The Doomsday Scenario - What If?

by: Roger Nusbaum

A reader left the following:

Please talk about the deep recession or depression scenario.

As you say, a 100 depression is also "normal" and we are do but you seem to be too "emotional" to take this scenario seriously. It is a very, very real scenario everyone that built financial careers of the last 30 years is ignoring, seems like almost denial and I'd love to hear your macro analysis of that very possible and normal scenario?

I pasted the whole thing because there are parts of it I don't follow, but as to the parts I do follow...

First, I would say I am not sure why a depression is very possible. From a stock market standpoint, 'down a lot' would start out as 'down a little'. So, same as anything else - have a strategy devised to take defensive action. I have spelled out mine countless times. So far I have tweaked the portfolio and am ready to take more action if the market devolves from here.

According to the Stock Trader's Almanac, the Dow Industrials peaked at 381.17 on September 9, 1929. It bottomed on July 8, 1932 at 41.22 - about a 90% hit. So that is probably the biggest fear out there, another 90% drop in the market. A couple of things to keep in mind: the Dow was up 80% in 1933, almost 40% in 1935 but it fell 27% in 1937.

Although the market did not take 381 back until 1954, from the period between 1929-1954 inclusive there were 15 up years and 11 down years. This tells me that a repeat of the 1930s will have some chance for gains, but even if you cannot catch any of those up years, discipline to a get-defensive plan could add tremendous long term value. This will make some people groan, but down 40% in a down 80% world would be a colossal success.

Unemployment during the depression was, I believe, around 25%. That was at a time when more people had manufacturing jobs. Now we have a lot of service jobs. Demand for a lot of services will not wain as much as the need to manufacture big heavy things made of metal.

There would be plenty of jobs lost and I also think people would face taking pay cuts to keep their jobs. So who does this hurt the most? My first thought is people who are over-leveraged, but this is always true. Regardless of what is going on, a couple living beyond their means will be in deep trouble right away if one of them loses their job. If you have a low monthly budget you face an easier time covering the bills with replacement work.

I am not sure a depression and a 90% stock market decline is normal, and I apologize if I ever said it was, but it has happened before and could happen again at some point. I do not think it is a realistic possibility this decade, but if it happens it will take a long time to unfold, giving plenty of time to reduce exposure.

Things to own might include equities from countries in their own world, foreign currency and bonds from certain countries and some commodities.

As far as being emotionally complacent, I'm not sure how to answer that. Down a lot, whatever it becomes, starts with down a little; I preach about taking defensive action all the time. Not overextending yourself in life seems to me to be common sense, even though many folks are too extended.

I can only account for myself - when I first started managing money I had two clients and some savings that I did not want to spend. I spent my afternoons doing things like logging, putting on a roof and building a rock wall for money so I wouldn't have to spend the savings. Point being, I was willing to do whatever it took.

If this person is right, we may all have to have some sense of whatever it takes. I was not put off by doing it then I won't be in the future, if that is what it takes. To me this is what being enterprising, entrepreneurial and living the American dream is all about: taking the bull by the horns and doing what needs to be done.

This post really offers no macro analysis because analyzing is it does not benefit my clients. What benefits them is staying disciplined to the defensive strategy I tell them we use and believe in and figuring out what to do if, I think the rest will take care of itself.