Economy: Surviving the Wall Street crash

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Dave Deruytter asks who the winners were in the 1929 financial meltdown.

The stock exchange crash of 1929 is to date still the most severe crash in history. After a bull run of about nine years, in two days at the end of October 1929 the Dow Jones index lost more than 10% each day, continuing to fall for about two months thereafter.

Before the crash there had been quite a few warnings that the market was heavily overvalued, not least from the Federal Reserve as early as February and from prominent investors later on. The final well-publicized warning that a crash was imminent came from financial expert Roger Babson in September 1929, but the dip in the stock market on September 18 was short-lived as banks and market makers stepped in to buy shares and support the market with success, but it wouldn’t last.

A few people made money before the crash by selling an important part of their investments, as they were able to keep their greed in check. Bernard Baruch was one of them. He was also able to keep his fortune for the rest of his lifetime and stayed a very well-respected individual and advisor to many presidents. Another one was John Raskob. Though he lost part of the money he made before the crash later on, he still had enough left over to develop the Empire State Building.

After the crash there was mostly deep misery for all investors. Actor Groucho Marx’s wealth was heavily connected to the stock market that he had to sell his luxurious Hollywood home. But the less wealthy investors, many of whom had borrowed money to invest, lost everything and were heavily indebted. They had to sell their homes and cars at a price well below their value.

The winners in the aftermath of the crash were generally very quiet as they saw the misery of the crash spread all over the country and later on all over the world. Still, fortunes were made during the downfall of the stock market. Jesse Lauriston Livermore had already made big money from the 1907 crash by short-selling (selling shares you do not have in the hope to buy them back cheaper later) and did it again in 1929. In the former crash he earned $1 million, and in the latter $100 million. That is worth several billion dollars today. Yet he lost most of that fortune in later years.

Banker Albert H. Wiggin short-sold his own portfolio when his bank was buying those shares to try to stabilize the market. He made a fortune. In those days such insider trading was not yet formally forbidden.

Irving Kahn borrowed money from a relative to short-sell a mining company called Magma Copper and doubled his money in the crash. In the late 30s, he started cooperating with Benjamin Graham, one of the inventors of securities analysis and of the concept of ‘value investing’. One of Ben Graham’s pupils at university was Warren Buffett, well-known for his investment company Berkshire and Hathaway.

Only a few industries kept doing well. The cardboard industry, for example, thrived because it diversified by investing in real estate. After the initial two-month crash, the stock market recovered for five months into early 1930, before sliding again almost continuously for two years and two months until almost 90% of the peak value of the stock market was wiped out. It took just over 25 years to reach the 1929 peak of the market again at the end of 1954.

The famous economist Milton Friedman eventually found the reason for the Great Depression that lasted for 10 years in total. It was the collapse of the banking system during three waves of panics over the 1930 to 1933 period. So neither the Stock Market crash nor a weak economy was the chief cause for the decade of depression. They are considered to be merely typical events of economic cycles.

Authorities learned from the crisis by building a Chinese Wall between deposit seeking banks and investment banks, and later on by tackling insider trading and adding increased transparency to the markets.

In the 2008 financial crisis the authorities were quick to ring-fence the banks to protect depositors and keep liquidity for the real economy going. That was key to a rather fast recovery of the stock markets and the economy. But by adding the new liquidity measure of Quantitive Easing (buying huge amounts of financial assets, mainly bonds) it needs to be seen how this can eventually be unwound and what effect that will have on the economy and the financial markets.

Today the risk of a major stock market crash maybe more present in the less mature or less transparent markets, like the Chinese domestic financial market for example, which suffered a severe crash a few months ago. The country is still recovering from the shock, and regulation, transparency and insider trading aspects still need to be fully sorted out. The once rich Middle East markets are also to be monitored given the drop in income these countries are earning at the current oil prices –less than half their peak price for quite some time.

For investors such major financial crashes teaches you to keep your greed in check, not to borrow to invest and to diversify your investments as suggested by the portfolio theory: diversification not only leads to less risk, but also to higher return in the longer run.

Keep some cash for a rainy day. Dare to take the opposite view of the market. Be patient and do not let emotion rule your investment decisions.

Know who you are: a short term trader or a long term investor.

A trader goes for speed. When a position increases in price he buys more. When it loses he sells quickly.

A long term investor is guided by patience. He buys when an uptrend confirms. He sells when the bull runs out of steam.

But the typical investor maybe be better served by one or a few well-managed mutual funds that take the day-to-day management of his investments out of his hands. Morning Star ratings may guide you there.

Finally, do not forget to enjoy your money too. There is some truth in the saying ‘You are only as rich as the amount of money you spend.’