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October 09, 2009

A Step Back In Time
by Sol Palha

"A generation which ignores history has no past and no future." - Robert Heinlein, 1907-1988, American Science Fiction Writer

The info below provides an interesting view of what took place in the 1929-1930 time periods. If one had to take away the dates, one would think that the writers were referring to current events. History clearly repeats itself and the stories posted below quite clearly illustrate this point. Our comments are posted in blue.

Events leading up the Crash of 1929

Investors had long borrowed money to buy stocks, but the amount they borrowed and the enthusiasm for borrowing grew rapidly in the late 1920s, as credit became plentiful and the stock market started to boom. Borrowing to buy a stock -- an investment representing a share of a corporation -- meant putting up "margin." Margin was like a down payment on the stock purchase, sometimes as little as 10% of the purchase price. Investors didn't have to pay anything more upfront, unless the stock price fell. The loan would be paid off by the rising value of the stock.

In 1927, brokers borrowed $4 billion, up 33% from the previous year, and they in turn would lend the money to stock buyers. By the end of 1928, brokers' loans had exploded to $6.4 billion, a 56% increase in one year.

In fact, in 1929, nearly $4 of every $10 banks lent was for stock purchases. Even corporations jumped in on the lending business. John D. Rockefeller's Standard Oil of New Jersey, Chrysler and General Motors all made millions of dollars in stock loans.

Interesting is it not that many banks reported record profits and most of these profits were made from trading the markets. So instead of lending money banks are now moving more and more into trying to time the markets. Indirectly, this is the same thing that took place in 1929 when 4 out of every 10 dollars banks lent went into the market; the final destination was still the stock market. Sounds like a recipe for trouble.

But stocks continued to fall, dropping 12.8% on the following Monday, Oct. 28, and nearly another 12% on Oct. 29, Black Tuesday, one of the worst days ever in the stock market. Over six days, the stock market lost nearly one-third of its value -- $25 billion in savings disappeared

The stock market crash was painful, wiping out the life savings of millions of people and leaving some deep in debt. After watching the devastation of such a borrowing binge, federal officials were determined to keep people from overindulging again. They took steps to keep interest rates high and discourage borrowing. So people didn't borrow -- and companies didn't either. Consumers couldn't buy houses. Companies didn't have money to expand. Workers lost their jobs as the businesses shrivelled. The result was a downward economic spiral.

The stock market crash of 1929 was the first clear sign of an economic downturn. But it was the policy aimed at preventing a repeat that sent the nation sliding into the horrific slump that that became the Great Depression.

From the book "Six Days in October: The Stock Market Crash of 1929," by Karen Blumenthal. © Copyright 2002 Karen Blumenthal

After the Crash

The following stories extracted from the following site news from 1930 blogspot

From June 2-7 1930 Wall Street Journal

Henry Ford says business is getting back to normal and the worst of the economic depression is past.

Brokers and financiers "seem to think the business depression has touched bottom, and the next turn will be for the better."

Present dull period is giving Wall Street brokers time to improve their prowess at many games, including golf, bridge, checkers, chess, and ping pong.

June 13, 1930 Wall Street Journal

Business is not improving as predicted, which is lowering market sentiment. Business volume is holding fairly steady week-to-week, but prices are lower, which should lead to lower earnings. Wages aren't going down as fast as earnings, but fewer people are employed.

Market has confounded observers by slumping when two weeks ago at least 75% of the Street was predicting a rally.

Strange the market actually has a mind of its own, interesting how 80 years later and very seem to have understood this simple concept.

June 23 1930 Wall Street Journal

Col. Ayres, VP Cleveland Trust, predicts an abrupt recovery in stock and commodity prices by Labor Day due to current consumption exceeding production. Distinguishes between two types of depression, "V"-shaped and "U"-shaped.

Reduction of the rediscount rate to 2 1/2 percent is considered beneficial in several ways. It indicates credit will be easy for some time; should benefit many industries including farming, building, and construction, and make bond issues easier for corporations resulting in lower unemployment.

Stocks continued down, with big declines in the large trading stocks. Bears encouraged by the failure to hold Thursday's rally after good news, and further breaks in the commodity market (wheat, corn, cotton). US Steel hit a new yearly low, followed shortly by Bethlehem Steel, Union Carbide, and American Can. Some rallying on the close on short covering. Volume not very heavy.

