Not Seeing 1929 Today

While a chart comparing 1929 to now is unsettling, digging deeper reveals the risk is marginal, more subdued, and noise to disciplined investor.

A friend of mine asked my thoughts the above chart, which has been popular over the last week.  Naturally when you see our current stock market compared to 1929 that raises some alarm bells, but let me dampen some of those concerns (also see here and here):

1. Chart overlays are relatively common.  I see maybe 5 a week?  This one took off I would suspect given the 1929 comparison.  That doesn’t invalidate the chart, just shows that this isn’t the only chart overlay around. 
2. When looking at the chart, the first thing that came to mind was the scale (see below numbered bullets).  As Jeff Saut notes:  “You can ‘scale’ any chart to do just about anything you want it to imply! In this case, the scale makes the comparison to 1929 with the present stock market chart pattern appear eerie. However, if you index that same chart so that you are comparing apples to apples, the correlation to 1929 disappears.”
3. For arguments sake, let’s say this isn’t just a coincidence and that the market does follow the path implied by the chart.  The 1929 fall was about 50% per the chart, when scaling to today that fall would be almost 20%.  So while it would indicate a bear market, a properly diversified portfolio with some risk control parameters would certainly weather this storm.
4. The 1929 crash was after a near 10 year bull market.  We are 5 years into this bull market and I would guess the euphoria in 1929 dwarfs the enthusiasm for stock now.
5. The 1929 crash was also after a massive leveraging up.  We are currently deleveraging or maybe bottoming there, but certainly not in ramp up mode.
6. Totally different monetary systems.  We were pegged to Gold then and have a fiat currency now.  This means the Fed can create liquidity during market stress if they see fit, which could (and has since 2009) put a floor on the drop.

Is there anything to the chart overlay?  Probably not.  It could be coincidence or perhaps the author was looking for confirmation bias (searching for evidence to support his claim).  While I do think investor behavior tends to rhyme (not repeat), I just have a hard time seeing that in this chart.  And at least on the positive side this is a good reminder there is always risk in the markets.

Hopefully investors didn’t react emotionally to the chart as since it came out the S&P had a nice snapback and is close to flat for the year.  Nothing about the latest pullback indicates there will be a sustained fall in the markets, but if that proves to be false and the chart overlay comes to fruition a strategy to minimize drawdowns likely will prove more useful than the chart.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market The Dow Jones Industrial Average is a widely watched index of 30 American stocks thought to represent the pulse of the American economy and markets. 

Patience Can Help With Capital Preservation

“A cheap asset presents an opportunity for increased future returns, but if your goal is minimize your drawdowns, then wait for those assets to stabilize.” 

In my 2013 thesis I used the following: “On a relative value basis… emerging markets face secular headwinds they do appear cheap.”

If you read my commentary and/or listen to Warren Buffet you buy assets when they are cheap.  The price you pay is as important as the quality of the asset you are buying.  This increases the likelihood that future returns will be higher.  The logic is simple, but I do think comes with a caveat.

I noted later in that thesis the following on Emerging Markets: “while there are opportunities for upside until the trend reverses it’s hard to have much conviction”.  Trends in major asset classes start quickly, but play out over a longer time period.  As result, if your goal is to get reasonable returns over a longer time horizon and reduce your risk it makes sense to wait until the trend appears to have bottoms and more than likely has moved into an uptrend.  Thus, while you miss some of the upside, maybe even the bigger moves, you also avoid the large moves down in that asset.

Which brings me to Emerging Markets, here is what they look like as of 02/03/14 close:

What I see:

• YTD down 7%
• Trend is moving down, doesn’t appear to be stabilizing
• Valuations are now cheaper, but they were cheap to start the year (i.e. just because an asset is cheap doesn’t mean it will reverse)

Thus, while enticing on a value basis patience can help you avoid any further drawdowns before adding to this position, or any other asset class in a downtrend. 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.