1929 All Over Again?

Includes: DIA, QQQ, SPY
by: Avery Goodman

Yesterday’s fake rally has created a good opportunity for those who want to exit the market to sell at a higher price. There may be some additional appreciation today, and, maybe, a lot to come with various bear market fake rallies. But, sometimes it is better to be safe than sorry, and better to take a smaller loss than a larger one. Nothing is definite and things are looking very bad. Let me explain:

On October 25, 1929, in the midst of the crash that led to the Great Depression, later known as “Black Thursday”, the most powerful bankers met in New York. Confidence in the stock market had dropped from levels enjoyed at the height of the roaring 20’s. They decided to intervene to “restore confidence.” In September, 1929, the average P/E ratio on the S&P 500 composite index was 32.6. In September, 2008, the average P/E ratio on the S&P 500, using anticipated earnings, was 25.6.

The 1920s banking tycoons appointed Richard Whitney, Vice President of the New York Stock Exchange, to act as their proxy, and began funding the mass buy up of stocks, without regard to earnings or other traditional investment criteria. Mr. Whitney’s job was to use the ample liquidity, supplied by the bankers, to bid at prices far above the prevailing prices. This, they thought, would force the stock market up, and preserve confidence in the markets.

Whitney’s first buy was a large position in U.S. Steel. He continued buying and buying, not only USX, but many other stocks. The bankers were very sure the tactic would work. It had worked in the past, putting a quick end to the Panic of 1907. That panic, 22 years prior to the Crash of 29, led to the creation of the Federal Reserve. Legend has it that banker J.P. Morgan himself acted, in this manner, to stem the tide of market collapse, in 1907. In 1929, however, the gambit failed miserably. People simply took the banker’s money, and ran. The market turned up, in the middle of the day, but turned back down, again, shortly thereafter. People continued to flee. Bankers, however, are a persistent lot, and not so easily dissuaded by one failure. 

So, by Black Tuesday, October 29, 1929, the interventionist group had recruited a number of even richer men, including William C. Durant and various members of the Rockefeller family, and these all joined together in a massive attempt to buy up large quantities of stocks at inflated values. The idea was to demonstrate to the public their confidence in the market. At first, the second attempt seemed to work. Between the low at mid-day on October 29th, and the close of trading on Thursday, October 31st, the strengthened consortium managed to induce a 32% rally in stock prices. It was not enough. By November 1, 1929, the stock market resumed its fall, in spite of the best efforts of the bankers. Here is a table of the date, opening and closing prices of the Dow Jones Industrial Average between October 16, 1929 and November 14, 1929. By the 13th of November, as you can see, the market continued to fall until hitting a 1929 bottom of 198.69. This was a total decline from the artificial level achieved at the height of the robber baron intervention of 27.4%. The DOW continued, after that, to rise and fall periodically, over the next three years. 

People saw one false rally after another, punctuated always by a deeper decline, just like what we are seeing now. By 1932, the market finally hit bottom. Finally, on July 13, 1932, the DOW hit 41.22 for a total decline of 89% from the top to the bottom, based on the top height having been reached earlier in 1929.

Click to enlarge

In many ways, unfortunately, the nation’s financial situation is now in much worse shape than back in 1929. Leverage is far higher, for one thing. The fabric of the banking industry, back then, was not being torn apart by defaults. That came much later. Although many banks eventually failed from panic withdrawals, most banks were solvent in 1929, before the start of the crash. Now, in contrast, some of the biggest banks are already insolvent. Instead of a select group of incredibly rich robber-baron bankers intervening in the market, we have a select group of robber-barons, in positions of power within the government, like Henry Paulson and his underlings, who are redirecting public treasury funds into private hands. Yesterday, we saw the Federal Reserve, G7 nations, and the Group of 20 (which includes the rising economies of China, India and Brazil) loaning money to each other to carry out a mass intervention. After an intense weekend meeting, these nations, apparently, decided to try to rescue the stock market. That resulted in yesterday’s incredible rally.

When nations intervene heavily by taking ownership of private business, whether by purchasing shares of stock directly, or through proxies such as the Fed’s primary dealers, the end result is the same. It is called socialism. Socialistic economic structures tend to cause complete stagnation. Anyone who visits modern day former Soviet Republics fully understands the extent of the failure of socialism to bring real prosperity. Therefore, anyone who believes that the fact that the unleashing of treasury printing presses will save the day, is lying to himself.

