santoli has noted in his Streetwise column. So, too, has Louise Yamada, the doyenne of technical analysts, who now counsels clients via her LY Advisors after her long career at Smith Barney.
• "It is almost uncanny the degree to which 2002-08 has tracked 1932-38," Yamada writes in her latest note to clients. She has posited in her so-called Alternate Hypothesis that the structural bear market would be less like its most recent predecessor, from 1966-82, and more like 1929-42.
• So the dot-com collapse parallels the Great Crash and its aftermath, followed by a rather nice recovery in 2003-07, similar to 1933-37. The parallels continue, with the collapse from late last year into this March tracing a similar, sickening trajectory to late 1937-38, as illustrated in Louise's chart nearby. That drop led to a strong reaction rally, not unlike the current one, for a total gain of 60%. But that was broken into three segments: an initial rally of 46%, similar to the move from the March lows. Then we saw a 10% pullback, not unusual in a rally, then another gain of 22%.

I do believe history rhymes if not repeats... but frankly if we pulled back 10% and then reversed and gained 20%

ish

from there... that would be quite amazing.

• From there comes the hard part. Starting in November 1938, there was a 22% drop, qualifying for the 20% rule-of-thumb definition of a bear market; then a rally of 26%, fitting the definition of a bull market, into the fateful month of September 1939, the start of World War II.
• Then came a series of bull and bear trades -- down 28%, up 23%, down 16%, up 13%, and the final decline into 1942 of 29%. After this nauseating roller-coaster ride, the market was down 41% from the 1938 highs (analogous to where we are now) to the 1942 lows.

I do believe we will trade in a quite large range, and as we entered 2009, I stated as much... the ping pong between hope and reality. We've already has a multitude of "technical" bull and bear markets (mindlessly set as a +/- 20% move) just in the past 18 months.

• The positive aspect of this, writes Yamada, is that the arduous process permitted individual stock consolidations to develop over years ultimately provided the base for a bull market in 1942.
• But, she emphasizes, that means investors probably face years of frustration if they think a new, sustained bull market has begun. Structural bear markets typically last 13 to 16 years. Given the declines that have been suffered so far -- topped only by 1929-32 -- the structural bear has several years to go to complete the repair process.

So if this indeed somehow plays out in parallel, we are in 1938 and the next bull begins 2013. That would fit into the 1938 = now, and 1942 = 2013. And would put us in the front end of the 13-16 year bear market theory. Probably works well with what some of the Elliott Wave guys forecast, but I don't know enough about that art to comment. [

Robert Prechter of Elliott Still Extremely Bearish

] Now with that said, there are so few statistical comparisons to this type of era, that it takes some leaps of faith ...

• As for the current rebound, it is rather like a bungee jump, with an elastic snap-back after a terrifying plunge. And it has been a kind of worst-to-first move. David Rosenberg, ensconced at Gluskin Sheff in Toronto after years of distinguished duty as Merrill Lynch's North American chief economist, observes that the best performers have been the lowest-quality stocks or those with biggest short interest. "In other words, this was a rally built largely on short-covering, pension-fund rebalancing and the emergence of hope wrapped up in 'green shoot' data points," he contends. That makes its sustainability in doubt.

Boy, we've lived and breathed that... shorting "worst" has been a painful experience for the past 10 weeks.

• WHAT IS LIKELY TO DISAPPOINT THE BULLS is the pace of recovery in corporate profits, according to the perspicacious Smithers & Co. of London. Earnings per share -- the sustenance of equity investors -- will be hampered by punk economic growth ahead and the need to repair corporate balance sheets.
• Deleveraging means share issuance rather than buybacks -- a reversal of the trend of recent years that worked to the benefit of corporate chieftains' bonuses. "The growth rate of earnings per share is thus likely to be worse than that indicated by profit margins alone," his report logically infers.
• Investors had come to regard the record profit margins of recent years as the new norm. Last year's were above average, despite the general perception they were squeezed. With U.S. growth likely to stabilize at only 1% into 2010, the outlook for earnings is apt to be, in a word, lousy.

This is also my theory. The "new normal" will be a very different situation, but if American consumers rebuild their balance sheets over the next 3-4 years, they can forget the lessons we've just gone through .....and return to their proliferate ways. Right around 2013.

It's all coming together splendidly.

Comments

[Dave Wrixon:]

I think you are going to have to face the fact that the current crisis has no precedent in American history. This is looking more like the Weimar Republic with every passing day. The only difference is that the Germans had a reasonable excuse for getting into their economic mess.

