Is It 1929 Deja Vu All Over Again?

If the late great Yogi Berra were able to look at the charts I will detail in this article, I believe he would likely say “it’s deja vu all over again”, since current stock market and economic conditions are eerily similar to those seen at the 1929 stock market peak.

While we have progressed (?) from Louis Armstrong and radio to Taylor Swift and AI over the past century, human psychology and the laws of economics have not changed.

Cynics will say I’m just trying to get attention by comparing current conditions to 1929. My response: 1) yes, I like when people read my articles and 2) as you’ll soon see, I believe there are some very important similarities between now and 1929 that informed investors should be aware of and factor into their thinking.

Four Steps To Bull And Bear Profits

I monitor hundreds of different fundamental and technical indicators to identify and profit from bull and bear market cycles. I categorize each of these indicators into four different areas, which I call the “four steps to bull and bear profits.”

These four steps are as follows:

1. Valuation metrics for estimating long-term returns of stocks and other major asset classes
2. Leading economic indicators for determining the outlook of the “boom and bust” business cycle
3. Leading sentiment and technical indicators to identify potential changes in bull and bear market trends and
4. Technical trend indicators to determine current bull or bear market trends

Here are some key indicators from each of these four steps that show we are in a period that is remarkably, and disturbingly, similar to 1929.

Step 1: Estimating Long-Term Returns

In my opinion, economist and fund manager John Hussman does the most useful valuation work in the investment industry, in terms of identifying and using the best valuation metrics to estimate long-term (10-12 year) stock market returns.

In his research, Hussman has determined the best valuation metric for estimating long-term returns for the stock market is the ratio of Nonfinancial Market Capitalization to Nonfinancial Corporate Gross Value Added Including Estimated Foreign Revenues (“Market Cap/GVA”). This is a somewhat more sophisticated version of Warren Buffett’s favorite valuation metric, which is the ratio of Total Stock Market Capitalization to GDP.

Over the past century, Hussman’s metric has over a 90% correlation with forward 10-12-year returns for the S&P 500, which is higher than any other valuation metric, including forward P/E ratios, the Shiller P/E, dividend yields, etc. For more details on valuation metrics and analysis, please see my Seeking Alpha article, “Stock Market Valuations Near All-Time Highs Are Pricing In Negative Long-Term Returns.“

As shown in the chart below, this ratio is currently near the highest levels in history, rivaling the levels seen only in 2021 and, yes, 1929.

Based on this valuation level, Hussman estimates forward annual total nominal returns for the S&P 500 over the next 10 years will be about negative 5%, as shown below. That means the S&P 500 will likely be at least 40% lower in a decade.

As Hussman explains:

The chart below shows the relationship between MarketCap/GVA and subsequent 10-year average annual nominal S&P 500 total returns, in data since 1928. The only instances more extreme than today were 28 weeks surrounding the 2022 peak, and 5 weeks surrounding the 1929 market peak. The present extreme is about three times the valuation that has historically been associated with run-of-the-mill S&P 500 total returns averaging 10% annually.”

For those who think it is impossible for the S&P 500 to be at least 40% lower in a decade, recall that the S&P 500 was nearly 60% lower and the NASDAQ was 75% lower nine years after the Tech Bubble peak of 2000. The S&P 500 was nearly 70% lower 12 years after the 1929 peak and it took 25 years for the S&P 500 to return to its 1929 level. An even scarier precedent is the Japanese stock market, which was 80% lower 20 years after its 1989 peak and is just now returning to that level 35 years later.

Step 2: Forecasting The Economy

The Great Depression was initially caused by the Federal Reserve growing the money supply aggressively during the Roaring ‘20s boom and then slowing the money supply with higher interest rates, thereby causing the bust of the early ’30s. Does this manipulation of money and interest rates by the Fed sound familiar?

The initial cause of the Great Depression was explained by economist Murray N. Rothbard in his masterful history of the era entitled “America’s Great Depression.”

As famous historian Paul Johnson wrote in the introduction to the book in 1999:

[T]he writer who, in my judgment, has come closest to providing a satisfactory analysis is Murray N. Rothbard in America’s Great Depression. For half a century, the conventional, orthodox explanation, provided by John Maynard Keynes and his followers, was that capitalism was incapable of saving itself, and that government did too little to rescue an intellectually bankrupt market system from the consequences of its own folly. This analysis seemed less and less convincing as the years went by, especially as Keynesianism itself became discredited.

His book is an intellectual tour de force, in that it consists, from start to finish, of a sustained thesis, presented with relentless logic, abundant illustration, and great eloquence. I know of few books which bring the world of economic history so vividly to life, and which contain so many cogent lessons, still valid in our own day…It has stood the test of time with success, even with panache, and I feel honored to be invited to introduce it to a new generation of readers.”

