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Risk-Aversion Meets a Hypervalued Market

Risk-Aversion Meets a Hypervalued Market


Sooner or later a crash is coming, and it may be terrific.
– Roger Babson, September 5, 1929

Roger Babson’s first rule of investing was “keep speculation and investments separate.” He is remembered not only for founding Babson College in Massachusetts, but also for his speech at the National Business Conference, warning of an impending crash just two days after the 1929 peak, at the very beginning of a decline that would wipe out 89% of the value of the Dow Jones Industrial Average.

As I’ve observed before, the back-story is that Babson’s presentation began as follows: “I’m about to repeat what I said at this time last year, and the year before…” The fact is that Babson had been “proven wrong” by an advance that had taken stocks relentlessly higher, doubling during those two preceding years. Over the next 10 weeks, all of those market gains would be erased. If Babson was “too early,” it certainly didn’t matter. From the low of the 1929 plunge, the stock market would then lose an additional 79% of its value by its eventual bottom in 1932 because of add-on policy errors that resulted in the Great Depression.

To slightly paraphrase Ben Hunt, how does something go down 90%? First it goes down 50%, then it goes down 80% more.

This lesson has been repeated, to varying degrees, at every market extreme across history. For example, the 1973-1974 decline wiped out the entire excess total return of the S&P 500 Index (market returns over and above T-bill returns) all the way back to October 1958. The 2000-2002 market decline wiped out the entire excess total return of the S&P 500 Index all the way back to May 1996. The 2007-2009 market decline wiped out the entire excess total return of the S&P 500 Index all the way back to June 1995. I expect that the completion of the current market cycle will wipe out the entire excess total return of the S&P 500 Index all the way back to about October 1997.

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