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EARLY LAST WEEK, The Wall Street Journal ran an article with the headline “Why This Frothy Market Has Me Scared.” The author cited a number of indicators that have him worried, including a survey of investor optimism that’s at a 35-year high. Investors, the Journal said, are feeling “euphoric,” and that’s often a bad sign.
So, as we head into year-end, it’s worth taking stock of where things stand. The stock market has returned nearly 25% so far this year. That’s on top of a 24% gain last year. Over the past five years, even including the 34% decline in 2020 when COVID arrived and another double-digit decline in 2022, the S&P 500 has risen more than 85%. On a valuation basis, the price-to-earnings ratio of the S&P now stands at about 22 times expected earnings—far above its 40-year average of 16.
It’s figures like this that are giving some observers a fear of heights. Those who are particularly worried point to the crash that followed the peak in 1929 and ask why something like that couldn’t happen again today. During that unpleasant period, the Dow Jones Industrial Average slid 89% and didn’t fully recover until 1954.
While anything is possible, there are several structural reasons why, in my view, today’s market is unlikely to experience a decline of that magnitude.
Perhaps the most significant difference is that in 1929 there was no Securities and Exchange Commission to maintain order in the markets. The SEC was actually created in response to the 1929 crash and didn’t open its doors until 1934.
Today, the SEC exercises broad authority, policing public company disclosures, monitoring for insider trading and regulating investment advisory firms. While there will always be some number of hucksters peddling poor investments, the SEC works hard to root them out. By contrast, in 1929, investment markets were more like the wild west. In the eight years prior to the crash, the Dow Jones index rose sixfold, driven by unhealthy speculation.
Among the regulatory rules that have been tightened since the 1920s: margin requirements. Before the crash, investors were able to purchase stocks “on margin” in a way that’s no longer allowed today. Under the prevailing rules then, an investor could borrow up to 90% of the purchase price of a stock. The result: If that stock declined just 10%, the investor would be wiped out and forced to sell. In a bear market, when there’s already downward pressure, these kinds of forced sales can accelerate the decline, and that was a key factor in 1929. While investors can still borrow on margin today, borrowing is limited to just 50%, rather than 90%.
The Federal Reserve also provides stability today in ways that it didn’t back in the 1920s. In his book on the founding of the Federal Reserve, Roger Lowenstein illustrates how different our economy was then. He describes a German immigrant named Paul Warburg, who came to the U.S. in 1902. Having experience with the European system, which at the time was more developed, Warburg was surprised to find that the U.S. didn’t have something as basic as a central bank to maintain stability in the system.
Warburg compared the banking system in the U.S. to a town without a fire department, with each bank left to fend for itself. In 1907, when a recession caused hundreds of banks to fail, many came to appreciate Warburg’s warning, and his efforts led to the creation of the Fed in 1914.
Thus, the Fed did exist in 1929, but its mandate was very narrow: to protect the banking system against a repeat of what had happened in 1907. In the years since, the Fed’s mandate has expanded. In fact, if you consult its governing document today, you’ll see that it now views its first responsibility as maintaining a stable employment level—to help prevent financial calamities, in other words, and to help minimize them when they do happen.
With the ability to essentially print money, the Fed has enormous firepower to head off crises, especially since the money supply is no longer constrained by the gold standard, as it was in the 1920s. As Roger Lowenstein has put it, there’s now an organization to “lean against the wind” in a way that didn’t exist in 1929. We saw that most recently in spring 2020. With a single press release, the Fed rolled out a set of policy actions to help lift the economy out of recession. On that day, the stock market turned positive and began its recovery.
As a result of past crises like this, policymakers today have more experience to draw on. They’re better equipped to handle crises today because of mistakes that were made in the past. In 1932, for example, President Herbert Hoover raised taxes in an effort to shore up government finances, making life harder for people struggling through the Depression. What we know today, of course, is that the government should do the opposite during crises. It should run deficits to help support the economy. It’s doubtful a future president would make the same mistake.
Another difference between 1929 and today: Investors’ portfolios are more diversified. The first mutual fund got its start only in 1924. In 1929, most investors still held concentrated portfolios of individual stocks. Today, investors have access to a wide range of investment options and are able to diversify broadly at low cost. This, in my view, reduces volatility and is another factor that makes today’s market less susceptible to panic.
A related and final factor: In the 1920s, the technology underpinning markets was primitive. Stockbrokers worked by telephone. When the market began to drop in 1929, brokers couldn’t keep up with the volume of orders. This led to delays and errors in executing orders. According to accounts from that period, this compounded the panic and made matters worse.
To be sure, markets will always be vulnerable to crises. Human nature today is fundamentally the same as it was 100 years ago. But nearly everything else has changed and, for that reason, I don’t see the risk of a 1929-style decline being one that should keep us up at night.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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I always disliked the term “investors” in passages like:
While investors can still borrow on margin today, borrowing is limited to just 50%, rather than 90%.
