S&P 500: ‘worst start since 1933’

by George Hatjoullis

The headline may or may not be true but it has popped up in various forms today and overnight. A look at 1933 seemed only polite, though getting data is less easy than one might imagine. The internet threw up a monthly series for the S&P 500 but in constant December 2013 prices. In other words it is a real price series. Even better and here is the link (http://bit.ly/1e0aOkP). The % changes do seem consistent with other sites that quote return data for this period. Percentage changes quoted here are from data on this site.

January 1933 was a bad month (down around 11%). Unfortunately, there is no intra-month data so the depth of any further decline in February is unclear. However, the index ended up on its February 1 value! More important the index then rallied strongly achieving 74% gain between February 1 and July 1. Not too shabby. The attempt to ‘scare up’ equity moves by including a ‘since 1930s’ comparison is misleading and disingenuous. This was not the unmitigated bear market that lives in folklore. There were good periods and 1933 was one of these periods and it started badly. It is ironic that those looking for a bear market in 2014 should choose this year to compare.

The regulatory authorities constantly warn that history is no guide to the future yet ‘experts’ constantly refer to history in making their pronouncements. It is best to focus on the present and leave the past to historians and the future to the astrologers (many of whom will give investment advice). The year began with nervousness. In part this nervousness rests on the strong gains made in 2013. A correction was likely simply because these gains were so good. In the so-called emerging markets, money has been flowing out since May 2013 and the outflow has attracted attention. The problem here is that these markets only went up in the first place because of weight of money flowing in during the crisis. The attempt to exit has caused a ‘revolving door’ event, a small market failure. The nature of such events has been discussed at length in Economics 1-18.

The catalyst may have been the Federal Reserve taper but the crisis is entirely self-made. Part of the problem has been the concept of a ’emerging market’. It implies dynamism and growth and the ability to benefit from capital. The old terms were ‘third world’ and ‘underdeveloped’, which, whilst less politically correct, better conveyed the essential feature of having limited capacity to absorb capital. The fault lies with the research departments of banks that are not really research departments but more extensions of the marketing effort. Many of these emerging markets also have issues of governance which is often ignored when it suits and then becomes a ‘surprise’. The implication of funds leaving these markets for the S&P 500 is hardly negative. Where exactly are these funds going to end up?

Looking at the asset classes available at the start of 2014 it all looked rather gloomy. Cash pays little nominal interest though with deflation a legitimate concern the ‘real’ return might not be so bad. The problem is more where to hold large wads of cash rather than the return, as the security of bank deposits is not what investors used to believe. Bonds offer a better prospect except that the taper has made long maturity bonds less appealing. Short maturity bonds however seem safe enough (even in the eurozone) and not a bad prospect for a deflation risk. However, safety-first is not the only consideration. Hedge funds, pension funds, insurance funds etc all need some significant returns to justify their existence and meet their long-term liabilities. Corporate bonds,property and equity are the only remaining primary asset classes ( bank loans are like corporate bonds).

The CB policy set up is still for low rates and easy reserve conditions. The Federal Reserve may be easing back on asset purchases but it will not be raising rates any time soon. Nor indeed are any central banks outside of those being forced to do so by capital flows. There does seem to be far too much money capital looking for a home, and a return, than there is opportunity. This situation may not improve and the result may be deflation. However, this is a process of gradual awakening rather than crisis. There is no reason to think the S&P 500 will do more than correct in 2014. Going forward however it may be quite different.

Looking along the real S&P 500 index in the above link, the level of February 1, 1933 is not seen again in real terms. It is approached only during WWII, a very unusual situation. This comparison with 1933 is at once reassuring and rather disconcerting.