Secular and cyclical financial markets since 1896.
American household wealth more than doubled between 1990 and 2000 because of the booming stock market. After a brief pause between 2000 and 2002, rising real estate values increased American wealth by another 50-percent by the end of 2007. As foreclosures in real estate escalated in 2008, the loss in American wealth also increased rapidly. The stock market decline started in October 2007. Subsequently, consumer confidence fell and unemployment started to rise. By the end of 2008, the National Bureau of Economic Research announced that the American economy had entered recession in December 2007. By March 2009, U.S. wealth had declined by $13 trillion or 18-percent from the second quarter of 2007 (Kalita, 2009).
The Dow Jones Industrial Average (DJIA) index had lost 54-percent of its value between March 9, 2009 and its high established on October 9, 2007. It was still down by 18-percent at the end of December 2010. Irrational waves of enthusiasm or pessimism in short-term economic conditions and uninformed investor who acts emotionally rather than rationally increases volatility and sways the stock market indices away from fundamental values. This reaction redistributes wealth towards savvy investors who are invested for long-term and respond to changing business fundamentals. Wealth redistribution favoring the rich and speculation in the financial market with an intent to create wealth with disregard for fundamentals of the overall economy and/-or corporate profits give rise to short-term cyclical bull markets that ends as the speculative bubble bursts.
This paper discusses secular bull and bear markets and the economic conditions that prevailed since 1896. We chose 1896 to begin our research as Dow Jones started to publish its first "Industrial" average consisting of 12 stocks closing at 40.94 on May 26, 1896. Financial markets tend to move in cycles. Since 1896, the U.S. economy has four secular bull and bear markets. Each secular market is punctuated by several cyclical bull-bear markets. Cyclical markets lasts for two-to-three years on average whereas the secular bull and bear markets last longer in duration. The average duration of past four bull markets is eleven years whereas the average for past three bear markets is nineteen years. The current bear market is in its twelfth year.
The first secular bull market lasted from 1896 until 1906 as the U.S. economy was changing from agricultural to industrial economy and the second bull market occurred from 1924 to 1929 and was created by increasing innovations and productivity in the automotive sector. The American economy was shifting from a military economy to a consumer economy with new government programs to alleviate people out of poverty created a third long bull cycle in the financial markets from 1954 to 1966. And the fourth, the most recent and longest bull market lasted from 1982 until the beginning of 2000. During this period the economy was going through the information technology revolution and globalization of our markets.
Powerful short-term, cyclical bull and bear markets occur within each secular bear market. However, the secular bear market may or may not post gains from the beginning to the end. The secular bear markets are much more emotional and volatile than bull markets and may post large one-day percent gains or losses. Bear markets have posted gains between 9.36-to-15.34-percent and the losses between 6.98-to-12.82-percent in a day. The period between 1929 and 1933 witnessed eight big losses and year 2008 had one such loss to report. However, the all-time high one-day loss was during the last bull run on October 19, 1987 when DJIA lost 22.61 percent on a single day. The losses during a bear market come as the market participants uncover wide-spread abuses and fraud by the corporations and financial sector in the economy which had been ignored during the bull run of the markets.
The next section discusses characteristics of secular bull and bear markets followed by discussion of each market. We make policy lessons and recommendations to keep the economy growing at a steady state rate followed by conclusion of the paper.
BULL AND BEAR MARKETS
Bull and bear stock markets are two sides of the same coin. Bull and bear not only describe the market condition but also reflect the state of the economy and the emotions of investors. A cyclical bull market is a condition in which the major stock indices rise more than 20 percent without any major decline in the indices over the period. Conversely, during a cyclical bear market the stock indices fall by 20 percent or more from their highs established during the bull market peak. In contrast, a secular bull or bear market consists of long-term stock market trends punctuated by several short-term cyclical bull and bear markets.
In secular bull markets, stocks tend to rise more than they fall with any setbacks being more than compensated for by the subsequent increase in stock prices. Although there are cyclical bear markets and/-or corrections contained in this period, the overall trend is such that buy-and-hold strategies work well to create wealth for investors. In general, an investor is optimistic about the future of the economy and about corporate profits. This euphoria propels investors to accept higher risks and ignore the underlying problems with the corporate balance sheets, hence creating bubbles in the asset prices.
Increased mergers and acquisition (M&A) activity during the economic expansionary periods intensifies the cyclical bull market. The U.S. economy has seen five M&A waves, the first three occurring during the first three secular bull markets (1897-1904, 1916-1929, 1965-1969). The fourth wave in the 1980s was much stronger but confined to the U.S., whereas the fifth merger wave of the mid-1990s went global.
