The Truth About the Crash of 1929
Q: I don't understand SMI's "stay the course" attitude about the current market slide. Hasn't the market gone down so much before that it's taken decades to recover, as in 1929?
A: Many people have seen the chart of the Dow Jones Industrial Average following the 1929 crash, which appears to show that it took 25 years for the stock market to regain its former high. This is a key argument of those selling strategies like market-timing and defensive investments like gold.
The 1929 example, and others like it, foster a giant misconception that colors the decision-making of many investors. Mark Hulbert wrote an excellent article on this subject last year, in which he made several crucial points. One was that looking only at the price of the Dow over those 25 years, rather than its total return, leads to a distorted conclusion:
"Dividends also played a big role in stocks' recovery from the 1929 Crash and subsequent bear market. Consider the stock series constructed by Jeremy Siegel, a finance professor at the Wharton School of the University of Pennsylvania, and author of the classic book 'Stocks for the Long Run'. He shows that, for all intents and purposes, stocks on a total-return basis in late 1936 and early 1937 had risen back to their September 1929 high, before entering into another bear market. This puts the recovery time at a little more than four years from the stock market's July 1932 bottom."
Hulbert went on to point out that the 30 Dow stocks really weren't representative of the stock market as a whole:
"It turns out that the particular stocks that were included in the Dow in the 1930s and 1940s performed significantly less well than the overall market. Perhaps the most celebrated example of how unrepresentative the Dow was then: The now-infamous decision Dow Jones & Co. made in 1939 to remove International Business Machines from the list of the 30 Dow stocks. (IBM was not added back to the list until decades later.) According to Norman Fosback, the DJIA would be more than double its current level if Dow Jones & Co. had not made that decision."
The same issues—a non-representative index and not accounting for the reinvestment of dividends—shows up in the other common misbelief that it took the stock market until 1982 to recover to the level of its 1973 high. If you look at the Wilshire 5000 (the index SMI uses because it incorporates all publicly-traded U.S. stocks) rather than the DJIA and assume dividends are reinvested, Hulbert showed it took only until December of 1976 to eclipse the 1973 highs.
Also, don't miss the fact that all of these examples deal with market indexes. Upgrading recovered from the 2000-2002 bear market much more quickly than the market indexes. For example, the Wilshire 5000 took until March of 2006 to finally eclipse its former high (when including reinvested dividends). Upgrading did so by August 2003, just 10 months after the official end of the bear market. Upgrading then went on to gain another 70% in the time it took the Wilshire to reach break even.
We're not saying that bear markets aren't painful, or even that you shouldn't consider steps to reduce some of that pain. However, if you're doing so out of fear that the market might take 25 years to recover from the next bear market because "that's what happened in 1929," you're giving too much weight to a scary imaginary risk (that stocks will be down for a decade or more) and not enough weight to the very real, but less dramatic, risk that your purchasing power will be steadily eroded over time by inflation.
Sadly, because these misconceptions are foisted regularly upon the investing public, many investors fear bear markets intensely and make poor decisions as a result. Given the real historical track record, plus Upgrading's strong performance through the significant bear market of 2000-2002, we feel most investors are better off simply continuing to Upgrade through the market's inevitable downturns, rather than trying to time the market by moving their money in and out.
Great article. I had sort of suspected this, but good to see it said by someone much smarter than me.