They say everything is bigger and better in Texas. I say, everything is bigger and “badder” (as in worse) on Wall Street today than 85 years ago.
Despite all the parallels that exist between today and the Great Depression, there is one factor that just doesn’t match up — time. The Great (post-2007) Recession has already lasted longer than the 1929 to 1932 market meltdown.
If you focus merely on elapsed time, you can reach two conclusions:
- Either there is no parallel, or the 2007 bear market is over
- The 2007 bear market will be more intense and last longer than the 1929 – 1932 parallel
A look at the pattern and shape of the post-1929 and post-2007 declines, along with the sentiment that accompanied major events within both periods, suggest that we are in a monster version of the Great Depression with the next leg down not too far away.
If You Think It Can’t Happen Again, Think Again
I’ve often heard that the Great Depression can’t happen again because we are no longer on the gold standard — the absence of the gold standard now allows the Federal Reserve to print their way out of any recession.
That is true, the Fed can now print unlimited amounts of money. However, the non-existent gold standard is a double-edged sword. Just as it enables the Fed to print money (which the Fed has done for decades), it has enabled a massive leveraged bubble. It’s this unbridled (by the gold standard) leveraged frenzy that created a huge financial leverage bubble, and the Federal Reserve attempted to fix the bubble’s consequences with a new bubble — the QE2 bubble.
Regarding the QE2 bubble, the May ETF Profit Strategy Newsletter stated that: “The Fed is fueling a new bubble to combat the damage left behind by the previous one. Once punctured, bubbles tend to deflate quickly.” Deflate it did. The S&P lost 296 points from the May 2 high to the Oct. 4 low. The “liberty” of an unbridled currency did not prevent the decline.
Here’s where the parallels between the Great Depression stock market meltdown and the post-2007 decline become interesting:
Both declines saw an initial leg down followed by the mother of all counter trend rallies. The 1929/30 counter trend rally lasted a little more than five months and retraced 62% of the previous decline. The 2009-11 counter trend rally retraced 86% of the previous decline (based on the Dow).
Here are some newspaper headlines that appeared in April 1930 towards the end of the biggest sucker rally, so far:
- “The outlook is favorable” — Harvard Economic Society
- “The depression is over” — Herbert Hoover
- “There is nothing in the situation to be disturbed about” — Andrew Mellon, Treasury Secretary
- “Wall Street was in a cheerful frame of mind as a result of numerous vague reports of improvements in business and industry” — Wall Street Journal
Following this brief flash of confidence, the Dow tumbled 10% within two and a half months. Interestingly, this second major leg of the bear market kicked off in April.
Fast-forward 81 years to April 2011 and we read the following headlines:
- “Global economy is improving” — GE (NYSE:GE) CEO Immelt
- “Sales growth the biggest surprise on Wall Street” — Wall Street Journal
- “Equities finally seeing light on the economy” — MarketWatch
Just when Wall Street thought the bear market was over, the S&P delivered a six month, 20% drop. The Dow, NASDAQ and Russell 2000 followed suit.
The chart below compares the Dow’s performance of 1928 to 1932 to that of 2007 to 2011. It took a break below trend lines in 1929 and 1930 to kick off powerful declines.
It also took a break below trend lines in 2008 and 2011 to unleash massive bearish forces. The Jul. 28 ETF Profit Strategy update pointed out that the corresponding trend line for the S&P is at 1,298 and stated that: “A break below the trend line may trigger panic selling”.
The S&P dropped below this target on the following day and lost over 20% in the next seven trading days. Since this trend line has been rising pretty rapidly, it is unlikely that the S&P will visit this trend line before the next leg down.
However, there’s another trend line (not shown in the above chart) that’s crucial for the short-term fate of stocks. This very trend line is now the ideal target for this rally. This is apparent because this trend line corresponds exactly to the trend line created by the 2007/08 market top.
In fact, the parallels between today and 2008 are so pronounced that the Aug. 7 ETF Profit Strategy update dubbed it “the script”. Based on the script, the Aug. 7 update predicted that:
- There will be a new low (occurred at 1,075 on October 5) and
- There will be a powerful counter trend rally to around 1,250
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