In secular bear markets, the overall trend is one of wealth destruction as the real purchasing power of stocks decline more than it advances. Volatility increases and each successive downturn in indices may establish at a lower level than the previous one. Every rally in the stock prices fails to exceed the top of a previous rally. In the end, the stock indices end up where they started or perhaps lower thus creating a trading range. However, secular bear markets can also present an opportunity to buy some good corporation stocks at very low prices to hold for long-term. As general malaise and pessimism takes hold, investors exit from the stock markets.
The First Bull Market: 1896-1906
During the prosperity of the 1880s, the railroads were vastly over-built and many new silver mines began production. As a result the Philadelphia and Reading Railroad declared bankruptcy in 1893, and failures of the Northern Pacific Railway, the Union Pacific Railway and the Topeka and Santa Fe Railroad soon followed. Production of silver was flooding the markets. Drought in the Midwest was driving down the value of farmers' land and causing them to default on their debt. Almost 500 banks failed and unemployment reached 12 percent in 1896 (Romer, 1986). The U.S. economy finally began to turn around in 1896 and so did confidence in the U.S. economy. The unemployment fell to 5 percent by 1900. The Dow Jones Industrial Index (DJIA) closed at 41.82 on August 8, 1896 and by April 25, 1899 closed at all time high of 77.28, gaining almost 85-percent since august 1896. The economy faced rising interest rates and falling surplus deposits. The tight money policy caused a setback in the stock market (Wyckoff, 1972). By December 18, 1899, the market had lost 31.47 percent, but it recovered to its April 1899 levels by June 20, 1901 as President McKinley was re-elected (Pierce, 1982). Table 1 summarizes the factors affecting cyclical markets during the period between 1896 and 1906.
Acquisitions and mergers increased in the steel industry and the market once again took off. The DJIA peaked at 78.26 on June 17, 1901. Stock market sentiment was strongly affected when President McKinley was assassinated in September 1901. However, the short sales frenzy that started with the stock of the Northern Pacific Railroad and ensuing greed resulted in a loss of 46.14 percent by November 10, 1903.
The recession that started during September 1902 was over by August 1904 and the economy grew until 1907. Immigration increased by 21-percent during the first decade of 20th century. Agriculture was being replaced by manufacturing and the aviation and automobile industries emerged. The Income share of the top one-percent had been increasing since 1870 when it was 27-percent (Piketty & Saez, 2003). The DJIA closed at 103.00 above 100 for the very first time on January 19, 1906 posting total returns of 149-percent for the bull market.
The U.S. economy recovered from 1903, a minor banking panic and President Roosevelt got re-elected. Money, once again, became abundant and interest rates declined. The U.S. per capita wealth increased to $1,310 from $307 in 1850 (Wyckoff, 1972). A strong cyclical bull market ensued posting gains of 144-percent.
The First Bear Market: 1906-1924
The Banking Panic of 1907 ended the bull market and the stock market started to decline in response to the decline in the economy. In October 1907, the Mercantile National Bank in New York collapsed because of improper speculative investments, and the Knickerbocker Trust Bank of New York collapsed because of heavy investment in United Copper Company whose shares fell sharply. The panic spread to the stock market as banks began to call margin loans. The stock market went into free fall with mounting bank runs and high inflation giving rise to credit crisis (Wyckoff, 1972). Between January 9, 1906 and November 15, 1907, the DJIA lost 53-percent. The passing of Aldrich-Vreeland Act on May 30, 1908 helped banks to organize the National Currency Association and gave confidence to the investor in the stock market. By November 19, 1909, the DJIA once again passed 100 and it stayed in its trading range for next three years. Table 2 below summarizes the secular bear market of 1906-1924.
The Federal Reserve Bank of the United States of America (the Fed) started its operation on December 23, 1913 as President Woodrow Wilson signed the Federal Reserve Act into law. The NYSE closed from July 31, 1914 to December 11, 1914 due to the start of World War I, and then it doubled during the next eleven-months. By the end of December 1914, the DJIA declined by 36.27 percent. In September 1916, the DJIA was expanded from twelve company stocks to twenty companies. The war revived industry and the stock market recovered set a new high by November 21, 1915. The DJIA recovered its losses which occurred during 1914 by September 1916 and then dropped by 38-percent by the end of December 1917 when the U.S. entered the war with Germany.
The war ending in November 1918 resulted in the NYSE becoming the basic financial center for rest of the world making the United States number one financially (Wyckoff, 1972). By July of 1919, speculation was growing once again and scandals started to rock Wall Street. The Fed made a statement regarding the excessive speculation on the Wall Street causing heavy liquidation. The DJIA reached its high on November 3, 1919 at 119.62; even in the face of growing industrial unrest. The subsequent decline in the DJIA was sparked by the tight monetary policy. By August 24, 1921 the market had lost 47-percent of its value.
