In a few days, we will commemorate the 80th anniversary of the most searing event in the financial history of the United States: the great crash of October 1929. Many observers will contend the four-day collapse in share prices, which sparked the Great Depression like a match in a can of gasoline, could never happen again due to improvements in information flow and technology. Others will say it may recur any day now.
The reality is that a crash absolutely could happen again, though not for the same reasons as in '29 and not when most people expect it. So while you don't need to mark your calendar with a big red circle for at least the next four to six months, for reasons I will describe in a moment, the potential for a substantial decline in the future is something that all investors need to recognize.
So why not now?
Market crashes occur in the wake of extreme informational disequilibriums, which is a fancy way of saying big surprises. If a lot of people are expecting a crash, ipso facto it can't happen.
Though it may seem as if major surprises happen all the time, that's not exactly true for modern securities markets. Thanks to 24/7 news broadcasting, social networking, international commodity exchanges, central bankers' powwows and Group of 20 meetings, so much is known about business conditions, trade flows, interest rates and government policies today that price discovery -- the heart and soul of smoothly functioning markets -- occurs around the clock.
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Nothing in common with '29
Today is quite unlike 1929 or even 1987, when government and corporate information was bottled up in each country and company, and dispensed thinly. The more information seeps out and oozes into the public for investors' rumination and consumption, the less likely surprises will occur.In the 1920s, you see, corporate-disclosure rules were limited to a short list of balance-sheet line items. Today, rules set forth in seven decades of securities legislation, ranging from the Securities Act of 1933 to the Sarbanes-Oxley Act of 2002, have stampeded companies into issuing a news release practically every time their chief executives catch colds.
Video: We dodged a second Great Depression
Pre-announcements of earnings, same-store sales reports, presentations at investor conferences, detailed Securities and Exchange Commission filings, executives' TV appearances, Twitter messages and blog posts all serve to release billions of data points and nuances into the infosphere for alert investors' eyes and ears. There's surprisingly little chance for highly engaged market participants to be blindsided.
Moreover, virtually every major crash of the past century has started in October when a) stock markets were within inches of their all-time highs, b) public bullishness was at a peak, c) borrowing to buy stocks was at a peak and yet d) a smaller number of stocks was climbing. Three examples:
- In 1929, the Dow Jones Industrial Average ($INDU) hit its then-all-time high Sept. 3, less than two months before the 82% crash began. The market had been rising steadily for eight years from its 1921 low for a total gain of 400%. But in the final six months of that period, breadth -- jargon for the ratio of advancing stocks to declining stocks and the ratio of new highs to new lows -- had been narrowing sharply.
- In 1987, the Dow hit its then-all-time peak Aug. 25, nearly two months before prices tumbled 23% on Oct. 19. Before the September peak, stocks had risen 225% over the previous five years. Breadth had again been narrowing for months, as smart insiders and big investors crept out of shares while feeding them to the public.
- In 2007, the Dow hit its all-time peak Oct. 10, and the ensuing slo-mo crash saw prices tumble 54% over the next 16 months. Before that top, stocks had risen 100% over four years, yet breadth had been narrowing for seven months.
Continued: No new crash in the cards -- yet
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