The Roaring ’20s came to a screeching halt when the stock market took a historic nosedive at the end of the decade. In the early part of 1928, the Federal Reserve Board began to feel a little uneasy about the situation in the stock market, where prices had been rising with alarming rapidity. Given that there have been more than 32,000 trading sessions since then, the judgment of at least this swath of history is that in any given six-month period there is a 0.79% chance of a daily crash that severe. Historically, this month is the worst month of the year for stocks, and most of the biggest stock market crashes throughout our history have come in the fall. We can infer unfavorable market internals in that instance because we know that cumulative NYSE breadth was declining for months before the 1929 high. Uncertainty seems to have increased already during the summer, and the crash brought about a substantially larger increase.
When the crash hit the economy and stock prices fell sharply, people holding these various views should have interpreted its implications in different ways, and consequently the disagreement among them should have increased. Emerging market currencies are crashing hard, recessions are starting, and equity prices are getting absolutely hammered.
Applying the same ANOVA test to the Shemitah cycle, Pound’s research revealed that the sabbatical years were the only group of years in which the market cycle averages consistent significant losses since 1871. The Dow Jones Industrial Average nearly doubled, rising from 191 in early 1928 to 381 by September 3, 1929. This is a strong indicator that the upcoming crash could be far more devastating than the previous two. The stock market crash was a wake up call to those who had put all of their eggs in one basket. See, for example, Kezdi and Willis (2008) about American households and Hurd, Rooij and Winter (2009) about Dutch households. That is, this assumption ensures that the signal-to-noise ratio is constant in terms of perceived stock market returns. The results of the estimates suggest that the effect on the stock market crash on expectations was different in different groups of the population.
However, during this period stock prices were rising far more rapidly than dividends, and it is reasonable to assume that the judgement of a number of investors was clouded by the prospect of an inexorable increase in stock prices. On October 23, the stock market lost thirty-one points, approximately seven percent of its value. A well-respected financial expert that correctly predicted the last two stock market crashes is now warning that we are right on the verge of the next one. There were already fears the election could cause a stock market crash in 2016 before voting started on Tuesday. Bond proceeds frequently ended up buying back shares or boosting dividends, thus elevating the stock market on the back of heavier debt levels on corporate balance sheets. This quick and precipitous decline in stocks’ value in October 1929 became known as the Stock Market Crash of 1929.
Between the uncertainty of Election Day and weak economic indicators, now is a time every investor should have a stock market crash protection plan. It acted as a backstop for falling stock market prices more than a few times in the five years immediately following the financial crisis. If earnings continue to deteriorate, market valuations could rise rapidly even if prices remain stagnant.