The Second Bull Market: 1924-1929
In May, June and August of 1924, the Fed had cut discount rate. By July 29, 1924, the DJIA had recovered and started a new secular bull market. Businesses started to thrive based on new innovations in every field. Industrial production increased by 70-percent and GDP rose by 40-percent between 1922 and 1928. The top one-percent of banking corporations controlled 46-percent of banks. The top 200-corporations controlled 50-percent of industry and 49-percent of the corporate wealth (http://bss.sfsu.edu).
Profits rose due to enhanced operating efficiencies and so did wages for workers. Executive salaries ballooned widening the gap between executives and the workers. Corruption was wide spread. Per capita income for the top one-percent of the population rose by 75-percent between 1920 and 1929, whereas it increased by 9-percent for the nation as a whole (http://bss.sfsu.edu). The second secular bull market is summarized in table 3 below.
The post-war recession was forgotten as Americans went on a spending spree. The United States became a modern middle-class economy that used consumer appliances and automobiles. Approximately four million vehicles were owned by the people in 1928. By the end of 1929, nearly thirty million vehicles were on the road, one for every five residents of the country (DeLong, 1997). Eight percent of American households were wired for electricity in 1907, and 80-percent were wired by the beginning of World War II (De Long, 1997). The increased spending was funded by the newly introduced credit. Eighty-percent of American families had no savings but were financing their consumption on credit. Consumer credit outstanding rose from $1.38 billion in 1925 to $3.0 billion by 1929 (http://bss.sfsu.edu).
A large number of people started to move from rural areas to urban areas. Over one million people moved from rural areas to urban areas in 1926 alone. The Revenue Act of 1926 sharply reduces tax rates across the board while raising rates for corporations (Batra, 1987). Tax reports by the U.S. Treasury show that the number of people with annual income of a million increased from 21 in 1921 to 75 in 1924 and 207 in 1926. There were an estimated fifteen thousand millionaires in 1927, and at least one billionaire (1920-30s.com). The richest one-percent of the population owned about 45-percent of the total wealth (DeLong, 1997).
The Second Bear Market: 1929-1954
Amid the affluence of late 1920s, an average person viewed participation on the Wall Street as a way to become rich. Out of 121 million people only 1.5 to 3 million people actually owned stocks. The Fed pursued tight monetary policy to tame the speculative bubble in the real estate and stock markets in 1928-1929. On August 6, 1929, the Fed raised interest rates to six-percent. Consumer spending, employment and business starts had all began to fall (Wright, 2002). The recession had already started during August, 1929. DJIA closed at 381.17 on September 3, 1929 and then started to decline and closed at 41.22 on July 8, 1932, a lose of 89.2-percent at a level below August 8, 1896 close. More than sixteen-million stock shares traded on the NYSE. The value of listed securities declined to $75 billion in March 1932 against $87 billion in September 1929. That pushed the economy into depression. National debt reached $194 billion whereas national income declined to $85 billion (Wyckoff, 1972). Industrial production fell by 47-percent, GDP declined by forty-four percent, unemployment rose to twenty-five percent, farm values declined by 60-percent, more than 10,000 banks failed and the money supply contracted by 40-percent by mid-1932.
Table 4, above summarizes the longest secular bear market. The crash of Wall Street did not cause the depression as reported by the Ferdinand Pecora committee. However, Pecora committee did uncover a large number of bankers who had committed breaches of law and ethics (Wright, 2002). By December 1932, DJIA recovered and closed at 59.93. The governor of New York declared banking holiday at President Roosevelt's inauguration to stop the ongoing run on banks, and the NYSE closed between March 3 and March 14, 1933. Roosevelt also took the U.S. off the gold standard at the same time. On March 9, 1933, the President called Congress into special session and passed the Banking Act of 1933, also called the Glass-Steagall Act, separating depository banking and investment activities; and creating the Federal Deposit Insurance Corporation. Banks were required to select between commercial and investment activities. The Securities Exchange Commission Act was enacted on June 6, 1934. It instituted government regulation of securities trading for the first time and established the Securities Exchange Commission (SEC). The economy as well as the stock market started to recover and gave rise to a very strong cyclical bull market. By March 10, 1937, the DJIA closed at 194.40, a gain of 371.62 percent from July 1932.
On January 30, 1937, the Fed increased reserve requirements against demand and time deposits of member banks. Government also warned of inflation rising in the economy. This started a cyclical bear market during March 1937 and pushed the economy into a recession by May 1937. In March 1938, Conway Committee recommendations for reorganization of the NYSE and a simplified management structure that would include a salaried presidency of the exchange and ruling on short sales were approved. The stocks index bottomed out and a short but strong bull market started. The economy recovered by June 1938.
