What Really Caused the Stock Market Crash of 1929?

Key Concepts

• Government Shutdown: Ongoing shutdown impacting federal employees, SNAP benefits, and critical services like the FAA.
• Big Tech Spending: Massive capital expenditures by tech giants on AI infrastructure, driving revenue and stock prices.
• Compute Power: The ability to process information with AI in data centers, a key driver of tech company growth.
• Tale of Two Economies/Markets: A stark contrast between booming tech and AI sectors and widespread layoffs in other industries.
• 1929 Stock Market Crash: Historical event with parallels to current market conditions, characterized by speculation, leverage, and greed.
• Democratization of Finance: The trend of making investments more accessible to the general public, both in the 1920s and today.
• Leverage and Credit: The role of borrowed money in fueling speculation and amplifying market movements.
• Federal Reserve's Role: Historical and contemporary debates surrounding the Fed's monetary policy and its influence on the economy.
• Key Figures of 1929: "Sunshine Charlie" Mitchell, Jesse Livermore, Ferdinand Pecora, Evangelene Adams, Roger Babson, and Groucho Marx, each representing different facets of the era's financial landscape.
• Hindenburg Omen: A technical indicator signaling increased probability of a stock market crash.
• Money Flows: Recent shifts in investor sentiment, with outflows from gold and inflows into cash, bonds, and tech stocks.
• November-April Stock Market Trend: Historically, the strongest six-month period for stock market performance.
• Earnings Growth: Positive earnings per share growth for the S&P 500, indicating a resilient corporate profit environment.

Current Economic and Market Landscape

Government Shutdown and its Impact

The government shutdown has entered its second month, marking day 34 and on track to surpass the previous record of 35 days set in 2018. This prolonged shutdown has resulted in missed paychecks for furloughed government employees, escalating from a problem to a crisis for many. The potential delay of SNAP (food stamp) benefits for over 7 million Americans is a significant concern. Furthermore, the shutdown has led to FAA workers not showing up for work, causing flight delays and cancellations, impacting air travel across the country. The proximity to Thanksgiving is highlighted as a potential catalyst to break the stalemate and bring parties back to the negotiating table, as Americans value their ability to travel.

Big Tech Dominance and AI Investment

Despite the government shutdown and other concerns, the stock market is performing strongly, with stocks near record highs. This rally is primarily driven by "big spenders," particularly in the tech sector, focusing on Artificial Intelligence (AI) capital expenditures. Major tech companies are investing over $350 billion this year in building AI infrastructure, with no end in sight to this spending. The demand for "compute power"—the ability to process information with AI in massive data centers—is a recurring theme in earnings calls and tech deals. This has led to significant revenue boosts for cloud storage and computing giants like Amazon (AWS revenue over $691 billion), Google Cloud, and Microsoft Azure. Companies like Meta, Microsoft, and Google are experiencing substantial revenue growth, directly linked to their cloud computing services. Nvidia has reached a $5 trillion market cap, becoming the first company to do so, by supplying the essential chips for AI mega-computing.

The Tale of Two Economies and Layoffs

In contrast to the booming tech sector, there's a stark "tale of two economies" and "tale of two stock markets." While big tech thrives, numerous companies are announcing layoffs to improve margins and revenue per employee. Recent layoffs include Amazon (14,000 employees), Paramount, UPS, Phillips, Target, and GM, among others. This divergence highlights a growing disparity in the economic landscape.

Historical Parallels: The 1929 Stock Market Crash

The Great Crash of 1929

The discussion then shifts to the 1929 stock market crash, nearly 96 years prior. The Dow Jones Industrials experienced a 25% drop between Black Thursday and Black Tuesday, and a staggering 89% decline from its peak in September 1929 to July 1932. This nearly three-year bear market triggered the Great Depression, leading to a 25% unemployment rate and a halving of industrial production. It took until 1954 for the Dow to regain its 1929 peak.