Regardless of market interventions, and even fake rallies that temporarily cheer people up, the fundamentals remain what they are. We are entering a period of deep economic decline. We have unsustainable trade deficits which will eventually result in a deep fall in the value of the U.S. dollar. We have seemingly unlimited money printing, and flooding of the financial markets with dollars, in order to induce banks who don’t trust each other to lend to each other. We now have government guarantees on such loans, even though there will surely be huge defaults, and this will cause unendingly increased liabilities for governments worldwide, especially in the USA. We will have much higher taxes to pay for all this. We will have hyperinflation as a result of putting huge sums of money into the same hands that irresponsibly frittered away the assets of their own companies.

Since tripling or quadrupling the tax rates is impossible, to pay for multi-trillion dollar bailouts, we are about to see outright printing of extra money, or, in the alternative, the issuance of trillions of dollars worth of new sovereign debt, both in the United States and Europe. It cannot possibly be done completely on debt, because, as noted above, there is a limit to how high taxes can be. Assuming that most of it is debt, however, this mass issuance will squeeze private borrowers, who will be in competition with the government in raising funds. This, in turn, will injure earnings going forward, in all industries, except for the banks being bailed out. That will tend to cause deflation. That is why it won’t happen. The money will be printed, not borrowed.

Earnings are already bad, and getting worse. Retail sales are declining and will continue to do so. Realistic earnings forecasts this year, going forward, indicate that share prices, even after these big market drops, are still not attractive. Stocks are not cheap at all. They are expensive, in terms of historical dividend payment levels, and historical price-earnings ratios, if you look at the earnings estimates going forward, rather than past earnings. If governments continue to simply print up more money to directly intervene in the stock market, like they did on Monday, in order to forcibly turn the situation around, flooding the markets with so-called liquidity, in the face of an insolvency crisis, they will accomplish little more than to induce runaway inflation levels reminiscent of the post-WWI Weimar Republic, in Germany. Once inflationary expectations take hold, in order to control them, interest rates would need to be raised to punitive levels, in the face of falling bank earnings. This would lead more banks into insolvency, leading, in the end, after the short detour into hyperinflation, to a Greater Great Depression, and massive deflation.

For those of us who believe that capitalism is the most efficient way to organize an economy, the emerging socialism, and all its likely results, are bad news. Experts in trading should be able to make lots of money trading the huge swings, up and down, of this collapsing market. However, they would be wise to store any profits in gold or silver, rather than in depreciating paper currencies. In the long run, the new economy being forged by Henry Paulson and his friends will bring neither stability nor prosperity. Socialism for the rich will eventually lead to the impoverishment of the common man, as it has for every nation that has followed this route. 

The taxpayers, their children and their children’s children, all over the western world, will pay, with a pound of their flesh, for the bad decisions being made today. Long term investors should use the fake rallies – bounces, like yesterday – to sell out of the market. Only superb traders, and those with inside information, will do well in this market. Better to buy gold, silver, and agricultural land, especially now that the price of the first two are temporarily severely depressed. For those who cannot bear leaving the stock market – shares in companies that produce basic goods with modern plant and equipment will depreciate the least. Retailers, however, will not be able to raise prices fast enough to make money, during the hyperinflationary period. Solvent banks will also be big losers, although their irresponsible brethren will reap the benefits of government largess, as their obligations become more and more worthless, and easy to pay off. Cash will be trash, as it becomes increasingly devalued. Some may be winners, temporarily, during the hyperinflation period, but after that is over, and all the debts are inflated away, the Big Depression will set in. Everyone will be a loser.

Instead of inducing severe temporary pain, but long term stability, by cracking down on lying banks, sending out an army of auditors to ferret out the lies and hidden losses, restoring the system by closing bad banks, and thereby increasing confidence between banks, shortsighted government officials, all over the developed world, have taken the easy short term thinking path. They are bailing out the rich and foolish, and that’s bad for everyone. Will it be 1929 all over again? I don’t know. History tends to run in repetitive cycles, rarely repeating itself in every respect. So it is impossible to say. One thing is sure, however. This will not end well.