Exorcising the ghost of 1929 sharemarket crash — part one

A109 Light Utility Helicopter flight with mayor Gisborne City from the air in November 2023.

Opinion

INVESTMENT VIEWS by Brent Sheather

Brent Sheather

What’s the biggest worry when investing in shares? For many people it’s the fear of losing the lot in some huge crash, like what happened in the 1930s. That scenario is routinely dismissed by most experts as being unlikely — back in the 1930s governments and central banks weren’t as smart as they are now. But in the past 50 years or so the level of debt in most Western economies has been steadily rising and all other things being equal, it seems like the more debt there is in an economy the more severe would be the impact of a deflationary crash. Furthermore, there must be some limit to central banks riding to the rescue, as they did during covid by reducing interest rates and increasing government spending.

With that background I thought it might be useful to look at exactly what happened to sharemarket investors in the great depression. Did everyone really lose everything and then jump out the window? Economist J.K. Galbraith writes in his excellent book The Crash of 29 — “A suicide wave was in progress, and 11 well-known speculators had already killed themselves. Clerks in downtown hotels were said to be asking guests whether they wished the room for sleeping or jumping.” Things are looking grim today so in the hope of saving a few lives, this note looks at what really happened to two prudent sharemarket investors — one wanting growth, the other income. This instalment tracks the performance of the portfolio of an individual focused on capital gain through that period (Uncle Sam) and next Saturday “part two” will examine the impact of the crash on the portfolio of Aunt Daisy, who is retired and for whom the income-producing ability of the portfolio was especially relevant.

To make the analysis simple we will assume that both investors’ portfolios were invested totally in US stocks; pretty risky, but what the heck — it’s August 1929, the stockmarket has risen by almost 80 percent in the past two years, cocaine is legal and everyone and everything is buzzing. Even President Coolidge is hyped: in his December 1928 State of the Union address he says: “No congress of the United States on surveying the State of the Union has met with a more pleasing prospect than that which appears at the present time.”

The 100-percent shares asset allocation decision will also serve to amplify the impact of the crash because stocks are typically more volatile than bonds and sensible people have some of each. Let’s further assume that Uncle Sam, who is saving for retirement, was aged 31 in August 1929 and has invested $10,000. We have picked August 1929 as our starting point because it was the peak of the 1920s bull market, the very worst time to invest in the US stockmarket. The analysis uses data for the entire US stockmarket index (all the shares in the market weighted according to their size) from the Ibbotson and Associates Yearbook.

The graph above charts the history of Sam’s portfolio in the subsequent 27 years until his retirement in 1956. It kicks off with the crash of October 29 (a fall of 20 percent) followed by a 25 percent drop in calendar 1930, a horrifying 43 percent plunge in 1931 and a further 8 percent in 1932. 1933, however, saw a 54 percent gain, the market finished 1934 about where it started then rose by 47 percent in 1935 and 34 percent in 1936. Now that is volatility! It took Sam 27 years to get his original $10,000 back after adjusting for inflation but excluding dividends. The graph thus highlights another important lesson about shares — they can require a very long-term commitment; selling out after even 10 years would have seen Sam lose around 60 percent of his money.

The first thing we notice about the performance of Sam’s portfolio is that he didn’t “lose the lot” but he certainly could have had he not diversified as widely as he did or if he had become depressed and sold out, like no doubt, so many did. In fact, the most Sam could have lost had he sold at the market low was 85.9 percent in June 1932. At that point the US market was yielding an attractive 6.5 percent but you can bet that with almost all the money gone Sam’s wife, if they were still together, would have been telling him how stupid he was. However, Sam had the last laugh — in the 27 years to his retirement in September 1956 his portfolio returned 7.5 percent pa with inflation included versus 2.9 percent pa for government bonds and less than 1 percent for bank deposits. Sam beat inflation, too, which averaged just 1.7 percent pa.

So pre-tax, pre-fees Sam made a real return over the period despite buying in just ahead of the worst bear market in the past 100 years. The reasons Sam’s portfolio held together were threefold: first and foremost he didn’t panic and sell. If he had sold out at the bottom in June 1932 and stuck the money on deposit his $10,000 nest egg would be worth only $2000 at retirement. The second important point was that Sam, because his portfolio tracked the market average, had lots of money in blue-chip names like General Electric, American Telephone and Telegraph and General Motors. Sam had only small weightings in the speculative, highly-geared investment trusts so popular at the time. Being widely diversified was critical to Sam’s financial health. The third reason Sam didn’t feel the urge to jump was because despite falling dramatically, his portfolio continued to produce cash dividends and it was these cash dividends that generated almost all of his return.

Whilst the crash must have been a terrible time — 1987 was bad enough — it inevitably had some humorous moments. J.K. Galbraith writes: “Outside the Exchange in Broad Street a weird roar could be heard. A crowd gathered. Police Commissioner Grover Whalen became aware that something was happening and dispatched a special police detail to Wall Street to ensure the peace. More people came and waited, though apparently no one knew for what. A workman appeared atop one of the high buildings to accomplish some repairs, and the multitude assumed he was a would-be suicide and waited impatiently for him to jump.”

Next Saturday we will look at how the 1929 crash impacted the portfolio of an individual relying on the stockmarket for income, and consider what we can learn from those turbulent times.

■  Brent Sheather is a financial advice provider and a personal finance and investments writer. A disclosure statement is available upon request.