Yesterday, I asked myself the question: "How long did it take to earn a positive return on equity for those people who bought in on the slide down during the Great Depression?" This also made me wonder how people had fared after other historical market crashes. I began examining the historical Dow Jones charts all the way back to 1900 and looked primarily at the various crashes of the Great Depression event, the prolonged mid-1970s crash, and the "Black Monday" Crash of 1987.
The Great Depression
Most historians mark the beginning of the Great Depression event with the Market Crash of 1929. The DJIA peaked at 381 in the early autumn of 1929. The oft-cited statistic is that if you bought in at that time, it would've taken till 1954 for you to have earned any sort of return. However, I'm not too terribly concerned about that --- I'm more curious as to how those who bought in after the initial drops fared based on the belief that they were getting a discount. For instance, if you bought in near the start of 1930 after the initial market plunge while the Dow was trading in the 240-260 range, how would you have fared? The answer is that you wouldn't have fared much better than those who bought in at the peak. It would've taken till about 1951 to earn any sort of return.
Let's say that instead of buying in on the initial drop, you bought in on the next plunge at the beginning of 1931. At that point, you could've bought in while the DJIA was in the 170-190 range. The good news is that you would've earned back all your money if you pulled out sometime near the middle of 1937. The bad news is that you basically made a 0% return for those six years. The even worse news is that if you weren't satisfied with that 0% return, you would've had to have waited until at least 1946 before making a return of about 20%. Then, there was another drop before you finally started seeing better days in the 1950s.
1931 was a very rough year for the Dow, so let's say you bought in at the end of the year instead of the beginning. You might've been able to get an entry point closer to 80 or 90 on the DJIA if you took this approach. While you still wouldn't have fared too well for the next couple of years, this would have been a reasonably good investment all the same (especially when you consider the era!). By 1934, the Dow was back in 100-110 territory, so you could've possibly earned a 15-25% return in a short time frame. If you were smart enough to hold till 1937, you could’ve sold when the Dow was in the 160-190 range, which means you would've netted a 100%+ return if you played your cards right. Of course, things went downhill again after that, but it at least looks like you would've had some good opportunities to cash in.
Finally, what would’ve happened if you bought in near the bottom in the middle of 1932? The Dow was trading in the 40-60 range at that time. If you sold off during the 1937 run-up, you could've seen your investment increase 3- to 4-fold. If you held for 25 years, all the way to 1957, you would've earned something close to a 1000% to 1200% return --- or roughly 20-28% annually. That sounds pretty good to me!
The Mid-70s Crash
In early 1973, the DJIA peaked around 1071 before it began its methodical drop. The 1973 event seems to have had more peaks and valleys in a shorter-time frame than we saw during the Great Depression-era crashes. If you bought in after the initial drop, around 900 - 930 range, you could've quickly sold off and made a return in the next few months, but if you waited longer than that, you would've had to wait till mid 1976 to make something like a 10% return. Things only got worse again after that and your next opportunity to make a profit would've been in 1981 when you would've earned roughly the same 10% return. There was even more rough sailing after that, till things finally start to pick up once you get to 1984 and you might've been able to make a 40% return by that point. Overall, you would've fared poorly no matter how you slice it.
If you waited till the beginning of 1974 plunge, you could've jumped in while the Dow was trading around 820. The results here are decidedly more mixed. Selling off in the '76 spike, you could've made a 20% return and 10% per year doesn't sound too bad during one of the biggest recessions of the past half-century! Once again, though, if you miss the window to sell in 1976, you don't make much of a return till a brief 1981 window; before you finally see clear daylight by 1984.
Let's say you buy in early to mid 1974 when the DJIA is in the 650 to 700 range. You fare decidedly better. If you sold off during the '76 spike, you made somewhere in the range of a 40% to 50% return over the course of a year and a half. You never earn a negative return after that, even during all the late-70s dips. If you held all the way till 1984, you earn a return of around 80 – 95%, which is about 8.5% annually. That’s certainly not too bad considering the time frame. If you hold for 25 years all the way till 1999, you earn close to a 1400% return or roughly 50% to 60% annually! Not too shabby, eh?
Given the success of our last scenario, I hardly need to mention what happened if you got in at the bottom in the 580 to 610 range. The interesting thing about this, however, is that even if you sold off during one of the late '70s plunges, you don't fare all that poorly. If you sold off near the beginning of '78 during the worst dip, you still would've made a 27% return or approximately 7-8% annually.
The Black Monday Crash of 1987
The 1987 event ends up being markedly less severe than the other two events we examined. If you bought in about halfway through the downturn when the DJIA was at 2250, it would've taken about a year and a half to earn a positive return. By mid-1990, you could've seen roughly a 25% return. If you held on through the '90s, obviously that return would've been upped considerably.
If you bought in closer to the bottom near the 1800 level and sold off somewhere in the middle of the 1991 build-up, you would've netted a return of about 35% - 40%, which isn't horrible. Even with the market downturn, if you held all the way to the present day, you would've earned a return around 400% or about 19% annually, which sounds like a very good investment!
The simple lesson here is to buy in at the bottom --- but everyone already knew that! The more difficult lesson is learning how to gauge where the bottom will be and how well or how poorly you'll fare if you mistime it. The Great Depression and the 1973-74 market crash event provide sobering examples of how things can be sour for a considerable period of time if you buy in too soon. However, we also see how massively one can profit even if they buy in a little bit before the market hits the floor. Perhaps this simply suggests that the safest route is to slowly buy in and gradually accelerate buying habits as the market continues to drop.
Of course, the fact that nearly 90% of the equity in the market was destroyed in the first three years of the Great Depression still lingers in the back of my mind. Which begs the question: “Is this a second coming of the Great Depression?"
While each individual investor has to answer that question for his or her self, I view the current market crash as being somewhat different in nature than the Great Depression. One of the major reasons for the massive run-up in the market during the late 1920s was speculation on a grand scale. While there will always be speculation, it seems that this crisis is less about that and more about market fundamentals and lending policies in the financial sector. However, the truly sobering historical lesson here is that it could be several years or even a decade before we see a return to consistent growth in the market.
Taking a look at stock prices of S&P 500 companies and comparing them to earnings, balance sheets, and cash flows seems to produce many attractive bargains out there. To be sure, earnings will decline as the recession is prolonged and possibly turns into a depression, but at the very least, valuations do not appear to be so out-of-whack that one would expect the Dow to fall another 5,000 points before finding a floor. For that reason, I tend to view the current market events as being more analogous to the prolonged crash event of 1973-74 and would be surprised to see the DJIA dip far below 7,000. Of course, that doesn't mean we'll see smooth sailing again anytime soon.
While only time will tell, my best guess is that the bottom is not all that terribly far away --- another thousand points away, possibly? On that note, I'm ready to start buying in --- with this history of the market tattooed in the back of my mind.
Disclosure: No position in any general market index funds.