The 20th century offers interesting parallels for the extraordinary start to 2018
John Authers
Black Monday in 1987: an alarming parallel with today © AP
History does not repeat itself, the saying goes, but it often rhymes. Where then can we find a market moment that rhymes with the extraordinary market conditions of early 2018? Taken together, this can fairly be called an unprecedented juncture. Stock markets are shooting higher with low volatility despite historically high valuations, while the dollar is sliding even as what looks like the end of the bull market in Treasury bonds should be bringing flows of capital towards the US.
These are strange conditions. But history still has clues as to what now confronts us. Naturally, as many of us who work in or cover the markets today have a lively memory of the global financial crisis and the dotcom bubble, the attention tends to focus on the possibility of bubbles and crashes. Going back earlier in history reveals several other incidents that may rhyme with what is happening now. The only problem is that some of them are mutually inconsistent.
Years that some believe could rhyme with early 2018 include:
1951
Not a famous time in the markets, this was the year when the Federal Reserve and the Treasury negotiated what was in effect the Fed’s independence. It could end the financial repression with which it had been capping yields on bonds, as part of what had been a wartime effort to help the government borrow more cheaply. Other postwar desperation measures, such as the Marshall Plan or the GI bill, were also running their course, and were beginning to have a mighty effect, fuelling an economy that had at last put the war behind it.
The Great Recession was nothing like as severe a trauma as the second world war, but their parallels are clear. As then, the Fed is at last free from the financial repression of QE and embarking on a more conventional policy. As then, the developed world economy is showing signs of synchronised growth.
There are differences. Stocks were nowhere near as expensive, and it is hard to believe that an ageing world can possibly match the performance of the 1950s. Exchange rates were fixed and the dollar tied to gold. But to the extent that the parallel helps, it suggests good times ahead, and buying stocks (which tripled over the next 15 years).
1966
The world of the mid-1960s may not seem very similar to today, but then as now, stock markets had recently had a period of exceptional calm (1964 was the only year in history even less volatile than 2017 on the US stock market), and had enjoyed a prolonged rally. American and European society were churned by the radicalism of the Sixties, which would culminate in the unrest of 1968. There may be some parallels there.
The important parallel: inflation. After years of inflationary spending to finance President Johnson’s social programmes and the war in Vietnam, inflation began to awake from its slumber, almost doubling to approach 4 per cent. Many believe that is happening now — after deep lows, oil, industrial metals and inflation forecasts derived from the bond market are all at three-year highs and rising. As inflation rose, so bond yields also began to rise, and equities began sliding into a bear market that would last the entire length of the 1970s. High inflation should make stocks more desirable as an hedge against rising prices, but the damage turned out to be severe. In real terms, the S&P stalled in early 1966, made a slightly higher peak in 1968, before tanking — it would drop by almost two-thirds before hitting bottom in 1982.
1987
Everyone knows what happened on Black Monday in October of this year, so this is an alarming parallel. The commonalities: stocks had hit bottom five years earlier, but it was only in early 1987 that true optimism took hold and equities began melting upwards. This is not unlike today. Financial engineering, in the form of junk bonds and mortgage-backed bonds, was booming, and it is again. Then as now there was a new and untried chairman at the Fed, after a questionable decision not to give the job back to the incumbent. Then as now the US Treasury Secretary (James Baker) spoke aggressively about forcing down the value of the dollar, while the president (Ronald Reagan) asserted that a strong dollar was good.
As the excitement took hold in 1987, the stock market surged and bond yields, which had been falling, rose menacingly. When the roof fell in, it did so with a vengeance. Both stocks and bonds were cheaper then, but the similarities are not far-fetched. If stocks continue to rally, and bond yields rally, expect self-fulfilling market chatter about 1987 to intensify (just as in 1987 there was much chatter about the parallels with 1929, on the eve of the Great Crash). Valuations are higher now, but bond yields are lower. The potential for a crash is there, but it would need a scare in the bond market to trigger it.
1998
The parallel: this was the only time when US stocks were as expensive as they are today, using cyclical earnings multiples. But it was a years-long melt-up that culminated in the bursting of the dotcom bubble in 2000. Alan Greenspan of the Fed warned of “irrational exuberance” in late 1996, and volatility was intense as the markets moved upwards. The excitement about the stock market is back, but we might, on this measure, still be only in early 1997, with three more years to go.
The rewards to timing a bubble successfully are immense, but that is largely because it is so difficult to do.
None of these years rhymes perfectly with 2018. This is not deathless verse we are talking about here. But they show enough doubt about the outcome to behave with great caution. If it grows clearer that inflation is rising and pulling up bond yields with it, then it looks like this could be a great time for those who want to time the market to start selling their stocks.
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