Similarities with Today's Market

Andrew Ross Sorkin, author of "1929: Inside the Greatest Crash in Wall Street History and How It Shattered a Nation," highlights several eerie resonances between 1929 and the present day:

• Euphoria around New Technologies: Similar to the 1920s' excitement over automobiles, telecommunications, and radio, there is significant euphoria surrounding AI today. This fuels an "animal spirit" in the market.
• Democratization of Finance: The phrase "democratizing finance" was used in the 1920s to describe efforts to give ordinary Americans more access to investments, a sentiment echoed today with the desire for opportunities in the market.
• Leverage and Credit: The 1920s saw the birth of the consumption economy, powered by credit and debt. This era normalized taking loans and mortgages, which fueled speculation. Today, while stock trading leverage might be less overt, significant leverage exists in areas like crypto.
• Speculation and Greed: Rampant speculation, unfathomable greed, and the pursuit of quick riches characterized the 1920s, with parallels to today's market dynamics.

The Role of Credit and Consumption

The 1920s marked the rise of the consumption economy, moving from farms to cities. This shift led to the birth of credit, which in turn fueled speculation. John Raskob's idea of a five-day work week in the 1920s was not just about leisure but about fostering a more consumption-led economy by providing more time for travel and purchasing goods.

Accessible Credit and Speculation in the 1920s

In the 1920s, brokerages proliferated, and it was common for individuals to borrow heavily to buy stocks, with some banks enabling this practice. People could walk into a brokerage with a dollar and borrow ten, often with little collateral, without fully understanding the implications of leverage. While margin buying exists today, the scale and accessibility of credit in the 1920s were unprecedented.

The Federal Reserve's Early Role

The Federal Reserve, established in 1914, played a significant role. In the 1920s, bankers on the Federal Reserve board debated monetary policy, including whether to raise or lower interest rates to curb speculation. There were concerns about politicization and the board members' anxiety about facing congressional scrutiny if their decisions negatively impacted the economy.

Key Figures of the 1929 Era

The book "1929" features several prominent figures:

• "Sunshine Charlie" Charles Edwin Mitchell: Chairman and CEO of National City Company and National City Bank (now Citibank). He was a celebrity banker who believed in democratizing finance and making stock buying accessible. He is credited with enabling significant debt and credit for individuals, making him a face of the crash. He was also on the board of the Federal Reserve and attempted to prop up the market with $25 million. His actions and the subsequent prosecution led to the formation of the Glass-Steagall Act.
• Jesse Livermore, "The Boy Plunger": A famous, albeit emotional, short seller obsessed with the stock ticker. He made significant money during the crash but lost it later. He tragically died by suicide in 1940. He is seen as a poster child for rampant speculation.
• Ferdinand Pecora, "The Hellhound of Wall Street": Chief counsel for the Senate Committee on Banking and Currency. A tough prosecutor who exposed manipulative activities, including investment pools and insider trading (which was not illegal at the time). His hearings brought Wall Street's practices to light, leading to the creation of the SEC and the Glass-Steagall Act.
• Evangeline Adams, "The Wall Street Seer": An astrologer who advised people on stock picks based on zodiac signs. She had a newsletter with over 100,000 subscribers and was even visited by J.P. Morgan. She famously predicted the market could "climb all the way to heaven" in September 1929, just before the crash.
• Roger Babson: A statistician and economist who predicted the crash, earning him the moniker "prophet of loss." He created Babson University and analyzed market data like price activity and advanced-decline trends, identifying the market as frothy. His predictions, though accurate in hindsight, were initially dismissed.
• Groucho Marx: The comedian's story serves as a parable for the era. Despite being conservative with money, he became addicted to trading and faced a margin call that forced him to mortgage his home, illustrating how widespread the speculative fever was. He questioned why RCA, a popular stock, didn't issue a dividend, highlighting the focus on future growth over current profitability.

