“In
the last three decades the prestige of security analysis in Wall Street has
experienced both a brilliant rise and an ignominious fall … the “new era” …
involved at bottom the abandonment of the analytical approach; and while
emphasis was still seemingly placed on facts and figures, these were manipulated
by a sort of pseudo-analysis to support the delusions of the period.” The above
quote is not about the current market from yesterday’s Wall Street Journal, but
from the 1934 Graham and Dodd textbook titled “Security Analysis”, which is the
bible of stock analysts. The words are a commentary on the speculation that led
to the Crash of 1929. As the French saw goes, “plus ça change”… the more things
change, the more things stay the same !To sell or not to sell, is the dilemma facing all investors today, but it is important to remember that cycles of boom and bust, and of greed and fear have repeated themselves throughout history. The raging optimism of yesteryear is being replaced by the manic pessimism of the current times. In a situation such as this, it is instructive to look at what happened after the Crash of 1929 that led to the Great Depression, and to see if there is a light at the end of this tunnel, which is not an oncoming train.
In the immediate aftermath of the Crash of 1929, the US financial authorities did take several steps in the short term to ease credit conditions. Banks were given adequate liquidity by allowing them to borrow at the Fed’s discount window, and the Fed injected reserves into the banking system to prevent a liquidity crisis from infecting the money markets. However, these actions were temporary in nature, and monetary policy soon reverted to a contractionary stance, which had caused the stock bubble of the 1920s to burst in the first place. In the event, monetary policy remained tight after the Crash of ‘29, monetary aggregates fell, and long-term real interest rates increased throughout 1930, even though a recession had already begun before the Fed tightened. Many economists believe that the Fed’s actions in the period after the Crash of 1929 contributed to a continuing decline in economic activity and the Great Depression.
The Greenspan Fed of the current era appears to be doing everything to avoid the mistakes of past policy and rates have stayed low. The staff of the Federal Reserve has published a working paper titled "Preventing Deflation: Lessons from Japan's Experience in the 1990s." Fed officials have looked into unconventional methods, such as the Bank of Japan’s ideas about direct purchases of corporate bonds and equities. While it is unlikely that the Fed will go that far, it is important to note that it has looked closely at the risks of a deflationary spiral and the experience of Japan. And this is why the Fed may even cut rates at some point from current historically low levels.
In the midst of the current malaise, it is important to remember that the US economy has resumed its growth in the first quarter of 2002. Amongst the greatest risks to the economy are slowdowns in consumer spending and business investment. Low interest rates have helped keep mortgage rates low and put money into the pockets of US homeowners. However, the negative wealth effect of the stock market decline could slowdown the consumer spending juggernaut, which is the backbone of the US economy. Likewise, if US banks pull in their horns and cause a credit crunch as some fear, this could put a crimp in business spending and activity, leading to job losses and a slowdown in consumer spending. This is why there have been calls in some quarters for the Fed to lower rates and to jawbone the banks into not instituting a credit crunch.
The last few days and weeks have been dominated by a constant search for the elusive market bottom. But like the Scarlet Pimpernel, the elusive market bottom is nowhere to be seen. If anything, the constant chatter about a “capitulation” sell-off is making it less likely that a classic market bottom will happen any time soon. Technical analysts who track momentum readings have suggested that the market may be oversold, at least temporarily, based on the CBOE VIX volatility index readings, and this is a bullish sign. By the same token, the S&P 500 has raced past several key support levels, which is a very bearish technical sign.
What is one to do about this stock market? Some investors and analysts may want to view the current markets as a buying opportunity. However, the best advice appears to be coming from cautious advisors, who are saying that this is no time to be a hero. Trying to guess the market bottom can be as hazardous as holding on to a stock in search of the market top. You can go broke being too early according to this view. Investors who have a long-term view may not want to sell depressed holdings at current levels. The best course appears to be a cautious one, which is based on the age-old wisdom of “steady as she goes” while not keeping all eggs in one basket. Prudent investors who had followed the dictum of portfolio theory had diversified their holdings amongst stocks, bonds and cash instruments, and are not feeling as much pain as those who had over-invested in stocks. In volatile and uncertain markets, it makes eminent sense to further lower the portfolio allocation to equities to levels at or below 50%, without exiting the stock market altogether as some may be tempted to do.
Indian-Americans for the most part appear to be handling the current downturn with relative calm, probably cushioned by the prudent approach to investing that is typical of new immigrants. However, some of the newer arrivals, and especially those who came during the tech boom of the 90s, and who had never seen a bear market, are hurting from a double whammy of job losses and portfolio meltdowns. Fortunately, this younger generation also has quite some time to go before retirement, and some help is forthcoming from friends and family, and other avenues such as the IIT old boy network. A low jobless rate, benign interest rates and zero inflation, in conjunction with housing price and stock gains from the boom years have allowed many to cushion the shock of the current stock market swoon. However, any further precipitous declines in the stock market or the housing market, or a jump in jobless rates could result in serious pain.
In the words of little orphan Annie from the eponymous Broadway musical, which refers to the times of the Great Depression and its aftermath …“the sun'll come out tomorrow … bet your bottom dollar that tomorrow … there'll be sun ! … Tomorrow ! Tomorrow ! I love ya Tomorrow ! You're always a day away !” Or in the immortal words of the Bhagavad Gita (2:54-56), investors should be like the “sthita-dhih” sage, whose mind is not shaken by adversity and fear … for the only thing we have to fear is fear itself.