Long-Term Slumps in Stock Prices

May 20, 2010

In an update yesterday entitled U.S. Unemployment, CPI Inflation, Stock Prices and Fed Policy, I quantified several data trends, which make a rate increase by the Fed this year unlikely.  This posting looks in further depth at the prolonged weakness of stock prices, which is already more than a decade long.  It’s not limited to the United States, either.

  • The Dow Jones Industrial Average is presently 13.8% below a peak of 11,723 reached 10 years, four months and six days ago.
  • The Japanese Nikkei is 51.9% below where it stood 10 years, 1 month and 8 days ago on April 12, 2000.
  • In the ten years, 4 months and 11 days, since peaking at 8065, the German Dax on balance has lost 27.2%.
  • The British Ftse is 26.8% weaker than it was 10 year, four months, and 20 days ago.

The scary part of this malaise is that it plausibly could run for many more years.  It is not rare to see multi-decade periods of excessive stock market appreciation alternate with similarly prolonged intervals showing a flat to falling trend.  Two historic examples of multi-decade weakness involved the DOW.  In the twenty years and four days between September 3, 1929 and August 30, 1949, the index lost 53.0% on balance.  Later in the 20th century, the Dow showed a net 5.7% increase over 20 years, 7 months and 30 days between December 13, 1961 and August 12, 1982, and imbedded in that period was a net drop of 21.4% between mid-December 1961 and December 6, 1974, nearly 13 years later.  Japan’s Nikkei-225 touched its historical high of 38916 some 20 years, four months and 22 days ago.  It is now 74.2% weaker now than then.

Reduced stock prices over a lengthy number of years connotes a chronic lack of confidence in the future, and the destroyed capitalization that such represents erodes spending power.  Working down the current excess of productive resources will take a very long time.  The aforementioned article from yesterday points to chronic and lengthy unemployment, low core inflation and weak stock prices as headwinds that will hamper the Fed’s ability to raise interest rates.  As one response to that difficulty, Fed officials have said that they at first plan to focus on the interest rate paid on bank funds held with the central bank and to begin increasing the Fed funds rate only later.  How long might that be? The target range has been zero to 0.25% since mid-December 2008, yet a move in 2010 seems out of the question.  Japan’s experience suggests that it may take years of additional waiting, not months or quarters.  The Bank of Japan’s overnight uncollateralized rate, which had been above 8% from November 1990 to June 1991, was reduced to 0.5% by September 1995 and never got above that threshold in the subsequent 14-2/3rds years.  Two attempts to normalize rates in August 2000 and July 2006 got no further than 0.25% on the the first try and 0.5% on the later one.

The Bank of Japan’s inability to raise rates has not been caused by low economic growth all this time.  Over the past year, real GDP in Japan expanded at annualized rates of 7.4% in 2Q09, 4.2% in 4Q09 and 4.9% last quarter, and GDP increased by 4.6% between the first quarter of 2009 and the first quarter of 2010.  That compares very favorably with the 3.2% rise of U.S. GDP in the year to 1Q10.  Japan has in fact experienced 20 quarters since 1990 with GDP growth of at least 3.5% annualized.  The problem has been the Japanese economy’s inability to tolerate short-term interest rates that are not near zero after becoming so accustomed to those conditions.  Before dismissing the validity of comparisons of Japan to the United States, consider what they share in common:  previous property and equity market bubbles, severe recessions sparked by financial system meltdowns, and the initial unwillingness of politicians to nationalize banks.  Japan developed deflation that has been very difficult to shake off, but it took years before negative inflation set in.  U.S. core CPI was yesterday reported to have increased only 0.9% in the twelve months to April, its lowest on-year advance in 44 years. 

It would be among the biggest market surprises if the Fed funds rate were no higher than 0.5% at the end of 2011, but Japan’s experience suggests such a scenario is far from impossible.  Indeed, the message from Japan is that an even longer delay could happen and that it need not lead to inflation or a weak exchange rate.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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