The stock market started to get nervous as World War II began on September 1, 1939 and lost 40-percent by April 1942. As the United States entered World War II in December 1941, Wall Street felt no panic and gained 124-percent between April 1942 and April 1946. For the next four years, the market stayed in a trading range and the economy weathered a mild recession. The economy recovered while consumption increased and the stock market started its slow climb. Even though the U.S. economy suffered another mild recession between July 1953 and May 1954, the U.S. enjoyed peace time and prosperity giving rise to a cyclical bull market that would become the next secular bull market.
The Third Bull Market: 1954-1966
On November 23, 1954, the DJIA closed at 382.74 for the first time. Its prior close of 381.17 was September 3, 1929. For the next eleven years, DJIA assumed an upward ascent without any major downturns. On December 31, 1959, the DJIA closed the decade of 1950s at 679.36, a gain of 240-percent. The DJIA kept climbing upward while setting new records. Selling at the NYSE started as the news of John F. Kennedy's assassination became public. The NYSE closed early induced by the panic of bad news.
The NYSE also set up a trust fund to rescue Haupt & Company from bankruptcy. Eventually this trust fund became the Securities Investor Protection Corporation in 1970. The U.S. economy was, generally, in good health during the period, except for the two short recessions. On February 9, 1966, the DJIA made an attempt to pass 1,000 but failed and finally closed at 995.15. Table 5 below summarizes the third secular bull market.
The Third Bear Market: 1966-1982
The Fed implemented tight monetary policy to combat inflation and disintermediation as market interest rates were higher than the bank savings rates under regulation Q in 1966. Fed regulators urged banks to restrain credit. Worries over tight credit conditions and tax boost sparked a sell-off on the Wall Street. Short-term interest rates increased significantly and commercial banks raised interest rates on long-term loans. Between February and October 1966, the stock market dropped by 25-percent. The economy did not see any recession since 1961 and the unemployment rate was below 4-percent. Defense spending rose from 7.4-percent of GDP in 1965 to 9.4-percent of GDP in 1968. Increased spending contributed to an economic boom and started a cyclical bull market in the beginning of 1966 that ended in December 1968 with 32-percent gain. The inflation rate increased from 4.72-percent to 6.04-percent and unemployment increased from 3.4-percent to 4.8-percent between December 1968 and May 1970. The DJIA responded by losing 36-percent during this period. The Fed restated its decision to control inflation by using tight monetary policy leading to a recession in December 1969 that ended in November 1970.
The market recovered as the Fed continued to decrease discount rates into the first-half of 1971. The strong economic growth gave a boost to the stock market and the DJIA gained 67-percent. On August 15, 1971, President Nixon announced "Wage, Price and Rents Freeze" for ninety-days and removed the U.S. dollar from the gold standard and fixed exchange rate system which devalued the dollar.
The inflation rate started to escalate from 3.65-percent in 1973. By December 1974, it had climbed to 12.34-percent and the unemployment rate had jumped to 7.2-percent resulting in stagflation. On October 16, 1973, OPEC announced its decision to increase oil prices by 70-percent, and immediately cut production by 5-percent from its September levels as well as to continue cutting by increments of 5-percent until its political objectives were met. This pushed the U.S. and other developed countries economies into a severe recession. The growth rate of real GDP declined from 7.2-percent in 1972 to negative 2.1-percent by the end of 1974. The DJIA lost 45-percent from its January 1973 level.
Between December 1974 and February 1978, a cyclical bull market took hold due to very low valuation of stocks. The DJIA increased by only 36-percent and could not erase losses of the prior bear market. As the economy faced high inflation, low productivity and very high interest rates, the Congress enacted the Depository Institutions Deregulation and Monetary Control Act, and the Fed tightens the money supply to control inflation. The economy experienced a mild recession between January 1980 and July 1980. The Fed's attempt to control inflation pushed the U.S. economy into a severe recession in July 1981. The unemployment rate increased to nearly 11-percent as the recession deepened and inflation rate dropped to 5-percent by September 1982 from 14.76-percent in March 1980. President Reagan announces a 25-percent across the board tax-cut and a five-percent increase in defense spending. Falling inflation, tax-cuts and increased spending fueled a rally on Wall Street and started a new secular bull market. Table 6 below summarizes the third secular bear market.
The Fourth Bull Market: 1982-2000
The bull market that started in 1982 was the longest and strongest with a small interruption in the 1987-1989 periods. The economy came out of the recession by November 1982. President Reagan not only cut taxes by 25-percent and increased defense spending by 5-percent, but also reduced funding for some social programs and deregulated the economy. This across the board tax-cut increased wealth inequality to 1929 levels by raising the non-home wealth share of the top one-percent of the population to 42.9%. Mean household wealth rose by 18-percent between 1983 and 1989. The strong bull market of 1995 to 1999 was mainly responsible for increasing the non-home wealth share top one-percent to 47.3%.
