Economic Predestination

Story Highlights:

• Disappointing housing numbers Wednesday brought fresh comparisons to the Great Depression.
• But a monolithic view of that era is overly simplistic and not especially informative for analysis of today’s economic conditions.
• When making investment decisions, it’s important not to get paralyzed by fear of economic doom—instead, focus on extant conditions and analyze their likely future direction.

Great Depression comparisons have become increasingly popular again (as they were in 2009 and again in 2010—while the global economy grew and stocks rebounded strongly.) Historic analogies are tough to make since economies are incredibly complex. A similar data point or two do not a perfect analogy make—like one of Wednesday's headlines suggesting housing today is Great Depression-weak.

Another problem with the Great Depression analogy: Many think broadly of the Depression as a stock market crash in 1929 leading to years of non-stop stagnation, which were ended only by the US’ entry into World War II. But take a step back from this rather monolithic picture of the whole decade and consider the following: There were actually two recessions that made up the broader period commonly referred to as the Depression (which doesn’t have a technical economic definition, by the way)—1929-33 and 1937-38. In between, US GDP actually experienced some pretty strong growth.

It might be easy to think of this (or any period) in broad brush strokes of “good” or “bad,” but the more you break down the period and examine causes and effects of the totality of monetary and fiscal policy, the more one thing becomes strikingly clear: What happened then wasn’t a uniformly terrible decade, and what did happen was the result of a series of frequently—and in retrospect—not-so-great choices. (Hindsight’s always 20/20.) In other words, the stock market crash and the recessions of 1929-33 and 1937-38 were in no way predetermined—and that the former happened didn’t necessitate the latter.

Going a step further, the stock market crash in 1929 in no way necessitated the depth of the next four years’ recession. Markets just don’t discount events that far out. Rather, the crash may have presaged some economic negativity or regulatory choices that could cause negativity, but it’s highly unlikely to have foreseen all the myriad decisions and subsequent economic events yet to unfold. Choices including monetary policy errors, protectionist tariff and trade policies (like Smoot-Hawley and the global reaction to it) and regulatory decisions (among many others).

So the lessons for today? First, what we’re experiencing is really nothing like the Great Depression. (For more on our in-depth views on this, click here.) Economic numbers are, with few exceptions, expansionary—with their occasional ups and downs of course, but we’d never expect straight-line growth, even in the most robust periods of expansion. But with corporate profits at all-time highs, exceptionally accommodative monetary policy (the polar opposite of what happened in the Great Depression’s early days), global output and productivity growing and reaching highs and trade barriers globally falling, comparisons to the Great Depression become a bit strained.

Yes, unemployment is higher than anyone would like—but even at ~9% (and down from its peak), it’s well below Depression-era highs. And just as it was in the Depression, high unemployment is a hangover from recession, not a cause of it. Ditto for the housing market—which is quite weak now and may take a while to bounce back. But while housing contributed to 2008’s crisis, it wasn’t the primary cause, and it needn’t spark a new crisis now (especially representing such a small portion of overall US GDP).

Second, while there’s always the possibility we’ll have another recession in the next few years, that fear is hardly a foundation upon which to build a portfolio or make investment decisions. Especially because we don’t know what choices will be made over that time—by politicians, central bankers, investors (driven by mass psychology) and the like. They could be overall fine decisions, and we could wind up with a period more resembling the mid- to late1980s and 1990s. They could be a mixed bag. Or they could be overall more negative. But we can only assess the choices made, their potential impact and the psychology surrounding them as they’re made. That’s why one has to shun biases—otherwise you can end up forecasting based on what your gut tells you is in the brain of someone you’ve never spoken with.

History, economic cycles and market cycles are never predetermined. Yes, eventually we’ll experience another recession (not likely this year, but at some point). But that’ll be more due to the fact that humans are fallible creatures, and the decisions they make occasionally reflect that. Just the same, where we head from here is in no way inevitable. Nor does our current economy much resemble the Great Depression—any portion of it. Just ask someone who lived through it.