August 6, 1930

Market seen as having prepared conditions for good uptrend on both fundamental and technical grounds. A year has passed since start of the downturn, typical lengh of depressions historically. Seasonal factors are favorable. Also, recent dull range-bound trading is typical as "market builds up its technical strength."

Are not many experts already making such comments now?

Market appeared to have been strengthened by past two days of consolidation; bulls encouraged by failure of bear efforts to bring out liquidation; also by increase of $8M in brokers' loans, taken as sign of greater public participation (though a relatively small increase). Retailers strong following news of improving Aug. sales at Woolworth. Major industrials recovered vigorously from recent lows. Amusements, utilities, banks also strong. Volume increased as prices went higher, and "bullish demonstrations" spread. Rails and oils neglected. Market closed on day's highs. Bond market strong; Dow 40 bond average at new 1930 high of 97.29; high grade corp. strong; convertibles more active; govts irregular, little changed.

Market opinion now sharply divided; bears cite repeated failure to break through 241 resistance level, bad farm news, and recent bad business news; bulls point to market resistance to selling (volume drying up on declines), and to strong positive reaction to good news as indicating path of least resistance is upward.

August 16 1930

Stocks staged a sensational late rally attributed to "wild covering movement" by over extended shorts. Pessimism over drought affects on business had induced "perhaps the largest" short interest in history. Bears made some further attempts early, particularly against coppers. News of heavy rains in drought areas caused a short covering movement, at first cautious but turning into a rout in late afternoon. "Spectacular uprushes" in stocks under recent pressure including US Steel, J.I. Case, Vanadium; general market rose aggressively. Bond market dull; corp. and preferreds up, foreign govts. mixed, US govt. steady.

August 25, 1930

Alarmed by shrinking population, France budgets $45M to encourage large families; parents to receive $20 for second child, $30 for each additional.

Bulls encouraged by Pres. Hoover's statement tax cut may be continued, by some favorable business reviews, and by market action on Friday. Some unsettlement in oil group caused by decline in gasoline prices and high inventories in spite of recent reduction; however, weakness was moderate and didn't spread to other sectors. Major industrials and trading favorites strong, some reaching best levels since July peak. Tobaccos, banks and trusts, utilities strong. Bond market in Saturday session quiet but continued higher; most activity was in a few rails and industrials; Dow 40-bond avg. up to new 1930 high of 96.87.

Notice how bonds rallied very strongly much like they did early this year before they suddenly mounted a very strong correction and are still trading significantly of their highs.

Editorial: Some have suggested banning short-selling as aid to business recovery. But recent market swings have not been due to short-selling but to public recognition of reduced earning power; similarly, farmland in Corn Belt has gone down by 2/3 from wartime level, though no one has been selling it short.

They blamed naked short selling recently for the damage caused to bank stocks and so they eliminated this practice. Time will tell if this ban on naked short selling was really a factor or not; we suspect that it simply delayed the inevitable. Weak banks are going to fail and should be allowed to be taken over or sink and not given extended life lines only to cause more damage down the line.

Sept 11

Market considered stronger technically from recent period of consolidation, move upward on higher volume; declines of June and early August are seen as having shaken out weak hands, as indicated by shrinkage in brokers' loans. Recent economic news has also been encouraging, including steel production, retail and mail order sales. Roger Babson's switch to bullish stance has also attracted attention. All indications point to good sized gains in stocks in the near future, though third-quarter earnings reports in a few weeks may change the trend.

An out-of-work broker asked a friend who owned a circus for work. His friend said the circus gorilla had recently died, and if the broker wanted to get into the gorilla's skin, swing around, growl, and amuse the children, he could have the job. Things went well until one day the rope the "gorilla" was swinging on snapped and catapulted him into the lion's cage. The lion let out a roar, which the "gorilla" answered with a timid yelp. The lion roared louder, and the "gorilla" lost his nerve and started screaming for help. The lion came closer and whispered "Shut up, you damned fool, you're not the only broker out of a job."

Sept 13

Current consensus is that "there will be a good advance shortly followed by a set-back before the end of the year", when disappointing Q3 reports appear. However, when "predictions ... are so nearly unanimous," market action may be contrary to the general opinion.