Federal budget deficits swelled from $207.4 billion in fiscal year 1982 to $269.3 billion in fiscal year 1991 before turning to surpluses in 1998. During the fiscal year 2000, the federal budget posted a surplus of $678.6 billion. The wave of deregulation for various industries coupled with tax--cuts and increased defense spending empowered economic growth in all sectors except agriculture.
Even though Congress raised some taxes to reduce the federal budget deficit by passing the Gramm-Rudman-Hollings bill, the U.S. economy kept growing at a very high rate. The stock market crashed on October 19, 1987. The Brady Commission was appointed to determine the causes of the crash. The Commission concluded that the stock market and derivative markets did not operate in sync and high selling volume on October 19, 1987 had produced illiquidity of the markets. The market recovered by January 1989. Deregulation of depository institutions in 1981 phased out regulation Q by 1985 and removed barriers to entry into the banking industry. One of the outcomes was that a large number of savings and loans institutions were making speculative real estate and commercial loans to increase their asset base and increase profitability. In 1989, the Bush administration bailed out savings and loan banks under the "Financial Institutions Reform, Recovery and Enforcement Act" and "Resolution Trust Corporation" by using over $200-billion of tax-payer money (U.S. Department of State, 2008).
In July 1990, the U.S. economy entered a mild recession. The unemployment rate rose from 5.5-percent to 6.8-percent by the end of recession in March 1991, but the inflation rate stayed below five-percent. By June 1992, the unemployment rate had increased to 7.8-percent but then declined to 4-percent by the end of 1999. The inflation rate had decreased to an average of 2.2-percent in 1999. The stock market stayed in a trading range of 10-percent between 1989 and 1991, increased between 1992 and the end of 1993, stayed flat in 1994 and then took off in 1995. As the information technology boomed and the preparation for Y2K started, technology company stocks gave a big boost to all stocks. Euphoria set in and with low unemployment and inflation rates; the U.S. economy started to expand at a very high rate. Mergers and acquisition activity increased and multinationals companies' profits skyrocketed. On December 31, 1994, the DJIA closed at 3834.44.
During July 1997, the Asian financial crisis began in Thailand with the collapse of Thai Baht due to the over-extension of their commercial real estate market. It affected Southeast Asia, Japan and Australia. In response to the crisis, the U.S. stock market had a correction of 11-percent between July 1997 and February 1998. However, Russia lost about 80-percent in their exports of petroleum, natural gas and metals and Russian economy suffered a crisis which began during August 1998. The American stock market declined by 11-percent by September 10, 1998, but fully recovered by October 30, 1998. On November 12, 1999, the Gramm-Leach-Bliley Act was signed by President Clinton to repeal the Glass-Steagall Act which separated depository and investment banking. The stock market rose until January 14, 2000, when the DJIA closed at 11,722.98. Table 7 below, summarizes the longest secular bull market with 1003-percent gains.
The Fourth Bear Market: 2000-present
The current bear market started in January 2000 with the internet bubble. Innovations in internet technologies expanded along with the financial globalization of the world. The U.S. economy suffered a mild recession between March and November 2001, which decreased wealth inequality only a little. The top one-percent of households still controlled 39.7-percent of the wealth, although down from 47.3-percent in 1998. In response to the recession of 2001, the Fed increased the money supply growth rate from negative 3.1-percent in 2000 to positive 8.7-percent by the end of 2001 (Economic Report of the President, 2008). President Bush signed a bill cutting taxes by $1.35-trillion on June 7, 2001 to spur economic and job growth (Center for American Progress, 2009).
After the September 11, 2001 terrorist attack, the Fed sharply reduced the interest rates and kept them at historically low levels to boost aggregate demand. In a June 17, 2002 speech, President Bush, said, "there is a homeownership gap in America.... so by the year 2010, we must increase minority homeownership by at least 5.5-million" (Office of the Press Secretary, 2002). In December 2003, President Bush signed "the American Dream Down Payment Act". The legislation offered a maximum down payment assistance grant of either $10,000 or six-percent of the price of a home or whichever was greater. In 2004, the home ownership rate peaked at 69.2-percent.
In 2004, then Fed chairman, Alan Greenspan, addressed the Credit Union Association and said, "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed rate mortgages" (FRB Speeches, 2004). Heeding his advice, adjustable rate mortgages became the choice for subprime borrowers. Down payments and other requirements for many mortgage seekers were also waived. Eighty-percent of mortgage loans offered by banks fell into subprime mortgage category during 2004-2006. These risky debts were then sold to Wall Street Firms like AIG, Bear Stearns, Merrill Lynch, Lehman Brothers, Bank of America, Goldman Sachs, Morgan Stanley, JP Morgan, Citigroup, Freddie Mac and Fannie May and many others who pooled these mortgage-backed securities with other securities and sold them to customers around the world. Since a large fee was collected by the Rating Agencies to rate these Collateralized Debt Obligations (CDOs) from the Wall Street firms, each of them had an A rating. This started an expansion in the real estate market which produced a bubble in residential and commercial real estate. Table 8 below, summarizes the current secular bear market.
