Doom and Gloom

I find conspiracy theories quite fascinating. A quick Google search will return all manner of stories surrounding September 11, the current situation in Libya, who really owns central banks and many, many more. The stories are interesting enough in their own right but it is their allure that is even more intriguing. Everyone gets a kick out of thinking they know something the ‘ignorant masses’ don’t but some people take this to a whole new level.

Doom and Gloom stories are often of a similar ilk, be it the end of the world or the next global depression. Recently I saw a video online espousing one such ‘theory’. It mounted a case predicting the complete collapse of the global ‘paper’ financial system. On the surface the argument was compelling and exciting but a little analysis revealed large holes in the story.

One piece of ‘evidence’ was that Apple shares are inflated and that outflows of money from AAPL to silver would cause supply issues in the silver market. The only point used to support the claim that Apple was overpriced was that it had recently (and briefly) surpassed XOM as America’s largest company by market capitalisation.

At the time, Apple was trading at around 15 times earnings (based on the calculation method used by Yahoo finance). This is hardly overvalued and is very near the long-term average of P/E’s for the stock market as a whole. Checking hundreds of indicators (technical-, fundamental- and sentiment-based) few, if any, provided an argument that Apple was significantly overpriced medium- or long-term.

The video ties this pseudo-fact about Apple back to silver by suggesting that if money flowed from Apple to silver, then supply issues may occur. This is a very tenuous link, to say the least, and is typical of the flaws in these types of theories. A few facts – like Apple’s market cap being higher than Exxon – are blended with unsupported claims to give an impression that the whole argument is factual or at least reasonable.

The video caused a fair bit of online discussion and one individual drew parallels between the current economic situation (including the GFC) and the Great Depression. The suggestion was that we are in the midst of a depression that began in 2000 and whose scope will rival the Great Depression.

This led me to compare the 1929 crash to the events of 2000.

The Dow Jones Industrial average lost more than 90% in the bear market that started in 1929 and almost 40% following in the 2000 crash, while the dotcom decline was just under half that of 1929.

Chart 1

click to enlarge

In the year leading up to each crash, the market gained just under half as much into 2000 as it did into 1929 - half the gain, half the decline. The three-year gains leading into each crash also match this pattern: 140% before 1929 and 73% before 2000. These numbers certainly suggest that the declines were actually quite similar. More importantly, it suggests that the 2000 bear market ran its course.

While there is no formal agreement on a definition of economic depression, it can be explained as a prolonged period of decreased economic activity. The housing bubble that occurred between the dotcom crash and the GFC makes it hard to suggest we have been in a depression since 2000. They can’t even really be considered part of the same episode. The low interest rate environment that followed the 2000 crash helped fuel the housing bubble, but I propose that the events of September 11, 2001 had a more profound and lasting effect on rate levels than the dotcom crash. US Government policies on home ownership also played a big part in the housing boom/bust.

So what does this mean for the current market? Will Greece default? It seems likely. Is the US about to go into recession? Possibly - recessions occur every few years. Will the S&P 500 reach bear market territory (>20% decline)? Also possible. Will any of these eventualities mean the sky is actually falling? Very unlikely.

In my opinion the US economy - and in turn the stock market - have more room for surprises to the upside than the downside in the coming years. To quote Warren Buffett: “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”

Happy Trading

Jordan Craw