There are some similarities between the U.S. stock market today and the wild Roaring Twenties market a hundred years ago, but it’s not a sign you can bank on.
Still, it would be very exciting if the stock market had another run like it did in the 1920s. In fact, the Dow Jones Industrial Average DJIA 0.24% would go over 150,000 if it raises as much between now and 2029 as it did during the same time period in the 1920s.
Even though there are some connections between now and the 1920s, there are also some big differences. Check out the picture above to see how the Dow has done since the 1920s and so far this decade. If you look closely enough, you might think that the two stories are linked. They’re not. On the other hand, the Dow’s decade-to-date return from January 2020 to August 2021 was a gain of 22.7%, while it was a loss of 41.2% from January 2020 to August 1921.
In fact, there have been many times in the last 100 years when four years or more have been just as strongly linked to the beginning of the 1920s, if not more so. Almost none of them say that the Dow will go over 150,000 in five years. To keep bringing up this one highly bullish comparison is the worst kind of data mining.
The 1929 crash is similar
This brazen data mining is shown well by a picture that made Wall Street go crazy ten years ago. In the chart below, the performance of the Dow from May 2012 to February 2014 is shown on top of the performance of the Dow in 1928 and 1929. There seems to be a strong link between the two series, and it looks like a crash like the one in 1929 is about to happen.
Of course, such a crash did not happen. It’s not just Monday morning quarterbacking for me to bring this up now; my articles on the subject have already said that it’s very doubtful whether it’s true. David Leinweber is the founder of the Center for Innovative Financial Technology at the Lawrence Berkeley National Laboratory and the author of the now-famous 2007 article “Stupid Data Miner Tricks: Overfitting the S&P 500.” I quoted him in one of my Wall Street Journal columns about the chart.
According to Leinweber, if you looked at enough periods of the same length [as the one that started in May 2012], you’d find a lot of very similar pictures that show what look like strong correlations. Most of them wouldn’t have a crash at the end. It is “the analytical equivalent of finding bunnies in the clouds” to keep focusing on the one parallel that makes you think a crash is coming soon. You would eventually find that bunny if you looked hard enough, but it wouldn’t be real any more than the wind that blows over the horizon.
The slump that was “forgotten”
A second important reason why we shouldn’t think that this decade will be like the 1920s is this: In the second half of the 1920s, the stock market went up a lot. This was partly because the U.S. economy had been through a very bad downturn in the first half of the decade. This is what Jim Grant, director of Grant’s Interest Rate Observer, who has learned a lot about the 1920s, says.
Few people who work in investments even know about this slump in the early 1920s. That’s why Grant called his book about it “The Forgotten Depression.” He says that between 1920 and 1921, there was a “deflationary depression” that was so bad that one economist at the time said the world was “nearer collapse than at any time since the fall of the Roman Empire.”
The U.S. economy and stock market both came back from the depths of the Great Depression. The Wall Street Journal told Grant that “scores” of companies were worth less than their working capital at the height of the Great Depression. Shares in “a lot” of industrial companies were being sold for “one-third of what they were really worth.” One company, Coca-Cola KO 0.77%, was trading for 1.7 times its earnings in 1922 and 2.5 times its profits in 1923.
You might be wondering if the bear market from February to March 2020 is the same in some ways as the slump from 1920 to 1921. It’s not. In the U.S., for example, there was no real deflation in 2020 because of the government’s huge spending programs. In May 2020, when inflation was 0.1%, the consumer price index had the lowest 12-month rate of change.
During the Great Depression of 1920–1921, on the other hand, the CPI’s 12-month rate of change was -15.8%, which was much lower than even the worst decline of the 1930s. In March 2020, almost no businesses were selling for less than their operating capital. The S&P 500’s SPX 0.20% price-to-book ratio was 2.5 at that month’s bear market low, which by any past measure is much more likely to mean that the stock is overvalued than undervalued.
There is always a chance that the Dow will reach more than 150,000 in the next five years. If you really think the Dow will go up that much, though, you should use something other than what happened to stocks in the 1920s to support your claim.