A cyclical bull market began during October 2002 with fiscal and monetary policy stimuli implemented to increase economic growth. Stock market participants had not seen a secular bear market since the last one ended in 1982. Income inequality was increasing once again and jobs were being off-shored to rest of the world. The bubble in real estate market started to form, and speculation in the oil market increased. At the same time, the stock market was reaching new highs and instilling enthusiasm among the participants, given the increasing wealth in their portfolios. This cyclical bull market posted a very strong return of 94- percent.
Increased demand for oil by the expanding global economies and the invasion of Iraq in 2003 impacted the oil market, and the price of oil began to rise. The inflation adjusted price of a barrel of oil stayed under $25 between the mid-1980s and 2002. Speculation in the oil market peaked during July 2008, and the price of a barrel of oil reached $147.30, which contributing to the decreased aggregate demand.
U.S. housing prices peaked in 2006 and began to plummet in the cities with greater expansion in residential construction. Meanwhile, interest rates on adjustable rate mortgages started to adjust higher. This initiated foreclosures of residential real estate during late 2005 as people could not afford to make higher mortgage payment and walked away from their mortgages leaving Wall Street and other investors with bad loans in their CDOs. During 2007, at least 100-mortgage companies either shut down or were sold to other companies. In March 2008, JP Morgan bought Bear Stearns for $2 per share, compared with its high of $170 per share during the previous year; Bank of America bought Countrywide Financial and Merrill Lynch; and Lehman Brothers declared bankruptcy in September, 2008 after 158-years in business; Smith Barney, the brokerage unit of Citigroup is sold to Morgan Stanley and many other financial firms were bailed out costing $700 billion to the tax payers.
The credit crisis coupled with the energy crisis rippled through the entire world very quickly resulting in a number of European bank failures, declines in the world stock markets, and large reductions in the market value of equities. The subprime mortgage crisis in the U.S. had affected world financial markets and pushed the U.S. and world economies into severe recession. For the first quarter of 2009, the annualized rate of decline in GDP was 14.4-percent in Germany, 15.2-percent in Japan, 7.4-percent in the UK, 9.8-percent in the Euro area and 21.5-percent in Mexico. The developing nations also experienced significant slowdown due to fall in trade, higher commodity prices, lower foreign direct investments and remittances sent from migrant workers according to the Overseas Development Institute in 2008. The U.S. economy has recovered from the deep recession it experienced due to the financial crisis but the recovery has been anemic at best and unemployment is still above nine-percent.
The extent of this financial crisis was so severe that the very institutions which created this crisis needed to be bailed out. American household's networth fell from $64.4 trillion in the second quarter of 2007 to $50.4 trillion in the first quarter of 2009. U.S. taxpayers risked $9.7 trillion on bailout programs (Bloomberg, 2009). The automobile industry in the U.S. also felt immense pressure; and General Motors and Chrysler were bailed out. Between October 2007 and March 2009, the DJIA declined by 54-percent making it the second largest loss since 1929. The DJIA has recovered since but still is below its January 2000 high of 11,723.
POLICY LESSONS AND RECOMMENDATIONS FOR FUTURE RESEARCH
In the global, interconnected and interdependent world, it is imperative for each nation to be competitive in generating employment for its people and sustainable growth. However, each economy is at a different stage of development with its economic and political systems. The United States of America has embraced a capitalistic economic system that rewards innovation and entrepreneurship, and it has been credited with raising the standard of living of its people. This capitalistic system encourages risk taking by entrepreneurs and rewards them financially, which can lead to a skewed wealth distribution.
According to Schumpeter (1912), long-run economic growth depends upon technological innovation. Innovations in the financial sector make it possible for entrepreneurs to obtain necessary credit (Hicks, 1969). To fuel economic growth and increase the profitability of corporations, financial institutions develop and sell risky financial instruments to meet the demand for credit by entrepreneurs. This results in higher levels of economic and financial activity and greater employment in the short-run as well creating higher peaks in the business cycle. Eventually, without an underlying secure asset base for increasingly risky financial instruments, financial markets incur steep losses.
Productivity gains increase employment and GDP that tend to create optimism among the general public. Policymakers, too, get caught in this wave of euphoria and start believing that the economy can grow at a higher rate indefinitely if they can keep fueling the growth with expansionary fiscal and monetary policies. However, demographics and technological innovations determine long-run or steady-state economic growth whereas activist fiscal and monetary policies often redistribute wealth and create income-inequality. Also, every bull market has enabled con-artists to engage in financial crimes which get exposed during bear markets.
