Special Report:
A Sneak Peek at the Next Bear Market in Stocks
Seventh-Year Panics
If you can keep your head while all about you are losing theirs, maybe it’s not the 7 th year. With the possible exception of 1929, years ending in “7” have traditionally served up the biggest stock market disasters.
1837: A real estate boom, fueled by an aggressive expansion of credit, ended in disaster. Leveraged speculators eagerly snapped up (mostly Western) land sold by the government, and found bankers all too willing to accommodate them. Public land sales zoomed from 4.7 million acres in 1834 to 20 million acres in 1836. Receipts were deposited in state banks, fueling aggressive expansion of credit and currency and an explosion in canal building.
By the time stocks topped in 1835, New York Stock Exchange volume averaged 8500 shares a day, up 50-fold in 7 years. Today, we’re again witnessing great optimism about the future of the exchange. When the NYSE finally went public on March 8, 2006, jubilant investors quickly bid up its shares by 25%.
In the 1830s, American prosperity and inflation resulted in record trade deficits, yet inflows of speculative capital from sales of securities in Europe were so great that the U.S. actually imported 4 times as much gold as it exported between 1834 and 1837. The money from overseas financed domestic railroad and canal building. Similarly, in 2005, the U.S. trade deficit rose 17.5% to an all-time high, but foreigners spent record sums (over $1 trillion) buying our stocks and bonds. By July 21, 1836, the drain in British reserves prompted a clampdown. The Bank of England initially hiked its rediscount rate to 4.5%, before ratcheting it up to a full 5% a few weeks later. The upsurge in British rates combined with U.S. inflation to draw funds away from securities. This year, in March 2006, the Bank of Japan announced the end to its 5-year era of super-easy monetary policy just days after the European Central Bank raised rates a quarter-point and left the markets expecting further increases when it revised its growth and inflation forecasts higher.
By the time President Van Buren took office in March 1837, currency shortages plagued the nation, with New Orleans banks in especially deep trouble. When some banks admitted their inability to honor drafts, the panic spread to Wall Street. Financial problems in London compounded the crisis. Between March 1 and April 10, 1837, stock in former highflier Morris Canal plunged 54%, from 96 to 44. By May 10, with runs a daily occurrence, all New York banks suspended operations. By early fall of 1837, 90% of eastern factories closed. Despite a temporary reprieve in 1838, the depression worsened over the next several years. Morris Canal went bust. Banks, which had accepted overvalued land as collateral for loans used to buy yet more real estate, took it on the chin. United States Bank shares, which hadn’t traded below 100 for 20 years, collapsed from 122 in 1837 to 4 in November 1841.
Although Merrill Lynch calculates that the housing market accounted for 55% of economic growth in 2005, new Federal Reserve chairman Ben Bernanke doesn’t regard the alleged real estate bubble as a threat. In his first semiannual monetary policy testimony before congress on February 15, 2006, Bernanke opined that housing activity will moderate, but remains consistent with solid overall economic growth. Meanwhile, the National Association of Realtors (NAR) reported that the median price of single-family homes fell more than 4%, from $219,700 in July 2005 to $210,500 in January, and the Commerce Department announced a record backlog of unsold new homes. The NAR predicts that sales of new and existing homes will decline in 2006 for the first time in 5 years. Home construction shares have failed to participate in the latest upturn in stocks, losing 41% in the last year, with Hovnavian Enterprises down 58% and leading luxury homebuilder Toll Brothers off more than 51%.
The financial storm of 1837-42 led to more lenient bankruptcy provisions and passage of a federal bankruptcy law wiping out $450 million worth of debts. So it’s perhaps worth noting that congress moved to tighten bankruptcy laws in April 2005. The more stringent regulations could require homeowners filing bankruptcy to sell their homes in certain cases.
1857: In 1848, booming grain exports fueled by poor harvests and revolutions in Europe combined with the Californian Gold Rush to make America a rich country. The good times rolled well into the 1850s. From 1847 to 1853, U.S. gold production skyrocketed over 7,000%. Without planes and automobiles, you needed trains to get to California. Domestic railroad building grew to rival that of all other countries combined. Powerful demand from the railroad and agricultural equipment industries caused pig iron prices to soar. Iron and railroad creation required increased coal production, further stimulating the need for railroads and mining equipment. Britain and France forgot all about the problems of a decade or more earlier and poured money into America’s rail boom. Foreign investment reached a high in 1853. The familiar ingredients of commodity price inflation, exploding energy demand, strength in industrial metals, a robust bull market in transportation stocks and excess foreign investment were in place.
Europe’s deficit spending to finance its wars sparked a sharp rise in interest rates and diverted investment funds into European bonds. Capital transfers to the U.S. slid 80% from 1853 to 1856. In 1857, grain prices and exports plunged amid record harvests and falling demand in Europe as the end of the Crimean War reopened world markets to Russia. Some railroads defaulted. As the situation worsened, Irish street gangs – their ranks swelled by heavy emigration to the U.S. in the 1840s – rioted in New York in July. The August 24 failure of the New York branch of the Ohio Life Insurance & Trust Co., which specialized in placing foreign funds in U.S. land and railroad investments, battered the market, causing the prices of most stocks to fall between 3% and 7% the next day. Mounting failures claimed legendary speculator Jacob Little on August 27 – not because he bet wrong, but because his debtors couldn’t deliver money and securities they owed him. Lest you think that such counterparty risk is a thing of the past, modern investment icon Warren Buffet, in a 2003 letter to shareholders, referred to the massive and mostly arcane derivatives markets as potential “financial weapons of mass destruction.”
