Saturday, August 13, 2005

The 1970s Bear Market 1 comments



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The 1970s was characterised by rampaging inflation in the US, first due to a legacy from the surging 1960s economy boom, then aggravated by the formation of the OPEC cartel which triggered cost-push inflation. It was not until the early 1980s that the US market started to recover from the inflationary spiral and resulting stock market swoon.

The bull economy of the 1960s had started to sputter by the early 1970s, due to falling unemployment causing tight supply and hence higher prices; this was further aggravated by the rise of labour unions with better negiotating power. Faced by such pressures, the US government appeared to seek alternative methods of stimulating growth through its actions on the forex market, where Richard Nixon cut the US dollar's convertability to gold and allowed the dollar to float freely; the intention was to raise the relative competitiveness of US exports. However it set off currency instabilities on the world market, dampened sentiment towards US assets, and further aggravated the inflation in the US.

Then the classic cost-push inflation was triggered when the newly formed Organisation of Petroleum Exporting Countries (OPEC) announced a sharp rise in the price of oil in early 1973, partly for political reasons and partly to compensate for the devaluation of the US dollar which was the currency denomination their oil was traded in. Within 1.5 years the price of a barrel of oil surged from 2.50/barrel to over $11/barrel. Since then oil has been a closely watched commodity, up to this day.

The annual inflation rate which shot up to over 15% by the mid to late-1970s as a result of these factors had an immediate effect on the stock and bond markets. Stock indices dove sharply in late 1973 and 1974, with individual stocks correcting to half their 1970 price was normal; in particular the Nifty Fifty stocks, wildly popular in the early 1970s and considered the best growth stocks, the "one-decision" stocks (only need to make one decision ever: buy and hold forever), collapsed. On the bond market front, yields rose in conjunction with interest rates, causing grief to incumbent bond investors.

Such a combination of low economic growth combined with high inflation is known as stagflation, and the US government finally realised that it had to focus on fighting inflation to solve such a paradoxical combination. Paul Volcker, the new Federal Reserve chairman, began a series of aggressive interest rate hikes after taking office in 1979, in an attempt to restrict monetary growth. This initially destabilised the markets but ultimately stopped inflation in its tracks. At the same time, as the high yields became too attractive to ignore, foreign investors started coming back into the market to buy US assets (US dollars, bonds, stocks), triggering a recovery in the capital markets. The tax breaks by Ronald Reagan's new government, influenced by supply-side economics, also boosted consumer spending. 1982 saw the turning point which was to lead on to a two-decade bull market. However, the legacy of this prolonged 1970s bear market would never be forgotten. Inflation is nowadays viewed as one of the most important, if not the most crucial, economic factor to monitor and tackle by the US Federal Reserve.

References:
(1) Wall Street A History (by Charles R. Geisst)

 

 

1 Comments:

Blogger Jon Sigurdsson said...

Thanks for the explanation!
Very useful in preparing for the future

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