Let's Take a Quant Look At History and See What it Says About 2023 and Beyond
Only other time we saw a market downturn like 2022 was in 1931 and 1969. Let's take a deeper dive into these periods and see if it can guide us to market conditions we can expect in 2023 and beyond.
Cartoons of the Week:
Worst Year since 1872!!!
This past quarter, I shared the below chart with many of you (if you are not my client, no big deal, I explain everything here).
In essance, this chart shows that 2022 was one of the worst, if not the worst year for a diversified stock/bond portfolio since 1872!!!
After sharing this chart, many had the same question.
“If 2022 makes it only the fifth year we have seen bonds and stocks down meaningful in the same year, what happened in the previous four occasions when looking out 3, 5, or even 10 years later?”
This was a question I was not able to answer, until now.
Let’s discuss….
It’s Rare to See Downside Across Stocks and Bonds
To do this analysis, I was able to get data going back to 1928. Unfortunately, this does not cover two of the dots in the diagram above (1907 and 1917). I would love to have this data, but I could not find it.
Below you will see over this 95-year period, how many times different markets were down on the year.
Gold has been down the most (34 years out of 95), followed by stocks, then corporate bonds and real estate. We have never seen 3-month treasuries down in a year.
Looking at the below, you can see out of the 26 times we have seen stocks weaker on the year, only 9 times have we seen corporate bonds weaker as well.
Stocks and Treasuries have a better result, seeing Treasuries down only 5 times in the same year as stocks.
Out of the 26 times stocks have been weaker on the year, only 4 times did we see all three of these asset classes lower at the same time, two of those being 1931 and 1969 (highlighted in the chart at the beginning).
The other two occasions happened in the last few years (2018 and 2022).
What separates 2022 from the other four times was the magnitude of the drawdowns versus the economic activity in the market.
Out of the 26 down years in stocks, 12 of them have been down more than 10%.
Out of the 19 down years in Treasury Bonds, only 2 have been down more than 10%. The first was during the great financial crisis of 2009, where we came within a few days of a total collapse of the US economy and dollar, we saw Treasury Bonds down 11.12%. The other was in 2022.
Looking at Corporate Bonds, out of the 16 down years they faced since 1928, only two of those years saw a downturn of over 10%. One was 1931, which we will discuss in more detail in a minute, and the other was 2022.
1931 – The Year the Great Depression Went Into Overdrive
Frontpage article of the New York Times on January 1, 1931, stated,
“Lack of widespread commercial failures, the absence of serious unemployment, and robust recovery in the stock market have been factors calculated to dispel gloominess.”
As 1931 got started, the market was rallying, and people were starting to feel a little better after the economic shock of 1929 and 1930.
The Fed cut rates and congress passed a few bills to stimulate the economy.
But under the surface, more problems were brewing from policies put into place during the downturn.
Protectionism started to gain a foothold, with the passage of the Smoot-Hawley Tariff Act which put tariffs on 20,000 US imports in 1930. President Hoover also banned all immigration in 1930.
By 1931, the Hoover administration continued to cut government spending to fight a rising deficit from the previous few years.
With the combination of these policies, by the second quarter of 1931, there was a global dollar shortage. The shortage of these dollars made the cost of borrowing higher (higher interest rates) and created a liquidity squeeze throughout Europe.
Germany faced a capital flight, pushing its gold reserves to new lows and forcing them to print money. This ultimately led to the hyperinflation situation they faced later in the decade and the start of the Nazi party.
Great Britain also saw a bank run on its currency, forcing their gold reserves to new lows. In September 1931, the Bank of England was forced to stop supporting the Pound and let its currency fall sharply as they announced a de facto default on its money, as they moved off the gold reserve standard.
This risk carried over to the US which saw stocks down over 30% in September and saw it down another 10.7% in one day on October 5th.
US Treasuries started to sell off in September due to balance of payment issues, pushing the yield on US treasuries to over 4%, one point higher than just a few months prior. This started a fear of devaluation of the US Dollar and another run on US banks.
Between the run on the banks and foreign governments selling their dollar reserves, US gold reserves fell by over 10% within a 3-week period in September.
By the end of 1931, unemployment had reached 20% plus, and the price of all goods was in total free fall, down over 10% on the year.
Stocks reached a new low in December 1931, closing the year down over 44% after rallying 48% at the beginning of the year, 16% in the second quarter of the year, and 21% right before September.
This was the only other time we saw both stocks and corporate bonds down by more than 10% at the same time, until 2022.
