The Stock Market: Are We Headed for Another 1929-Style Crash?

Recent stock market trends have drawn eerie comparisons to the period leading up to the infamous 1929 crash that triggered the Great Depression. The chart above overlays the S&P 500’s performance from January to October 1929 against its trajectory from January 2023 to February 2024, and the similarities are striking enough to give even the most bullish investors pause.

In both periods, the stock market showed a steady, seemingly unstoppable upward climb, punctuated by a sudden and sharp peak. In 1929, the S&P 500 reached a dizzying high of $31 in early September before plummeting nearly 30% in a matter of weeks, crashing to $19 by late October. Likewise, the index hit a record high of $4,800 in January 2024 – a staggering gain of over 10% from levels just one year prior – only to suffer a swift 6% correction over the following weeks.

While history doesn’t always repeat itself verbatim, market watchers are growing increasingly nervous over the uncanny parallels. Sky-high stock valuations, rampant speculative excess, rising interest rates, and signs of froth in everything from meme stocks to crypto assets all echo the ominous conditions that directly preceded the 1929 rout. The resurgence of margin debt, in particular, harkens back to the reckless borrowing that amplified the crash nearly a century ago.

However, there are also critical differences between then and now that may help avoid a similar fate. Today’s economy is far more diversified and less dependent on industrial production. The service sector, including industries like technology, healthcare, and finance, now accounts for a much larger share of GDP and corporate profits. This shift could potentially provide a buffer against the kind of broad-based collapse seen in the 1930s.

Monetary policy is also more flexible and responsive than it was during the Great Depression. In the 1920s, the Federal Reserve was still in its infancy and failed to act decisively to stem the panic. In contrast, today’s Fed has shown willingness to use all the tools at its disposal, from cutting interest rates to quantitative easing to backstopping key debt markets, in order to support the economy and financial system during times of stress.

Stricter financial regulations and transparency requirements, many put in place after the 2008 financial crisis, also aim to curb the worst speculative abuses and hidden leverage in the system. Banks are better capitalized and less vulnerable to runs. Margin requirements for stock trading are more stringent. And while risks have undoubtedly migrated to less-regulated corners of the market, regulators are arguably more vigilant about monitoring potential systemic dangers.

Investors also have access to a wider range of hedging tools and vehicles to help manage downside risk. From put options to inverse ETFs to volatility products, there are now myriad ways to position for or protect against market declines. Of course, these instruments can also be misused to amplify risk, as seen with the implosion of several leveraged volatility funds in 2018.

Still, the ghosts of 1929 serve as a stark reminder of the ever-present possibility of severe, prolonged market downturns. Even with modern safeguards in place, stocks can fall much further and faster than most investors expect, especially when starting from overvalued levels. The fact that we haven’t experienced a true crash in over a decade, with the March 2020 pandemic plunge proving shockingly short-lived, has arguably bred a sense of complacency and overconfidence among many market participants.

This complacency is evident in a range of indicators. Retail trading activity has surged, with a new generation of investors using zero-commission apps to chase momentum in often highly speculative assets. Options volumes have soared, with heavy call buying suggesting a widespread expectation that stocks can only go up. And investor sentiment surveys show bullishness at extreme levels rarely seen outside of major market tops.

At the same time, traditional valuation measures like the Shiller P/E ratio, market cap to GDP, and price to sales all suggest stocks are priced for perfection, leaving little margin for error should growth disappoint or risks materialize. While valuation is a poor timing tool, history shows that starting valuations are a key determinant of longer-term returns, and today’s elevated multiples suggest the odds are stacked against the kind of continued robust gains many investors have grown accustomed to.

Another key risk is the prospect of sustained inflation, which could force the Fed to tighten policy faster than currently expected. While most investors today have only known the disinflationary, falling-rate environment of the past few decades, a return to the kind of persistent price pressures last seen in the 1970s could be a major headwind for richly-valued stocks and bonds. The fact that inflation has so far proven “transitory,” to use the Fed’s term, doesn’t mean it will remain so indefinitely.

There are also growing signs of excess and “irrational exuberance” in pockets of the market. The meme stock craze, which has seen struggling companies like GameStop and AMC experience bouts of parabolic gains driven by retail speculation, feels emblematic of a market that has at least temporarily lost any fundamental anchor. The boom in SPACs, or blank check companies, many of dubious quality and promoted by celebrities, echoes the “blind pools” of the late 1920s. And the mania surrounding cryptocurrencies and NFTs, with prices soaring to stratospheric levels based on little more than hopes and dreams, has all the hallmarks of a classic speculative bubble.

None of this means a crash is inevitable or necessarily imminent. The market has proven resilient to an almost unimaginable range of shocks in recent years, from a once-in-a-century pandemic to a literal insurrection at the U.S. Capitol. And there are still plausible bullish narratives around a post-COVID economic boom, pent-up consumer demand, and ongoing technological innovation.

But the longer the market levitates at nose-bleed valuations, shrugging off bad news and risk factors, the greater the potential for an eventual reckoning. As the old adage goes, those who cannot remember the past are condemned to repeat it. While we can hope the current bull market has more room to run and will avoid a 1929-style catastrophe, the prudent course is to at least prepare for the possibility that storm clouds are gathering on the horizon.

For individual investors, this means staying disciplined and avoiding the temptation to chase returns at any cost. Favoring quality companies with strong balance sheets and sustainable competitive advantages over speculative fads and “story stocks” with little in the way of earnings or cash flow. Maintaining a well-diversified portfolio across sectors, asset classes, and geographies to mitigate idiosyncratic risks. Keeping some dry powder on the sidelines to take advantage of inevitable pullbacks and dislocations. Using tools like stop-losses, put protection, and regular rebalancing to systematically control downside and manage overall portfolio risk. And perhaps most importantly, being emotionally prepared for the fact that drawdowns and even bear markets are a normal, unavoidable part of investing that can actually create opportunities for those who keep a level head.

For policymakers and regulators, it means staying vigilant to signs of growing systemic risks, from excessive leverage to asset price bubbles to potential threats to financial stability. Being willing to take away the proverbial punch bowl before the party gets entirely out of hand. And ensuring that key guardrails like bank capital requirements, margin rules, and market circuit breakers are robust and fit for purpose in an ever-evolving financial landscape.

In the end, the stock market’s future is never certain, but its cyclical nature is. Booms have always eventually given way to busts of varying degree and duration. Whether the current eerie parallels to 1929 prove prescient or overblown, investors would do well to heed the time-tested advice to “hope for the best but prepare for the worst.” As the legendary Warren Buffett once quipped, “Only when the tide goes out do you discover who’s been swimming naked.” By controlling risk and keeping some powder dry, investors can aim to be the ones still fully clothed when the next proverbial low tide arrives – whenever that may ultimately be.

Of course, even the most well-prepared investor may not fully escape the ravages of a serious market downturn unscathed. As the great economist John Maynard Keynes famously warned, “the market can remain irrational longer than you can remain solvent.” But by staying disciplined, diversified, and focused on the long game, investors can at least tilt the odds in their favor and avoid the worst pitfalls of panic and capitulation.

So while the parallels to 1929 may indeed be troubling, they need not be paralyzing. With the right mindset and strategies in place, investors can navigate even the choppiest market waters with a degree of confidence and equanimity. By learning the lessons of history without being a slave to them, by respecting risk without being ruled by fear, and by embracing the market’s inevitable ups and downs as opportunities rather than threats, investors can chart a course toward long-term financial security and prosperity – come what may in the near-term.