Rothbard went into great detail in the book explaining the primary cause of recurring business cycles, which includes the 1920s “boom” and the 1930s “bust”:

Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business? The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in “longer processes of production,” i.e., the capital structure is lengthened, especially in the “higher orders” most remote from the consumer.

Businessmen take their newly acquired funds and bid up the prices of capital and other producers’ goods, and this stimulates a shift of investment from the “lower” (near the consumer) to the “higher” orders of production (furthest from the consumer)—from consumer goods to capital goods industries. If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion. Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest. Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in the old consumption–investment proportions. In short, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error: that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production have turned out to be wasteful, and the malinvestment must be liquidated.”

Now that we understand the economic theory of business cycles, let’s look at charts of two proven leading economic indicators.

The chart below shows M2 money supply growth since the Federal Reserve was created in 1913. M2 fell over 10% during the Great Depression of the early 1930s. It has fallen nearly 5% over the past year, the largest decline since the Great Depression. This is after the 25%+ growth the Fed drove in response to the government-imposed covid lockdowns of 2020. That was the largest increase in the money supply since the 30% increase to help fund World War II spending. Thus, the Fed has engineered a massive boom and bust of the money supply in the past few years that has caused a “boom” and will likely soon cause a “bust” for the economy.

As typically happens during a major Fed tightening cycle like we have just had, short-term interest rates have risen above long-term interest rates, which has resulted in an inverted yield curve. An inverted yield curve has preceded every single one of the past eight recessions since the late 1960s, as well as several other recessions, including the Great Depression.

As shown below, the 10-Year/3-Month Treasury yield curve inversion was as deep in 2022 as it was in 1928, before the Great Depression of the 1930s, and far deeper than it was heading into the Great Recession of 2008-2009.

For a more detailed discussion on leading economic indicators pointing to a coming recession, please see my Seeking Alpha article “The Fed Is Talking About Rate Cuts Because They Likely See A Recession Coming.“

Step 3: Identifying Potential Trend Changes

One sign of a potential top in the market, and a change from a bull to bear trend, is when the market is rallying on very narrow leadership, with only a handful of large-cap stocks driving the major stock indexes. We saw that during the Nifty Fifty era of the early 1970s, and we have definitely seen that over the past year with the “Magnificent Seven” (or “Super Six” with Tesla down 50% from its late 2021 highs) mega-cap tech stocks.

The chart below shows the top 10% largest stocks are now 75% of the entire US stock market capitalization. That is modestly higher than the levels seen at the 2000 Tech Bubble peak and close to the level seen at the 1929 peak.

Step 4: Determining The Trend

The following chart shows the price of the S&P 500 since early 2023 (white line) and the price from August 1928 to the stock market crash of 1929 (red line). While charts like this usually seem to work until they don’t, it is striking how similar the price trend has been so far, with a correlation of 0.94.

We obviously cannot say there will definitely be a crash similar to 1929 in the coming months based on this chart, but given the similarity of current valuation levels, leading economic indicators and narrowness of the market to 1929, unfortunately a major stock bear market cannot be ruled out.

Conclusions

To recap the facts, I have shared in this article:

1. US stock market valuation levels are near the highest levels in the past century, similar to those seen at the 1929 peak
2. proven US leading economic indicators, such as money supply growth and the inverted yield curve, as similar to those seen heading into the Great Depression of the early 1930s, driven by similar boom and bust manipulation of the money supply and interest rates by the Fed
3. market concentration in the largest stocks is at levels only seen near the 1929 peak
4. the market rally we have seen since early 2023, following the bear market of 2022, is very similar to the rally preceding the 1929 peak

Many investors will argue that one major difference between now and 1929 is that the banking system has greater protections (FDIC, regulations, etc.) and the Fed has learned from history and will “pivot” quickly to creating more money out of thin air and slashing interest rates if and when the economy noticeably weakens.

My response: 1) I agree it is highly unlikely we will have the massive wave of bank failures that occurred in the Great Depression, but we have seen some of the largest bank failures in US history over the past year and the banking crisis is not over, particularly given the significant losses they have on their bond holdings and commercial real estate loans, and 2) I agree with Fed will likely ease aggressively if and when the economy weakens materially, but a) inflation still remains well above their 2% target, so that may make it more challenging for them politically, and b) this last chart shows that Fed easing has not prevented major stock bear markets and recessions historically, once the economy is on a recessionary track and investor sentiment becomes fearful and risk adverse.

Since no one has a crystal ball, all we can do as investors is look to the past for clues about the future. The valuation, economic, sentiment and technical indicators we are seeing now are ominously similar to those seen in the 1929. As a result, I believe investors should be aware of this and prepare to protect their capital and potentially profit from the challenging times that are likely ahead of us.