The September 12 sinking of the steamer SS Central America in a hurricane off Cape Hatteras while carrying 30,000 lbs. of gold bound for eastern banks stirred up a fresh wave of panic and bank runs. Treasury Secretary Howell Cobb temporarily sought to restore confidence by using gold to repurchase state bonds, but a spate of redemptions depleted gold supplies and forced him to stop on October 13, 1857. The news ignited a tremendous panic, quickly causing New York banks to suspend gold payments and leading banks nationwide to follow suit. The shocks reverberated all the way to the major European bourses, where a third of all foreign securities traded were American. The Bank of England’s money rate jumped an unprecedented 3% in less than a month by October 8. The crisis hit Paris even harder and spread to exchanges in Central Europe in what is generally considered the first international financial panic. Railroad stocks in the U.S. plunged over 25% in October alone. By the time the carnage abated, Erie Railroad had plummeted to 11 from an 1857 high of 62, Michigan Central dropped from 96 to 40, and Reading Railroad fell from 81 to 30.
1907: The stock market, which topped in January 1906, actually held up pretty well for the rest of that year. However, the Bank of England started raising rates in December 1906, and the DJIA soon began to slide, losing 8.3% in one day on March 14, 1907, still the 7 th-greatest single-day percentage decline. When Judge Kenesaw Landis, later appointed commissioner of baseball in the aftermath of the 1919 Black Sox scandal, fined Indiana Standard $29 million for illegal rebates in early August, he sent Wall Street’s bulls to an early shower. The Dow got battered another 32% until the November 15 final low. Along the way, New York City endured perhaps its worst banking panic in 50 years. Trust companies, which competed against the more heavily regulated banking industry, had also enjoyed faster growth than the banks. On Friday, October 18, 1907, Charles Barney, president of Knickerbocker Trust, the 3 rd largest trust in New York, was reported to have been involved in a failed corner of United Copper shares, in which the mining company stock fell from 84 to 10 in a day. The following Monday, National Bank of Commerce announced it would stop clearing checks for Knickerbocker. The ensuing run on Tuesday, October 22 put the trust out of business. Runs commenced on other big trusts, threatening banks too because of trusts’ sudden need to liquidate stock-collateralized call loans, which imperiled the assets of banks involved in call money lending. Call money rates briefly soared as high as 125%. A consortium of bankers organized by J.P. Morgan saved the day by extending enough credit to the beleaguered institutions. The close call to the nation’s financial system spurred the government to create the Federal Reserve in 1913 to act as a lender of last resort. The 37.7% Dow decline for all of 1907 still ranks as the 2 nd worst in any calendar year. As in most crashes, the bigger of a success a stock was in the preceding bull market, the harder it fell. Copper giant Anaconda got strangled from 76 all the way down to 25. Amalgamated copper fell from 122 to 42, and U.S. Steel dropped from 50 to 22.
1917: Stock prices sank over 7% on February 1, after Germany warned that it would begin attacking neutral merchant ships in a blockade of the Allies. World War I caused raging inflation, and the U.S. government passed an excess profits tax (as some lawmakers now wish to impose on the oil industry), imposed price controls on steel and seized control of domestic railroads in December 1917. The Bolsheviks took charge in Russia. Shares of former bull market star Bethlehem Steel melted down over 70%. The Dow lost 40% in the bear market, more than it did in the crash of 1987 or in the entire 2000-2002 decline.
1937: Severe credit tightening by the Fed undermined industrial production, which fell faster than during the Great Depression in 1929-33. In an autumn crash, the S&P plunged over 9% on October 18. The Dow got hammered for a 34% loss in a span of less than 3 weeks. By the end of March 1938, the S&P was down nearly 55% in little over a year. Steel stocks were again big winners late in the bull market, only to lose 60% to 80% or even more in some cases in the ensuing bear.
1957: Not a true panic, but although the bear market lasted over a year, virtually all the selling was concentrated in a relatively brief July-October window in 1957 after the Dow triple topped. Numerous formerly highflying metals stocks got whacked for losses of around 50% or higher.
1987: New Federal Reserve Chairman Alan Greenspan replaced legendary Paul Volcker in August 1987 and wasted no time hiking the discount rate on September 4. Now Greenspan is the legend, and Ben Bernanke replaced him this year and began hiking rates. Flashing shades of 1937, the DJIA lost 34% in 2 weeks starting in early October 1987. A whopping monthly trade deficit report and a second raise in the prime rate jumpstarted the rout. On Monday, October 19, 1987, the Dow got slammed for a surreal 22.6% single-day loss, by far its largest ever. The industrial giants of the Dow 30 were among the few stocks anyone could reliably sell, as market makers in over-the-counter issues simply stopped picking up their phones. The next day, things got so bad the authorities came within a hair of shutting down the market before the Dow reversed to close over 6% higher. With liquidity restored, however, the NASDAQ got socked for a record one-day loss as anxious sellers were finally able to unload their positions.
Time to Prepare Yourself
Now that you’ve seen how recurring decennial cycles impact the market and promise to mark the current period as a calm before the storm, can you afford not to prepare? All of the key warning signs that presaged past 6 th-year tops and 7 th-year panics – especially after bull markets originating in the 2 nd year of a decade – are present to an almost absurd degree.
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The more things change, the more they stay the same:
Bull Markets Originating From Second-Year Lows
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James Flanagan,
President and founder of
Gann Global Financial
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