From 1932 onward, the stock market saw huge volatility, seeing big runs of over 50% higher in 1933 only to give back over 35% of those gains in 1937. In the following 10 years, the stock market saw six of those years lower!!!
Over the following 3- and 5-year period, stocks returned higher than average returns. Over the following 10-year period they underperformed their 95-year average, but still showed a positive gain of 8.8%.
After the horrible performance of Corporate Bonds in 1931, this asset class went on a huge run over the next 3-,5-, and 10 years.
Corporate Bonds returned 18.5% over the following 3 years, 16% over the following 5 years, and over 10% over the following 10-year period. They saw only one down year in the following 10 years following 1931.
US Treasury Bonds returned only average returns over this time period. Please note their 1931 return was down only 2.60% versus a 17.83% downturn we saw in this asset class in 2022.
1969 – The Year That Started the Economic Pain
Following 1968, which many would call one of the most politically trying years in history that saw Martin Luther King Jr. assassinated, Robert F. Kennedy assassinated, Vietnam War Protests, and the Chicago Riots, the rolling of the calendar into 1969 was welcomed by many.
While this time period was politically charged, it was still a great time for the US economy.
Nixon became President and saw the US budget move into a surplus for the first and only time in the 1960s.
The unemployment rate was only 3.4% (just like today).
And it continued what was the longest-ever economic expansion in US history.
It was the year we put the first man on the moon in July and had a revival in Woodstock in August.
It was the year we got introduced to this notable crew.
And it was the year everything in the economy started to unravel.
Within a year, unemployment doubled from 3.4% to over 6%.
What was a minor inflation scare in the mid to late 1960s turned into something more “sticky” as we saw growth slow but inflation make moves higher.
By mid-1969, inflation was over 6% and started the talk of “Stagflation.”
While they did not know it at the time, 1969 was the prelude to a very rough 10 to a 12-year period that saw four recessions, each one more severe than the next, sticky inflation, and a very beaten-down US consumer.
As stated in the Book “The Great Inflation”
It started the decade where lower or falling inflation saw higher stocks, bonds, and housing only to be struck down when inflation turned and moved higher, pushing stocks, bonds, and housing down.
During this time, from 1965 to 1982, the Dow Jones Industrial Average gained zero!!!
As for historical performance after 1969, we saw the following.
Over the next three years, stocks, Treasuries, and bonds all performed well, outpacing their average over the 95-year period we tested.
But the pain felt in the mid-1970s from inflation and stagflation really pushed down equity returns for both the 5 and 10-year periods after 1969.
Treasuries and Corporate Bonds did better over this time period, from a relative standpoint. When factoring in inflation (I do not show this data) it was a much more difficult time period for bonds.
Conclusion
Using history as a guide sometimes works and sometimes does not.
Many who know statistics will tell you a sample size of just two over a 95 year period can tell you nothing. Others would use this data as gosple on how 2023 and beyond will perform. I think the real answer is somewhere inbetween.
The market is a discounting mechanism. The pain we felt in 2022 was unpresidented, as highlighed above. To think the markets discounted this type of fear for the economy, only to face a minor economic set back and continue on its huge growth ways, is a tough argument (but one many in the market are making today).
I think we can probably take away a few key points from the analysis above.
We will probably be facing an above average volatile market condition, especially for stocks, over the next 3, 5 and 10 year periods. Both 1931 and 1969 where followed by huge volatile moves in the stock market. In 2023, inflation is still around, the Federal Reserve and other banks are not coming to the rescue, stock market valuations are still extremely high, and the US cosumer is just now starting to feel the pain of the rate increases from 2022 which will pressure US earnings over the coming quarters.
As we saw in 1969, the employment market can change very quickly. In less then a year, we saw the unemployment rate double, which led to more pain on Main Street, which eventually hit Wall Street again in 1973-1974. Watch employment data for any weakness in the coming quarters.
While volatility may be higher as we look out into the future, market returns should be above normal across all asset classes over the next 3 years. Even the pain we felt in the 1930’s and 1970’s still gave us a nice run 3-years after the initial downturn in ‘31 and ‘69. As I told many of you, Wall Street felt the pain already, it is Main Streets turn to feel the pain in 2023. Looking out further, I feel much more comfortable today in either US Treasury Bonds or Corporate Bonds then I do in US stocks (as of today). Stocks face a challenge ahead, and as we saw in 1931, even during bear markets, we can see huge moves higher only to give it back and move lower.
Have a wonderful weekend!!!