Conclusion

All the quotes posted under the section titled "after the crash" were obtained from this site. For more info click here

One can clearly see the similarities between what took place 80 years ago and what is transpiring right now. Once individuals are used to fast money they keep coming back for more and the only thing that can slow them down is a massive dose of pain. The dotcom melt down of 2000 only briefly stopped investors, a few years later they jumped into real estate and created another bubble and now they are trying their hands at stocks once again.

Banks are supposed to generate most of their money from loans; however the major banks are actually taking on larger amounts of risks by using the stock market to beef up their gains. In many cases the trading dept is producing up to 50% of the banks revenues. They are now using the money the government lent them to take on even more risks.

MR Durant was one of the richest men in Wall Street before the 1929 crash; he controlled over 4 billion dollars (4 billion dollars that time was an incredible amount of money, probably in the order of 1 trillion plus dollars in today's money). After the crash he was left with just $250.

There are some differences or so called differences between what is occurring now and what took place last time

Last time round the Fed's immediately cut back on lending and drove up interest rates. This time round they have aggressively lowered rates and provided huge amounts of liquidity to the markets. The difference however is that in 1929 we were not a debtor nation, but now we owe money and continue to require huge infusions on a daily basis. Overseas investors are simply not going to keep lending money at such low rates. The fed is going to be forced to raise rates sooner or later and once they start raising them, they will have to do so rather aggressively to satisfy foreign investors. When you owe money you are no longer in charge, you answer to someone else; only the illusion of being in charge is left, the real power lies in the hands of those that provide the funding.

Second problem now; is that the private and government debt combined is over 400% of our GDP. They mask this fact by only quoting the government debt and private debt separately but combined these debts are now at unsustainable levels.

Third problem; the commercial real estate sector is threatening to fall apart.

Thus while many will claim that the situation is completely different, the main problem that caused the plunge last time is the very same problem that could be unleashed in the not very distant future. What was this problem? Inflation; in 1929 the effects were felt immediately because the Feds aggressively raised rates. This time there is going to be delayed effect because the Feds lowered rates but they are pumping so much money into the market that it would be almost impossible to avoid some form of run away inflation in the future that could very well spiral into hyperinflation.

Finally we were a strong manufacturing nation back then, now all we seem to be producing is boat loads of paper and debt accounts for over 70% of our GDP; this is an unsustainable trend. In order for this scenario to work, individuals must be willing to take on more and more debt (basically borrow forever) but with banks cutting bank on lending and home values falling in the toilet, the consumer has only one option, cut down debt or burn. The average consumer in the USA has no savings and has only started to save recently not because they wanted to but because they were forced to. Consumer credit dropped almost 22 billion last month, that's the equivalent of a 10% decline on an annual basis and we suspect those numbers will rise. If consumers are cutting their debt levels, increasing their savings, then how is an economy that is based on debt going to recover. This is why we stated that the change in the spending patterns of the American consumer is going to affect every single nation; no other country purchases as much as America does and there is no immediate replacement. In the long run Asia can and will replace America but not within the next 3-6 years.

A 1 hour documentary on the build up to the 1929 crash and it's after effects. http://www.economicpopulist.org/?q=content/friday-movie-night-great-crash-1929-plus-1930s-fdr

Conclusion

Esoteric cycles and visual analysis are suggesting the following.

The Dow is long overdue a correction and the projected ranges for this correction are in the 8100-8300 ranges with the possibility of the Dow spiking down to 7700 if the downward momentum gathers steam.

The next step is a rally to at leas the current highs if not higher. We have subtle signs that the Dow could rally much higher but they need to be confirmed; the Dow would need to trade to 10,000 before our indicators could issue a new buy or a new sell signal.

Ultimately, though we expect this rally to fail regardless of how strong it ends up being and the ensuing correction should be rather vicious.

"Not to know what has been transacted in former times is to be always a child. If no use is made of the labors of past ages, the world must remain always in the infancy of knowledge." - Marcus T. Cicero, c. 106-43 BC, Great Roman Orator, Politician

Sol Palha
TacticalInvestor.com

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at www.tacticalinvestor.com.

The information contained herein is deemed reliable but no guarantee is made about its completeness or accuracy. The reader accepts this information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial advisor & is not acting as such in this publication. Investors are urged to obtain the advice of a qualified financial & investment advisor before entering any financial transaction.

Copyright © 2004-2009 Sol Palha, All rights reserved.

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