The more things change, the more they remain the same. Let’s compare today’s economic situation with the 1920s and finds some interesting parallels.

As computers continue to dictate many of the trading decisions of our generation in both the stock and futures markets, fundamental economic data appears to have less and less relevance in the daily heat of market trading. However, when you step back and take a look at the big picture, it makes more sense to examine some of the economic factors that contribute to a market psychology, for, in spite of technical analysis, there is a psychology to the markets that ultimately determines price direction.

Success is more dependent on the timing of a particular trade rather than on any particular assumptions from evaluating the fundamental supply and demand factors. Consequently, because trading decisions are based on mathematical concepts, lets be placed in the technical camp of trading and market analysis.

At the moment, all anyone can say about the stock market seems to be a variation of the following:

  1. Yes, the stock market is overvalued by traditional standards, but times are different now.
  2. The stock market will eventually top out, but there is nothing out there to indicate that a top is approaching yet.
  3. The top in the stock market will come from a surprise.
  4. As long as we have low interest rates and low inflation, the stock market has no reason to top out.
  5. Demographics of the babyboomers will drive this market to a 10,000-level Dow Jones Industrial Average (DEA) and more over the next five to 10 years.
  6. Yes, a correction is due, but it will be the greatest buying opportunity of this decade.

So with that in mind, lets take a look at an aspect of the markets that is very real to all market historians, that aspect known as « investor psychology. »

The real estate inflation boom of the 1970s and the gold and silver markets that peaked out in the 1980s were events, in market history, where market psychology became finnly affixed with a particular mindset. Ultimately, the market tops out when the last buyer buys. (And no market is immune to this statement.)


This article is about such market events that are driven by market psychology. Modern-day circumstance tends to obscure market reason when a psychological bubble is driving prices rather than a logic based on fundamental values.

It’s impossible to say how mass psychology takes control of a market, but when you hear the chief executive officers of mutual funds and brokerage firms justify current stock prices by saying that no other investment looks as attractive, it is clear that the market has plunged from the economic laws of fundamental value into the land of market foolishness.

Technology may change and society may change, but human behavior and instinct never changes. The elements of fear and greed are permanently imprinted on every market bought and sold by humans, with or without their computers.


So forget your personal assumptions, and let’s address this stock market in terms of its mass psychology. Right now, we are living in one of the most economically stable periods since World War II.

We have all read theories as to why the stock market goes up dramatically. Regardless of your personal favorite, the stock market generally goes up when other investments that compete for investment capital do not appear to be a viable alternative when compared with the rates of return of the stock market. When bonds and real estate generate only single-digit annual rates of return and inflation appears to be low, then the stock market will attract an abnormal amount of capital and stock prices will go up dramatically. But the stock market usually produces an annual rate of return in the mid–single digit range that (for the risk) can make long-term bonds and real estate a more attractive risk-weighted investment.

The last major stock, crash — excluding 1987 — was the infamous 1929 crash. If we had lived during the five years preceding this critical stock market bubble, what would our assumptions had been about the economy? Are those assumptions similar to the majority of assumptions that prevail about today’s economy?

The phrase « If I had lived » is the point here because for the first time since the 1929 crash, those people who lived through the five-year period leading up to that crash are now well over 90 years of age. Conversely, all major stock market participants of today have no personal experience (or memory) of that period leading up to the stockmarket crash 70 years ago.

Whether or not you agree with me, in spite of what the history books say, human nature doesn’t learn (or appropriately respond) to life altering events by reading history books. Human nature has to personally experience an event in order to acquire the knowledge to learn from it. Learning in this manner is a flaw of human nature. But the majority of today’ s stock market investors are going to conclude that today is very different compared with the past much more readily than believe that we are experiencing a market that is primarily driven by a mass psychology based on incorrect assumptions.

This is how major market events tend to occur only once in a generation, because those people who experienced such events previously are no longer around to respond appropriately to them. As much as our society desires to eliminate risk from our lives, nothing can be done to eliminate a calamity that is a result of flawed thinking.

Unfortunately, there is a big difference between the profit generated by a company and the price of its stock traded in a free-trading environment. For years, stock prices didn’t rise in a proportionate manner with company profits. Over the long term, the price of a company’s stock has often not been directly correlated to company profits, and that can go on for years. Today’s stock owners are forgetting that stock prices (not value) are not necessarily correlated to company profits. Stock prices and company profits can be two entirely different things.


In the 1970s, inflation (and real estate) was rising and attracted a great deal of investment capital from the stock market. More recently, real estate does not look particularly attractive as an investment, and has not since the mid-1980s. For the first time, inflation appears to be under control.

When you compare non-stock investments trying to compete for investment capital with average annual rates of return generated by the stock market over the last five years, alternatives to the stock market look paltry. Today’s investor is expecting an unrealistic average annual rate of return that exceeds 20% per year, and the general public is concluding that there is nowhere else an investor should be but in the stock market.


Is it good for the stock market to be the only investment game in town? I began to look at the five years leading up to the market crash of 1929 and I quickly noticed that the exact conditions that exist today existed nearly 70 years ago. The same set of circumstances exist that led investors of the 1920s to the same conclusions that today’s investors.

In the 1920s, market analysts had been looking at the same kind of economic data for nearly five consecutive years that we have been seeing in the 2010s. Many of the articles back then use some of the exact words and phrases to describe the prospects for a continuation of economic prosperity, as you would find in the news media today. Similar economic circumstances led to a process that cloaked the events that ultimately created an economic disaster.

Real interest rates began rising in the late 1920s and moved well above 5% after the stock market crash of 1929. In both the 1920s and the 2010s, higher real interest rates were caused by a deflationary environment, which is something entirely new for those born during the decade of the 1920s and afterward.

If conditions were to change that would make investments other than the stock market more attractive, it might eliminate a potential train wreck that is currently developing in the stock market. Even if the stock market went flat for a few years, you would probably defuse an economic disaster that could ensue when too much capital is banking on higher and higher stock prices. But as long as conditions stay the same, we are turning the heat up on a stock market that will eventually explode in a historic and violent manner.

Hearing from the leaders of mutual funds that as long as nothing changes in the economy, stocks are going to continue to rise. This is precisely the market logic that existed in the 1920s leading up to the market event that redistributed the wealth.

When too much capital is invested in a single market medium, it becomes more vulnerable to greater risk for those participating. When the last buyer buys, as is destined to occur some time in this bull market, the stock market will top out. The problem is created for investors and the economy as a whole when the controller of this investment capital decides to find a new home away from the stock market.

When this occurs — as it surely will— those totally in cash will be insulated from this event. Those who risked a great deal by stepping in front of a historic bull market by shorting stocks, anticipating an end to rising prices, will certainly reap their rewards as a massive redistribution of wealth takes place. The best way for stock market participants to protect themselves is to respect the power of an unrealistic market assumption like the one that has been driving this market for the past several years. Perhaps it is more prudent to develop an infatuation with a more typical single-digit rate of return from long-term investments rather than worry about how much return you’re missing out on by not being in the stock market.

It is important to remember that the funds now being lured into this stock market are supposed to be play-it-safe/nest-egg money. This is certainly important to remember, because if we do experience a market debacle, no one will be immune from its effects.

If today was anymore like the 1920s, alcohol would be illegal and Herbert Hoover would be President of the United States. Conditions couldn’t be riper for a once in a lifetime event to occur.

Norman Sachs





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