Investors are constantly looking for historical counterparts when it comes to different market cycles.
It makes us feel more confident in our investment position if we have some similar idea of how things are going.
No two environments are ever the same on the market, but there are always some similarities because human nature is the only constant in all cycles.
The 2020-2022 market environment has some frightening parallels to the dot-com bubble and the depression of the late 1990s and early 2000s.
In every boom, you’ve had tech stocks going vertical, the glut of IPOs, the rise of day trading, the renaissance of retail investors, rampant speculative behavior, the mockery of Warren Buffett, people getting rich in a hurry.
In every crash, tech stocks have been squashed, speculative securities are down 70-90%, retail volume has dried up, Warren Buffett has made a comeback, value stocks are back in vogue, and investors have been reminded that making money isn’t always easy.
The Nasdaq has fallen nearly 80% from the tops of the dotcom bubble while the current bear market has seen it drop by only 30%. There may be more downside but the overall market hasn’t seen anywhere near the damage from the dot-com explosion.
The pandemic has thrown a monkey wrench into this analogue even though the economy is now in a much weirder place than it was in the 1990s. The best historical example I can come up with for the current economic setting is the post-World War II period.
Both the war and the pandemic saw unprecedented government spending:
After the war, there were all kinds of supply chain problems. There were not enough homes built in the aftermath of the Great Depression for all the soldiers returning home who wanted stability.
Plus, you had companies like Ford and GM that were helping manufacture tools, equipment, and supplies for the war that then had to reverse course and go back to their previous auto business.
This combination of supply chain disruption and wartime government spending combined with consumer consumption led to massive price hikes:
By 1947, the inflation rate was nearly 20% on an annual basis. This was followed by a shallow 11-month recession that began in 1948 as GDP declined by 1.7%. This led the economy to transition from inflation to deflation by the end of the decade.
Then in the early 1950s, there was another bout of inflation from the Korean War that increased prices by about 10% per year. This mini boom was followed by a 10-month recession as GDP shrank by 2.6%.
By 1954, the federal funds rate was less than 1%, still somewhat accommodative, and they became concerned about the possibility of higher inflation. From 1954 to 1957, the Federal Reserve raised interest rates from 0.75% to 3.5%. Tight monetary policy caused another slight recession that lasted 8 months with GDP falling 3.7%.
The unemployment rate fluctuated with economic activity but did not reach double-digit levels:
In fact, the lowest unemployment rate in history was printed in 1953 just before the recession began.
Post-World War II economy It is generally seen as one of the biggest prosperity in the history of our country. We’ve seen the rise of the middle class, high wage growth, suburban construction, a glut of new housing, and one of the most underappreciated rising markets in history.
From 1945 to 1959, the US stock market rose nearly 900% or more than 16% annually. But there have been a lot of corrections and even a few bear markets along the way:
So despite two inflationary spikes, three recessions, and 11 stock market corrections, the country has experienced one of the biggest booms in history.
Now, I’m not saying we’re preparing for a similar tour.
There are a lot of differences between these two periods as well.
The point here is that recessions don’t always mean the world is coming to an end. Sometimes, the US economy just needs a stopping point.
Every time inflation rises, it doesn’t mean that it has to be a repeat of the 1970s or the start of hyperinflation. Sometimes, all it takes is a little slack to reset prices.
And every time the Fed tightens its monetary policy, it doesn’t mean the economy will collapse. Sometimes interest rates need to rise from emergency levels to get the economy back to normal.
Look, I don’t have the ability to predict what’s coming next with the economy, inflation, or the Federal Reserve. The $23 trillion US economy is so large and dynamic that it is almost impossible to predict what will happen using a set of economic indicators.
Recessions are not great because people lose their jobs, businesses sink and people lose some money.
But economic downturns are a feature, not a fault, of the system we all participate in.
In many ways, slack periods are a necessary evil to weed out some excess.
It was me and Michael simple english With Derek Thompson again this week talking about the fallout from the recession and more: