Monday Morning: Is market reliving 1973-74? Unlikely

More and more, today’s bear market looks like that of 1973-74, if for no other reason than it seems likely that the market will post negative returns again this year. Last year the market, as measured by the Standard & Poor’s 500 stock index, fell by 9.1%.

The S&P 500 is down nearly 18% year-to-date, and every rally has quickly been snuffed out by profit taking and renewed bad news about earnings.

The 1973-74 period was the last time the market had back-to-back negative-return years.

In fact, since 1926, there have been only five other periods of back-to-back negative return years. Three of those occurred during the Great Depression – 1929-30 ( down 8.4% and 24.9%), 1930-31 (down 24.9% and 43.4%) and 1931-32 (down 43.3% and 8.2%).

The next periods occurred as Europe plunged into war, 1939-40 (down 0.4% and 9.8%) and 1940-41 (down 9.8% and 11.6%). Since then, only in 1973 and 1974 have returns been negative for two years in a row. In 1973, the market dropped 14.7%, and in 1974, it plunged 26.5%.

after the euphoria

Are there any other similarities between the current period and 1973-74? The obvious one is that the earlier bear market occurred after a period of equity euphoria that drove the prices of many stocks to unreasonable valuations.

The valuations of many small-cap stocks returned to earth in the 1969-72 period, but the S&P 500, buoyed by the “Nifty Fifty” stocks, the 1970s equivalent of Internet stocks, continued to climb until 1973. Then sanity returned, the Nifty Fifty tumbled, and the market took back some of the gains of the 1960s.

The compound annual return on stocks for the 1960-72 period was 8.8%. For the 1960-74 period, it was only 4.4%. From the beginning of 1990 through the end of 1999, the compound annual return was 18.2%. That dropped by the end of 2000 to 15.4%.

But are there fundamental similarities? Well, during the 1960s, as computers became more powerful, jet airliners took over from piston-engine-powered aircraft, the interstate highway system was built, and manned space flight ventured as far as the moon, there was much talk of “new eras,” roughly equivalent to the last decade’s “new paradigms.” Both appear to have been mirages.

Oil prices shot up in October 1973 as Israel and the Arab nations fought a war. Oil prices surged this past year as oil-producing nations cut production to support higher prices. In each case, the higher prices acted as a tax on consumers.

Israel is again on deteriorating terms with its Arab neighbors because of the Palestinian situation, and instability in the Middle East is not good for U.S. equity markets, in part because of fears that it could lead the Arab nations to cut off oil supplies to the United States.

But looks can be deceiving. In other ways, the two eras seem very different. In 1973, the United States was still fighting the tail end of a war in Vietnam, and it seemed to be facing intractable inflation.

Now the United States is at peace, and deflation seems to be of greater concern than renewed inflation.

Despite the advent of computers, jet engines and the federal highway system, U.S. industry in the early 1970s was perceived to be falling behind Germany and Japan and becoming less competitive. The dollar was weakening.

u.s. competitive

Now U.S. industry – with the glaring exception of the auto industry – is perceived to be highly competitive, so much so that it has been able to survive even a strong, probably overvalued dollar.

In 1973, the federal budget was early in an era of increasing deficits. That year, the deficit was $2.8 billion. By 1975, it had climbed to $53 billion. We are now early in an era of budget surpluses.

On the surface, then, the differences between the current period and 1973-74 seem far greater than the similarities.

The fundamentals of the U.S. economy today appear far stronger than they were in the earlier period.

That should mean that, barring the outbreak of war in the Middle East, the market should begin to recover more quickly than it did in the 1973-74 bear market.

It could still end the year with a loss, but it’s my guess that the market will recover enough between now and yearend to escape a second down year.

Mike Clowes is the editorial director of InvestmentNews.