Unhedged Position | Is A 1929-Like Crash Coming?

“History doesn’t repeat itself, but it often rhymes,” Mark Twain is supposed to have said.

And the rhyme in the financial market is sounding eerily like something that has played out nearly 100 years before, according to a rising chorus of expert voices.

One of the loudest warnings comes from financial commentator Andrew Ross Sorkin, who recently authored a book called ‘1929: Inside the Greatest Crash in Wall Street History – and How It Shattered a Nation’.

In a recent interview with CBS, Sorkin noted similarities between conditions prevailing now and those ahead of the 1929 crash.

“I just can't tell you when, and I can't tell you how deep. But I can assure you, unfortunately, I wish I wasn't saying this, we will have a crash,” Sorkin said.

To be sure, the conditions between the 1920s – also called the Roaring Twenties – and the 2020s aren’t the same.

The 1920s boom was led by margin funding in stocks, a move that Wall Street copied from General Motors’ playbook of offering cars on easy finance. The leverage buildup in stocks combined with central banks’ inability to print their way out of a problem – thanks to the pesky gold standard – meant that a crash on Wall Street was accompanied by deflationary spiral on Main Street.

Today is much different, as ECB President Christine Lagarde noted in a widely-acclaimed speech last year, pointing to how central banks have used monetary policy to boost the economy while also being able to tame inflation that followed in the wake of their steps.

But while the conditions aren’t the same, there are similarities. There are three factors.

The stock market in the late 1920s had a problem that was simple to understand: a stock boom that led to a belief that prices would keep rising, which created more buying, till valuations got bubbly. The euphoria in the street was such that stock tables ran on the front pages of the newspaper.

To be sure, there was economic growth, but prices did not move lock in step. They moved way beyond – the Dow surged 600% in seven years.

Now, the gig is more sophisticated. Instead of retail investors, sophisticated funds are pouring capital into private companies. There are sovereign funds that invest in passive ETFs that blindly buy stocks. P/E ratios are at all-time highs. And then there’s crypto, whose fair valuations are terribly difficult to guess.

In the 1920s, Yale economist Irving Fisher felt bold enough to declare that “stock prices have reached what looks like a permanently high plateau.” Today, no one is saying this, but they are acting like it.

The 1920s instilled a genuine belief in people that they were living in a technological golden age.

Electricity reached homes. Automobiles started being mass made, thanks to the invention of the assembly line. Skyscrapers started going up. Aviation saw a boom. And radio brought information and entertainment worldwide.

Shares of the Radio Corporation of America went from 5.8 to 420 in a few years when the company never paid a dividend.

What radio was to 1920s, artificial intelligence (AI) is today.

In that, there is no doubt about the value that will be created through AI. But what is unclear is how the companies themselves – the multitude of AI firms, the data centres supporting them and the connected ecosystem – will make money.

The 1920s were associated with an inflection point.

Then, there was a steady increase in globalisation followed by sudden de-growth. The world today has seen 30 years of rising globalisation followed by a wave of economic nationalism.

The incumbent dominant power, England, was showing signs of weakening following World War I, with the emerging power, US, not yet ready to step up till it become necessary two decades later. 

Today, the US’ power appears to be waning, as its burgeoning debt threatens to become its undoing even as China is not yet ready to step up.

Ray Dalio, one of the world’s greatest macro traders and the founder of Bridgewater Associates, one of the world’s largest hedge funds, has compared the current period to a slightly different era: that of the 1930-40 where autocracy was on the rise.

“Classically, increased wealth and value gaps lead to increased populism of the right and populism of the left and irreconcilable differences between them that can’t be resolved through the democratic process. So, democracies weaken and more autocratic leadership increases as a large percentage of the population wants government leaders to get control of the system to make things work well for them,” Dalio told the Financial Times in September.

All of this means that the market isn’t pricing in risks that could be lurking in the system. There are two reasons for this.

One, over the past 30 years, central banks led by the Federal Reserve haven’t been afraid to step in and create a so-called “put” in the market when things go bad.

Two, as is their wont, investors often start truly believing their own narratives, and this leads to bubbles lasting longer than they should.

Does this mean that a global economic disaster, possibly perpetuated by a stock market crash, is around the corner? That would be a hazardous guess to make.

After all, as Twain purportedly said, history doesn’t repeat.

Meaning, for the next few years, you could have a roaring stock rally that will make you forget everything you read in this column before things get worse. Or the market could go into a painful time correction as opposed to a stock correction. Or, as investors sometimes say amid euphoria, this time is different.