1998? 1990? 1987? 1929? What is the right analogy

1998: financial stocks drop by more than half during the summer/fall of 1998 thanks to panic about the solvency of various brokers due to Long Term Capital Management's high leverage bets combined with Russian debt defaults and the Asian crisis. The Fed cut rates 3 times and stocks rebounded to record levels within a few months. If this is the right analogy, then you would expect a sharp snapback rally in the financials.

1990: Tax reform in 1986 took away certain real estate provisions that hurt the value of real estate as an investment. Falling values hurts collateral and when combined with poor savings and loan investments in high yield bonds, a lot of banks got wiped out -- Bank of New England being the most prominent at the time. Much of our banking system was technically insolvent just like the Japanese banks would become (or just like much of the hedge funds and other investment partnerships including potentially mortgage REITs are today) but we realized our losses and moved on unlike the Japanese who ignored them for years. Losses are a healthy part of the system -- they cleanse markets of investors who take too much risk or speculate too much. Lots of talk aboout Bear Stearns given their conference call on Friday -- if its 1990, then expect this firm to either go under or come close. Surviving firms will be great investments but there is lots of pain to get to the levels reached in 1990.

1987: Bond yields were rising all year at the same time that stock prices were rising too. By August the market peaked at 2728 (or thereabouts) or 22X earnings, while bond yields were near 10%. Why take the risk of the market, when risk free Treasuries are offering 10% guaranteed. Rates are near 5% and falling now on the flight to quality. Stock valuations are much better too. Unlikely.

1929: This period has been studied quite a bit but there are lots of myths or misunderstandings about what happened. Various factors conspired to create a debt financed boom that ended and was made worse by various policy mistakes. The Fed cut rates in the early 20's because Britain wanted to maintain the Pound at a 5 dollars/pound rate -- same as pre=WWI but that didn't make any sense given how much stronger we were post war then Britain. In addition, Mellon (Treasury Secretary) and Coolidge (Pres) engineered tax cuts that boosted after-tax incomes. New technologies such as mass manufacturing techniques plus electricity, radio, appliances, etc. created a huge productivity boom. Stocks were bought on margin -- there was no 50/50 rule like today -- people would margin their stocks up to 90%. The artificially low interest rates led to big growth in debt -- financing purchases of capital equipment, appliances and stocks.

Once the market crashed, the money supply began to shrink, Hoover raised taxes in a futile attempt to reduce the budget deficit, Hoover enacted the smoot-hawley tariffs that started a global trade war -- protectionism rose in most every country reducing the markets for our goods and making foreign goods more expensive. Falling incomes due to rising taxes, reduced trade and reduced liquidity combined with high levels of debt to create a death spiral for too many individuals and businesses. 2001-2003 the President engineered lower tax rates. 2001-2003 Greenspan kept rates lower than ever before -- down to 1% on the Fed Funds. Debt levels in the country have doubled since 2001. We have had a booming economy -- on a global basis and our markets reached new record levels thanks to booming corporate profits (increased productivity thanks to new technologies.) Concerns about our trade deficit have led some to call for protectionism against China. Democrats constantly talk about raising taxes. Don't know for sure but would expect liquidity measures to show declines.

There are the choices -- 1987 seems the most obvious to ignore. I believe we are in a 1998 scenario -- lots of liquidity driven panic but markets will rebound quickly once it passes. 1990 is next and I don't really believe a 1929 scenario is likely simply because there are too many safety nets around now vs. then.

If that is right and 1998 is the right analogy, then the fed will likely provide liquidity at some point to stem the panic and financial stocks will soar back to levels prior to the panic. Of course the question is where are we on the decline -- 2/3 done? 3/4 done or barely half way done with our decline? if we are early in the decline then stocks have a lot further to fall before the fed would take action.