To keep the economy growing at a rate that does not reduce employment or create higher income-inequality, policymakers have to carefully formulate plans to promote growth in both the labor force and new investment as well as plan regulations that maintain stock of labor force and encourage technological innovations to produce slow but steady increases in living standards for its people. All developed economies have graying labor force due to lower birth rates and increasing longevity. To address this issue, policymakers have to pay serious attention to immigration laws. Congress should provide funding for education that can address structural changes in the economy in order to provide the needed skills for the innovations which improve the well-being for masses by reducing the costs of services.
Fiscal policy makers can address the issue of income-inequality via changes in the tax-code for individuals and corporations and development of guidelines for CEO compensation packages. There is also widespread support for setting up reliable energy and healthcare policies. More generally, there must be progress on moving towards a balanced budget; reducing public debt and implementing rules for traders in the financial markets. Part of this will require Congress to set new rules for lobbying activities as a way to limit undue influence of special interest groups. On the monetary side, policy makers need to set the growth rate of the money supply in a range that does not ignite inflation or produce stagflation. They should refrain from lowering interest rates to make credit cheap for individuals and corporations in the name of economic growth. Excessive liquidity in the financial markets also reduces real value of financial assets that market participants own. Already existing regulations must be enforced to mitigate financial crimes as these crimes have devastating impacts on the affected people.
It would be interesting to empirically investigate the economic effects of fiscal and monetary policy measures adopted during each of the secular bear markets. Additionally, an intriguing issue to investigate is 'why secular bear markets are so much longer than secular bull markets' and 'can we really dampen the steep declines in cyclical markets and their impact on investors, especially retirees, effect on retirement accounts, using prudent fiscal and monetary policies'.
Exuberance and malaise, greed and fear define cyclical stock market cycles, whereas secular markets are created by economic conditions. Innovations, increasing productivity, a strong economy, and higher levels of spending create secular bull market. As technology becomes common and productivity declines, the economy starts to falter; a secular bull market ends and gives rise to a secular bear market that exposes the excesses of the bull market.
Secular bull markets are shorter in duration but post very healthy cumulative returns. The past four secular bull markets have posted cumulative returns between 149-percent and 1003-percent. The impetus for propelling a secular bull market to new highs comes from some major technological advances that improve life for millions of people. Also, consumers are confident in the economy and in their earning power. Higher levels of wealth and increasing wealth disparity occur during these periods as fortunes are made by the owners of new technologies.
The last three secular bear markets have lasted for 18-years, 25-five years and 17-years. Currently, we are in the 12th-year of the fourth secular bear market. Even though the bear market period is turbulent, the cumulative returns during the past three bear markets have been between negative 4-percent and positive 2-percent. Secular bear markets are characterized by the destruction of wealth as stock prices fluctuate wildly. The damage comes from the speculation that investors had accepted without worrying about the fundamental support for their decision to purchase assets during the previous bull market. Financial crisis is inherent to the capitalistic system and is not a rare phenomenon; however, the 2007-2009 crises have been very severe. It has affected not only the United States but also the entire world. This credit crunch originated because of the low savings rate, the high debt burden of U.S. households, very low interest rates, high budget and current account deficits, deregulation of financial markets, and increased complexity of financial instruments. As the credit crunch ends and the economy rebounds, seeds for new secular bull market will be sown with new innovations as they will increase the economic well-being of people.
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Harjit K. Arora
Le Moyne College, New York
Harjit K. Arora is a Professor of Economics at Le Moyne College in Syracuse, New York. She teaches Macroeconomics, Money, Credit and Banking and Global Economics. She publishes in the areas of Macroeconomics, Financial Markets and Global Economic Issues.