May 26 07:58 AM

[david levy_:]

what is amazing to me is that the financial media loves to call markets (real estate/stocks/etc.) a "new paradigm" when extending to new highs. Somehow "...it is different this time..."

but, when markets tank, the same media loves to draw everything in the light of history. the favorite, these days, is to compare the current economic environment and state of financial markest to those of the 1920's -30s. this is as ridiculous as calling a peak a "new paradigm."

the nature of industry and technology bears very little if any resemblance to that of the 1920s. even if one argues that, although the landscape is different, human behavior repeats, he/she still cannot discount the drastic change in the velocity and magnitude of information. whereas news would spread and markets would react over months and years in the early 20th century, today, what once took months and years might now take minutes, hours, or days.

drawing comparisons from a century ago in order to try and predict the future completely discounts the effect of instantaneous information which we all now enjoy.

imho
-dl

May 26 08:09 AM

[morph366:]

As the author suggess history may not repeat itself but it does rhyme and this is why I don't agree with David Levy that there are no parallels to be drawn with the past. The circumstances will definitely be different but the underlying characteristics of markets and human nature are a constant.
The breakdown in trust and confidence of the 1930's had many specific and unique factors but the dissolution of credibility in governments to solve crises is a motif that, already emerging, could gain a nasty momentum.
Let's hope that the 1938 parallel is wrong and that in a worst case scenario in what lies ahead only insolvent institutions end up on the scrap heap and not whole societies and human lives.

May 26 09:07 AM

[cynewulf:]

As usual ,Trader Mark stimulates thought in my brain. Big swings and connsistantly lousy earnings, hmm. It doesn't sound like Warren Buffet's kind of market. Too bad about the inflationary pressure.A lot of wealth might be redistributed.

May 26 09:20 AM

[TraderMark:]

all true

but one thing remains the same

human nature

ask the Dutch about their tulips


On May 26 08:09 AM david levy wrote:

> what is amazing to me is that the financial media loves to call markets
> (real estate/stocks/etc.) a "new paradigm" when extending to new
> highs. Somehow "...it is different this time..."
>
> but, when markets tank, the same media loves to draw everything in
> the light of history. the favorite, these days, is to compare the
> current economic environment and state of financial markest to those
> of the 1920's -30s. this is as ridiculous as calling a peak a "new
> paradigm."
>
> the nature of industry and technology bears very little if any resemblance
> to that of the 1920s. even if one argues that, although the landscape
> is different, human behavior repeats, he/she still cannot discount
> the drastic change in the velocity and magnitude of information.
> whereas news would spread and markets would react over months and
> years in the early 20th century, today, what once took months and
> years might now take minutes, hours, or days.
>
> drawing comparisons from a century ago in order to try and predict
> the future completely discounts the effect of instantaneous information
> which we all now enjoy.
>
> imho
> -dl

May 26 09:26 AM

[HardwoodFlo...:]

This is how I ended up at Seeking Alpha in the first place it was a google search under this exact same title.

What I found out were some really interesting analysis. The one I thought was the most optimistic was the analysis that the start of the 200 bear was like 1929 and that 2008 was like 1937-38 just like the analysis above.

There is an interesting technical guy who runs a site called "afraid to trade".

May 26 10:50 AM

[HardwoodFlo...:]

So what next? What got out out of this trend was WW2. Is there a stimulative war for us out there in the future? Canada, a la South Park, perhaps?

May 26 11:06 AM

[Wisdom vs. ...:]

there is one extremely strong parallel between 30's and now: there was no capital (therefore, no new jobs) created during the 30's, and there has been very little (relatively, of course) new capital created this decade. a lot of 'info' victims like to say that employment is a lagging indicator; sorry, but it still directly related to capital creation. large businesses can expand the economy by additional utility of capital without buying capital, that is what we have seen this decade

May 26 11:27 AM

[Gtarras:]

Lets see, what did we have in 1939? Nothing major, really, just the beginning World War II....

May 26 11:53 AM

[HardwoodFlo...:]

Wisdom, I inherently agree with you. Things are massively different today that in the 30s. We are no longer largely an agrarian society. 30% of the work force is employed by a government agency. Nearly 30% of our GDP is Health Care related. It's all together different from the 30s. However, on important thing is that large business doesn't employ the lion share of today’s population, small business does. Today, small business is being crippled by the banks. As the banks see them they are a fragmented lot so to cut their lines of credit or view them as expendable is no big deal- where as big business is apparently too big to fail and hence deserves bailouts. Who will pay for those bails outs going forward- ironically small businesses.

