Did last week’s sudden downturn in global stock markets make you think of the Bear Market of 1966?
Me neither, but don’t feel bad. Maybe you were not yet born in 1966 and have never read about that particular market crash, for the simple reason that hardly anyone ever writes about it. Or maybe you are a younger baby boomer, too young to have been abreast of financial news during the Johnson Administration, or you are an older baby boomer and your mind was on other things, such as rock ‘n’ roll, Vietnam and civil rights. Or you were a parent of boomer children. Even if you were in the market in 1966, chances are you have little recollection of this particular downturn.
Some market crashes are memorable, or even historic. Others are not. We can only be sure with hindsight which are which, though I think we make tentative sorting decisions as they occur.
That 1966 crash came after two decades of nearly uninterrupted economic growth and stock market gains following World War II. As Vietnam and Johnson’s Great Society social programs began to push up government spending, the Federal Reserve responded by tightening credit conditions early in 1966. After hitting new highs in January and March of that year, the Standard & Poor's 500 index dropped about 22 percent over the next eight months. It then rallied to even higher heights by early 1968, as the spending-fueled economy drove corporate earnings upward. The 1966 market downturn did not trigger a recession and never became a factor in the 1966 or 1968 elections. It was soon forgotten.
In retrospect, though, 1966 can be seen as a harbinger of difficult times ahead. The market reached a few new highs in the late 1960s and early 1970s, but inflation was gathering steam and the government was bleeding the reserves of gold that backed the dollar until Aug. 15, 1971, when President Nixon renounced the gold standard. Then came the brutal market downturn and recession of 1973-75, another bout of inflation, and additional sharp recessions in 1980 and 1981. Though nobody realized it while the Beatles still recorded together, 1966 was the start of a 15-year period in which stocks barely advanced at all. If you were in the market back then, you were rewarded eventually, but only if you were extremely patient.
A lot of people remember the crash of October 1987, which was the worst one-day stock market drop since 1929. However, unless you sold during or shortly after that crash, it was not particularly meaningful. The economy, supported by easy credit policies under Federal Reserve Chairman Alan Greenspan, never faltered, and the market recovered all the lost ground within about a year.
The crashes of 2001-2003 and 2008-2009 were different. Each was accompanied or followed by a major recession, and each was triggered by a major imbalance in the economy (the overinvestment in technology stocks and infrastructure of the dot-com years and the overinvestment in debt backed by real estate in the mid-2000s). Correcting those imbalances took time and painful adjustments that threw millions of people out of work for extended periods. As with the two 21st century events, the well-remembered downturns of the mid-1970s and early 1980s had profound structural causes in the surging inflation of that era. The eventual adjustments were painful, but they set the stage for many years of growth that followed.
So what should we make of the market dip that startled so many people last week, coming as it did on the heels of a powerful surge in 2013?
I would say: not much. There is a structural adjustment occurring, in the form of the Federal Reserve’s “tapering” of its super-easy money policies. Those policies flooded global financial markets with cash that could not generate any income amid the near-zero interest rates that the Fed and most other central banks in developed economies have maintained. Some of that money was supported personal borrowing and corporate investment that has generated economic growth at home, as the Fed intended. But a lot of it made its way to emerging economies around the globe.
Now, some of those economies are having problems and the flow of money has reversed direction, heading back to America where rates are starting to rise. Argentina, badly mismanaged as ever, faces a looming foreign exchange crisis in a year or two, even after a major devaluation last week. Turkey’s currency plunged to record lows before its central bank took the painful but necessary step of raising interest rates yesterday. Brazil is burdened by poor infrastructure, bloated government spending and slowing demand from China, which is itself fighting an array of domestic financial problems.
Except for China, however, these economic stories are not important in the global scheme of things. A strengthening U.S. economy and an increasingly stable picture in Europe’s financial system are setting the stage for the next round of global economic growth. China, despite its problems, remains the world’s leading trade economy and cannot help benefitting from recovery in its key trading partners. Outside China, most countries’ banking systems are reasonably well capitalized, and despite more-intrusive oversight, bankers are likely to find ways to make capital available to growing businesses. Even with the end of the Fed’s quantitative easing, interest rates remain historically low; allowing savers to earn some genuine yield can actually help make more credit available, rather than less.
If you are not in Turkey or Argentina or Venezuela, there is no sense of economic panic right now, nor is there any reason for it. Maybe the long view of history will show that 2014 is going to be the year of a memorable market downturn. Right now, however, it feels a lot more like 1966. Sometimes being forgettable can be a good thing.