October 1929 and The Great Depression 0 comments

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The Wall Street collapse of October 1929 marked the end of a decade of US economic growth which was accompanied by surging stock prices. It was probably the first real market collapse in the US that affected a large cross-section of the population, and it ushered in a decade of further price falls before the market finally recovered, albeit slowly.

Post-war euphoria appears to be a social phenomenon. Post-Iraq in 1991 and again in 2003; post-WW2 in the 1950s; the decade following the end of WW1 was no exception. From Jan 1920 to Sep 1929, the stock market's total return (dividends included) was an astonishing 20% per year. It was indeed testament to another natural law: the law of means reversion, that this decade-long boom was followed by a bust.

A number of well-known speculators had bailed out earlier. In 1928, Joseph Kennedy, later appointed chairman of the newly set up Securities and Exchange Commission (SEC), liquidated many of his positions, fearing that the market rise was unsustainable. By early 1929, other personalities like Bernard Baruch and John Raskob were also beginning to do so. This was a warning sign: exit of the smart money.

The unrelenting rise in the US stock market in the 1920s, coupled with ample liquidity and credit, had steadily turned the wheels of speculation. Investment trusts were a popular theme, similar to our unit trusts today, where trust managers used investors' funds to purchase common stocks of chosen companies, thus allowing the small investor to buy a piece of the action of many companies even with his limited capital. Investment pools were formed by traders and speculators who massed their capital to selectively play up (or manipulate) certain stocks and then exit on profits. The market action had reached such a frenzy by 1929 that Wall Street became New York's greatest city attraction, where many members of the public congregated to see the famous personalities; the Morgans, the Mitchells, the Lamonts. Public sentiment has always been a reliable contrarian indicator as well.

Prices actually broke on heavy volume the week before, on a Thursday. A meeting of bankers who pledged market support alleviated the pressure, but the following Monday prices broke again and there was nothing even the big-hitters could do. Major blue chips lost a third to a half of their value in one day. This was Black Monday. As the days progressed, there was to be no respite to the selling, as margin accounts were wiped out and contributed further to the collapse. The market lost half of its value in two months before rallying slightly.

But it did not end there. The early 1930s was a period of rapid economic decline, and in 1932 the country's GNP was 60% of its 1929 value, while unemployement was almost 40%. The public launched witchhunts, a common phenomenon when things turn sour. Bankers were reviled for their perceived lack of integrity in disadvantaging the small investors through their roles in investment pools; monopolies such as utilities came in for scrutiny; the government launched a campaign against short selling.

Some good did come out of all this: the Glass-Steagal Act led to the separation of investment from commercial banking to minimise conflicts of interest; the Securities Act led to the formation of the SEC which regulated stock market practices and protected small investors from being disadvantaged illegally. Over the long term, these have significantly contributed to confidence in the US financial markets.

In the midst of all this, stock prices had plunged to about 10% of their pre-crash values by 1932, as the public came to eschew stocks for bonds. Prices were so low that dividend yield was almost 10% while almost all stocks sold below book value! It led to a 1934 investment classic from Benjamin Graham, the father of modern investing, advocating value investing in stocks.

The economy and stock prices recovered slowly over the mid- and late-1930s, and it took another world war, the resulting need for war production and increased investments, and deferred consumption satisfying itself with a vengeance after the war, for the after-effects of the Great Depression to be fully erased.

References:
(1) Wall Street A History (by Charles R. Geisst)
(1) The Four Pillars of Investing (by William Bernstein)