The Devastating Impact of the Crash

The 1929 crash was devastating due to the extensive debt taken on by individuals. When the market dropped, people lost not only their equity but also the borrowed money, leading to foreclosures and financial ruin. The crash was the first domino, followed by a series of policy missteps by President Hoover and the Federal Reserve, including tax increases and tariffs, which exacerbated the situation and contributed to the Great Depression. It took until World War II spending to fully pull the country out of the depression.

Lessons Learned and Future Risks

A key lesson from the Great Depression is the necessity of government spending during crises. Ben Bernanke's actions during the 2008-2009 financial crisis, informed by his research on the Great Depression, exemplify this. While a repeat of the Great Depression is considered unlikely due to lessons learned, safeguards, and better corporate and consumer financial health, parallels exist in leverage and new financial products. The complexity of identifying leverage in today's market, with tokenization, crypto, DeFi, and betting markets, makes it harder to assess systemic risk. The connection of this leverage to the banking system and the broader economy remains a critical unknown, to be revealed only when a crisis occurs.

Investor Sentiment and Market Indicators

Money Flows: Gold Outflows and Tech Inflows

Recent money flows show significant outflows from gold ($7.5 billion last week), despite $59 billion in year-to-date inflows. This marks the largest single week of selling in gold's history. Money is moving into cash ($35.5 billion), bonds ($17.5 billion), and tech stocks ($3.5 billion).

Reasons for Gold's Decline

Gold's decline is attributed to:

• Potential US-China Trade Truce: Cooling tensions reduce the appeal of gold as a safe-haven asset.
• Interest Rate Cuts: Falling interest rates are generally not bullish for gold.
• "Risk On" Sentiment: Investors are shifting towards riskier assets like stocks.

The Hindenburg Omen

The Hindenburg Omen, a technical indicator signaling an increased probability of a stock market crash, has been flashing. It is triggered by three conditions:

1. A significant number of stocks hitting new 52-week highs and lows simultaneously (on October 30th, 476 stocks hit highs while 170 hit lows, about 2.8% of NYSE names). This indicates "bad market breath," where only a few stocks are rising while many are falling.
2. The S&P 500 remaining above its 50-day moving average.
3. The McClellan Oscillator Index turning negative, indicating declining stocks are gaining momentum.

While the Hindenburg Omen is a warning sign, the current market has significant capital, safeguards, and healthier businesses and consumers compared to past crashes. A full-blown crash is considered less likely, though corrections and bear markets are natural.

The Week Ahead in Markets

November: Historically Strong for Stocks

November marks the beginning of historically the best six months of the year for the stock market (November to April). The market is entering this period with momentum, supported by interest rate expectations and growing corporate profits.

Earnings and Economic Reports

The S&P 500 is expected to deliver an 8.5% increase in earnings per share, marking eight consecutive quarters of earnings growth. Key events this week include:

• Monday, November 3rd: Earnings from Palantir and Simon Property Group.
• Tuesday: Earnings from Advanced Micro Devices (AMD), Shopify, and Uber.
• Wednesday: ADP private payrolls report (crucial due to government shutdown), earnings from McDonald's, Apple, ARM Holdings, and Robinhood.
• Thursday: Tesla shareholder meeting (focus on robotics and AI), earnings from AstraZeneca, ConocoPhillips, and Airbnb.
• Friday: University of Michigan consumer sentiment for November, potential October jobs report (may be delayed), earnings from Constellation Energy and KKR.

Conclusion

The current market presents a complex picture of robust tech sector growth driven by AI investment, juxtaposed with a struggling broader economy and ongoing government shutdown. Historical parallels to the 1929 crash offer valuable lessons on speculation, leverage, and the importance of policy responses. While a repeat of the Great Depression is unlikely, the proliferation of complex financial instruments and leverage necessitates vigilance. Investors are shifting away from safe-haven assets like gold towards tech and other growth areas, with the historically strong November-to-April period on the horizon. The week ahead promises significant economic data and corporate earnings reports that will provide further insight into market direction.