To me, borrowing on margin is pure speculation, we should call someone engaging in that a speculator.
AFAIK, much of market trading today is robots buying or selling based on automated programs.
So I would replace “investors” with FIBS (Financial Instrument Buyers and Sellers).
I have read the 1929 crash didn’t cause the Depression, it was already happening, and the crash was just a belated recognition by FIBS
that the real economy was in a toilet.
While a 1929 style crash may not happen, the underlying cause of extreme inequality is unfortunately is present today with levels of inequality similar to the 1920s
I have a niggle of worry when I read articles that say there is no need to worry.
I agree that the markets are substantially different. Trading now can be incredibly fast with essenfially no delays, but brakes have been added.
What we don’t know is how much of the regulation may be nixed. We’ve had stability in the system with tweaks, but the next administration promises major changes, but without specifics yet. One thing we know for sure, they don’t like regulations. So who knows what the SEC will be able to control? Controls on banks, such as stress tests and limits on lending put in place in 2008-09, could go. If credit cards become less regulated, this could make people stop using them becauss they’d become too expensive. Will tax free bonds continue to have tax benefits and revenues to support their payments? This is on the backdrop of ballooning national debt and politicians trying to control the Fed. I could go on to discuss the many threats to food and water safety with less regulation. A lot of unkowns.
This article does a good job of explaining why a “1929-style decline” isn’t something we should worry about. However, it doesn’t address whether there is less risk of the much more recent sell-offs that happened with the dot-com bust when stocks dropped ~39% or when stocks dropped ~43% in 2008-2009. Sometimes I think many have already forgotten that the market didn’t exceed its high in Dec 1999 until Nov 2013.
While each of your points has some validity regarding lowering the risk of a 1929 type crash, the only two that make a serious impact are Fed intervention and Government deficit spending, IMHO.
“With the ability to essentially print money, the Fed has enormous firepower to head off crises”.
“What we know today, of course, is that the government should do the opposite during crises. It should run deficits to help support the economy.”
I have read countless articles over the last 15 years or so referencing how money printing and deficit spending have been the saviors of our economy and stock/bond markets. Well, I don’t take this as a good thing. (US debt $36T, Fed Balance Sheet, $7T) Can it go on forever?
Maybe not something to lose sleep over tonight or next month, but at some point I fear this massive level of “control” of the economic cycles and financial markets will cause way more long term harm than good.
While the Fed is very useful, I do wish for a sensible floor for their lending rate. In my opinion, the seeds of our next crisis are sown whenever they set that rate well below the U.S. GDP growth rate.
I’ve always thought, but might be wrong, that for those taking RMDs it’s better that the market is at a low on the last day of the year’s close, then it surges during the following year. This way the RMD amount is low and the person has a larger portfolio from which to withdraw.
I’ve always thought, but might be wrong, that for those taking RMDs it’s better that the market is at a low on the last day of the year’s close, then it surges during the year. This way the RMD amount is low and the person has a larger portfolio from which to withdraw.
I believe the reverse case is the worse case scenario.
I agree with you about RMDs. The market goes up and down and I always hope it’s not way up on the last business day of the year.
Let’s hope the rules and regulations are not undermined in the new quest to minimize the federal government.
Given the explosion of rules and regulations we could likely get rid of 75% and still have more than 1990. The key tho is to prune with foresight and wisdom not a machete and a Red Bull.
Yeah, if we had the same number of laws maybe. Laws can’t be implemented without regulations explaining how. If a law has a purpose so do the regulations.
I spent many years reading regulations related ERISA and subsequent employee benefit and tax laws, many hours in Washington with attorneys trying to get compliance right. A royal pain in the neck and expensive for sure, but workers are better for it all.
The quest to reduce government and save trillions will not be found in administration of programs or regulations without serious consequences in services and programs. That’s not where the big bucks are. But I’m all for improved efficiency.
Which financial regulations do you recommend getting rid of?
I was referring to the entirety of regulation and how unlikely it is that something that suddenly has grown exponentially hasn’t created a lot of unneeded hoops.
(it’s the nature of bureaucracy to want to grow itself)
The idea that we can eliminate all regulations is an extremly naive view; the greed of a few could decimate all the rest of us.
The entire system of index funds and retirement systems rely on regulations. One example: trusts which are the mechanisms that IRAs and 401(k)s operate as. Rules have gotten more complex than needed, but throwing them out would cause the structure to crumble.
You wouldn’t even be able to trust that a mutual fund operates in your interest and is truthful about its fee structure and holdings.
Adam – I too am scared as we nervously continue to hold a portfolio over-weighted in stocks. Worst case: if the market pulls back 30% or so, it merely reverts to expected trendline and more normalized valuations.
I also agree that since the 2008 crisis, the Fed basically has the market’s back. The Fed can say it only worries about inflation and employment, but these two variables are data dependent on a healthy stock market. Here’s another view suggesting that the Fed now has got the market covered:
https://pomp.substack.com/p/quantitative-easing-made-market-bears