The future is to hard to predict, however, is seems easy- like the analysis above- to lay over a graph from some point in history and say see we've been here before.

Because of the uncertainty of the markets, a lot of people are searching for technical or hsitorical precident to predict the future...either they are right or they are wrong but only time will tell.

May 26 12:03 PM

[Alphameister:]

I find comparisons with 1938 very compelling. The actions taken by the government to prevent collapse in the short run all tend to pose significant hindrances to growth going forward. While the world has changed dramatically in the past 70 years, the human tendencies that led to the current-day crisis were the same as those leading to the Great Depression. In addition to the handicap of necessary deleveraging, today's market faces huge political handicaps related to the greening of America and a forced wealth and income redistribution that has historically been anathema to economic progress!

May 26 03:12 PM

[Erick Tippett:]

As hard as it is to believe, apparently some people today equate
the early part of the last century with the horse and buggy days
of 1800 when, according to one person's comment, "news would
spread and markets would react over months and years......the nature of industry and technology bears little if any resemblance
to the 1920s"... Indeed! A careful look at what was technologically available during the 1920s and 30s certainly paints a different kind of picture than that statement!

Ticker tape, telegraph, and wireless all readily available to transmit information globally in minutes! As far as other modern amenities of the era are concerned, rapid rail transportation (the Zephyr sped at over 110 mph, in fact the Empire express in 1897 travelled at an excess to that, find such average train speed in the U.S today!
Better yet, try to find a track that wouldn't come apart if one did!)
Oh, and how about all that playing around with the, what do they
call it now TELEVISION? Radio anyone? These were not unkown
gadgets to the roaring twenties folks in any manner whatsoever!

The patterns of the last depression have been examined by a number of experts, including Robert Prechter, who have made what I feel are convincing arguments that today's market environment and technology though different, bear uncanny similarities to the era of the last depression. In fact, in one of his texts he cites that there is a forward then backward pattern in human progress and this by all means includes industry and technology. (Include acknowlegement of the significance in human
affairs of historical events in that category as well , if you don't mind!) Did not the Greeks invent a functioning computer many centuries ago, fairly recently discovered?

But of course if one has not examined the data and facts on these cycles, one cannot in any intelligent manner merely invalidate them out of hand, now can one?

EDT
Chicago, Illinois

May 26 04:50 PM

[CLH:]

I agree with you Mark. The correction started in 2000 which was similar to 1929 and then the market came back until 2008 (like 1938). A credit crisis is a credit crisis. These are caused by too much debt. There is little the govt. can do (except go to war) but time will heal the correction. The correction was needed but the govt. was the cause of delaying the correction and thus making it worst. Both parties are to blame.

May 26 06:42 PM

[Mad Hedge F...:]

They do look alike. Today is the 60th anniversary of the launch of the Intelligent Investor, by Benjamin Graham, the Bible for all fundamental analysts. So it behooves us to recognize that multiples for the S&P 500 have just leapt from 13.1 to 15.5 times in a mere two months, the sharpest and most rapid multiple expansion in history. Did I say multiple expansion? Have the fundamentals really gotten that good, that fast? I think not. If anything, we are enjoying the calm between two back to back hurricanes. You only have three days left to sell in May and go away.

May 26 08:52 PM

[RiskReturnO...:]

This is a scenario worth monitoring. My best guess is that we can get there as follows:

2010 -- SPY EPS $55; PE 16 = $880 (inflation 2%)
2011 -- SPY EPS $60; PE 14 = $840 (inflation 3%)
2012 -- SPY EPS $65; PE 12 = $780 (inflation 4%)
2013 -- SPY EPS $70; PE 10 = $700 (inflation 5%)

In other words, inflation causes S&P earnings to rise, almost recovering to previous cycle high of $80, but PE ratio compresses as investors have other alternatives (10 year treasuries will be yielding 7-8% by 2013).

Let's monitor the relationship of 10 year treasury yield and PE ratio of SPY to see if this 1929-1942 scenario can play out again in 2000-2013.

The good news is that there is not much downside from the 666 bottom if we use this playbook, so one can pretty easily construct the best risk-reward optimized strategy using entry points below SPY $800 coupled with tight "at the money" covered calls.

May 27 08:15 PM