Table 1 Cyclical Markets within Secular Bull Market of 1896-1906 Total Cyclical Bear & Recession Dates Returns Bull Markets and Loss/Gain 148.92% 5/1896-4/1899 +85% 4/1899-9/1900 6/1899-12/1900 -31%. 9/1900-6/1901 +48% 6/1901-11/1903 9/1902-8/1904 -46% 11/1903-1/1906 +144% Total Factors Affecting Cyclical Markets Credit Returns Crunch 148.92% Excesses in Mining, decrease in No unemployment, mergers & acquisitions and greed, birth of aviation and automobile industries, assassination of President William McKinley Severe drought of 1901 Various banks were suspended Iron and steel industries were very depressed Table 2 Cyclical Markets within Secular Bear Market of 1906-1924 Total Cyclical Bear & Recession Dates Returns Markets and Loss/Gain -4.29 1/1906-11/1907 -53% 5/1907-6/1908 11/1907-9/1909 +90% 9/1909-3/1914 1/1910-1/1912 Trading Range 1/1913-12/1914 3/1914-12/1914 -36% 12/1914-11/1915 +101% 11/1916-12/ 1917 -38% 12/1917-11/1919 +81% 8/1918-3/1919 11/1919-8/1921 -47% 1/1920-7/1921 8/1921-7/1924 5/1923-7/1924 +60% Total Factors Affecting Cyclical Credit Returns Markets Crunch -4.29 Banking Panic Yes, WWI started only in Increase in interest rates 1907 Tight monetary policy NYSE closed between July 31, 1914 and December 12, 1914 U.S. entered war with Germany Table 3 Cyclical Markets within Secular Bull Market of 1924-1929 * Total Cyclical Bear Recession Dates Factors Affecting Returns Markets and Loss Cyclical Markets 294.66% None 10/1926-11/1927 No cyclical bear market Total Credit Returns Crunch 294.66% No * DJIA expanded to thirty companies as of October 1, 1928 Table 4 Cyclical Markets within Secular Bull Market of 1929-1954 Total Cyclical Bear & Recession Dates Returns Bull Markets and Loss/Gain 1.69 % 10/1929 -7/1932 8/1929-3/1933 -89% 7/1932-3/1937 +372% 3/1937-3/1938 5/1937-6/1938 -49% 3/1938-11/1938 +60% 11/1938-9/1939 Trading Range 9/1939-4/1942 -40% 4/1942-4/1946 +124% 2/1945 -10/1945 4/1946-3/1950 Trading Range 11/1948-10/1949 3/1950-11/1954 +84% 7/1953-5/1954 Total Factors Affecting Cyclical Credit Returns Markets Crunch 1.69 % Tight monetary policy in Yes, 1928-1929, stock market in 1929, speculation, banking crises 1937 and 1953 Passage of Banking Acts 1933 and 1934 Inflation fears, increase in the reserve requirements 9/1939-8/1945 WWII 12/1941 US enters WWII Korean War 6/1950-7/1953 Table 5 Cyclical Markets within Secular Bull Market of 1954-1966 Total Cyclical Recession Dates Factors Affecting Returns Bear Markets Cyclical Markets and Loss 154.29% None 8/1957-4/1958 Vietnam War 1961/ 4/1960-2/1961 1975 11/23/1963 John F. Kennedy assassinated Total Credit Returns Crunch 154.29% Yes in 1957 and 1960 Table 6 Cyclical Markets within Secular Bear Market of 1966-1982 Total Cyclical Bear and Recession Dates Returns Bull Markets and Loss/Gain 0.83% 2/1966-10/1966 -25% 10/1966-12/1968 +32 12/1968-5/1970 12/1969-11/1970 -36% 5/1970-1/1973 +67 1/1973-12/1974 -45% 11/1973-3/1975 12/1974-2/1978 +36 2/1978-10/1982 Trading Range 1/1980-7/1980 7/1981-11/1982 Total Factors Affecting Credit Returns Cyclical Markets Crunch 0.83% Tight monetary policy Yes in and Jaw boning by Fed 1966, and government to 1969, restrain lending 1973 Disintermediation as and market interest rates 1980 exceed Regulations Q ceilings OPEC shock in 1973 and 1979, high inflation and high interest rates Tight monetary policy, High unemployment Table 7 Cyclical Markets within Secular Bull Market of 1982-2000 Total Cyclical Bear Recession Dates Returns Markets and Loss 1,003.2% 10/1982-10/1987 7/1981-11/1982 +152% 10/1987-1/1989 -23 % 1/1989-1/2000 7/1990-3/1991 +447% Total Factors Affecting Cyclical Credit Returns Markets Crunch 1,003.2% High growth rate of US Yes economy, Innovations in information technology Repeal of Glass-Steagall Act in November 1999 Table 8 Cyclical Markets within Secular Bear Market of 2000-Present Total Cyclical Bear and Recession Returns Bull Markets and Dates Loss/Gain -1.24% 1/2000-10/2002 3/2001- -38% 11/2001 10/2002-10/2007 + 94% 10/2007-3/2009 12/2007- -54% 6/2009 3/2009-12/2010 +77% Total Factors Affecting Cyclical Credit Returns Markets Crunch -1.24% Internet bubble burst September No 11, 2001 attack on Twin Towers, New York Iraq War started in 2002 Sub-prime mortgages and real estate Yes in bubble burst Failure of Lehman Brothers 2008-2009 and Bear Sterns Government bailout of big banks and General Motors and Chrysler
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|Author:||Arora, Harjit K.|
|Publication:||International Journal of Business and Economics Perspectives (IJBEP)|
|Date:||Sep 22, 2011|
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