October may not be the cruelest month for investors -- based on the averages, that's September. But when Wall Street stumbles at this point of the year, it stumbles extra hard. And that's why Alison Southwick and Robert Brokamp picked October for a four-part series on the history of market crashes in the United States.
In this podcast, guest and former Fool Morgan Housel leads the discussion as they reflect on two major economic tumbles: the long downturn of the 1970s and 1987's Black Monday. If you're looking for root causes of those downturns, you need to go back three or four decades, to the U.S. policies that helped us escape a massive depression as we headed out of World War II. The Fed kept interest rates extremely low; and Washington loosened up credit and generally did everything it could to turn soldiers into consumers. Those policies solved the problem for the 1940s, 1950s, and 1960s. But then complacency, the law of unintended consequences, and inflation came into play simultaneously.
A full transcript follows the video.
This video was recorded on Oct. 10, 2017.
Alison Southwick: Today we're going to tackle two market declines: the energy crisis of the '70s and Black Monday in the '80s, and our tour guide in this journey through tough economic times is Morgan Housel. He's a partner at the Collaborative Fund. Hi, Morgan!
Morgan Housel: Hi, guys!
Southwick: Thanks for coming back! Again.
Housel: Thanks for inviting me back.
Southwick: We always are happy to have you back.
Robert Brokamp: Always a pleasure.
Southwick: So last week we talked about the Great Depression, and now we're taking a big jump to the '70s. We're all wearing polyester and sweating, or freezing, because there is no in between in polyester. We're also waiting in line to fill up our Buick LeSabres. Despite disco, the '70s don't sound like a whole lot of fun. I mean, people made pets out of rocks. That's just sad!
Housel: And Bro still drives a Buick LeSabre. Interesting fact.
Brokamp: That's not true, but I do still have my pet rocks. Thank you very much.
Southwick: All right, Morgan, take me back to the '70s. This is going to get really geopolitical-heavy, right?
Housel: Yeah. And when talking about the market in the '70s, I think you have to take it back a little bit further and start right at the end of World War II in 1945. Two really important things happened in 1945 that kind of paved the way for what happened in the '70s, and they're sort of interconnected.
One was at the end of World War II. It was indisputable among every economist, every policymaker, that at the end of World War II, once all the wartime spending contracted, the economy was going to go right back into the Great Depression. And World War II is what pulled us out of the Great Depression in the '30s, and it was assumed by everybody that as soon as that ended, boom, right back into it.
And this really freaked out policymakers, especially because you had 13 million U.S. troops that were being demobilized, were going to come home with no job, into Great Depression II. So this was a really big deal for Truman and for all the policymakers at the time.
And then to add on top of that, because of World War II the federal government had a massive amount of debt that they built up to pay for World War II, far more than we've had since. Far more than we have today. So this was a really big deal. "How are we going to deal with this? Maybe this is going to be worse than the Great Depression, because now we have all this debt."
So they did two things. One is the Federal Reserve, which was much more politicized back then than it is now, they said, "No worries. We'll keep interest rates at 0%. You're the federal government. You have all this debt. If interest rates shoot up, you won't be able to pay for it, so we'll keep interest rates at 0%. Guys, don't worry about it. We got you." That was one thing.
The other thing that they did at the federal government level for all the troops coming home, they really made an effort to say, "We've got to make sure that these people have jobs and that they turn into consumers. What can we do for them?" There was a lot that went on with the GI Bill and other works programs. But two other things that they did -- they loosened the restrictions on getting a mortgage and consumer credit to turn people into consumers so they could start buying stuff.
Both those things worked. Both those things worked really well. The federal government kept control of its debt in the 1950s and 1960s, and the debt that was accumulated from World War II got pared down over time. It wasn't that big of a deal. And also, particularly in the '50s and '60s, the U.S. economy was great, because consumers were buying homes. They were buying refrigerators. And because Japan and Germany, at the time, were literally in rubble, the U.S. kind of had a monopoly on the world economy, more or less.
So the '50s and '60s were this huge boom time where everything went right in the U.S. economy.
Southwick: It sounds like the lesson is there's no problem that you can't spend your way out of.
Housel: That's actually a good point to make, because that amount of spending worked really well in the '50s and '60s for various reasons. One, as I mentioned before, is because a lot of the developed world, particularly Japan and Europe, were just trying to rebuild themselves. It worked that we could spend all this money, because we had a monopoly on global manufacturing. Even though we're spending all this money, we had the capacity to build it. We also built up manufacturing so much during the war to build tanks and airplanes and whatnot that we had all this manufacturing capacity to build cars, and refrigerators, and washing machines.
So it really wasn't that much of a problem with interest rates low and having that much debt. It just kind of worked. And I think that set up a sense of complacency among policymakers, at the Fed, and at the president level, at the Treasury level, and among consumers that, A, you know, monetary policy and fiscal policy for the government didn't matter that much. We've got this down. We haven't really had any big consequences from it for a long time. So you just get complacent from it.
And U.S. consumers, too, I think, really got complacent with the lifestyle that they were living, that the U.S. would kind of own the world economy, that interest rates were going to stay low, that there was always going to be a good-paying job right down the street. And so those two senses of complacency kind of cracked in the late '60s and early '70s.
A lot of it started when spending for Vietnam came along, and then wartime spending had to jump back up again. But interest rates were still low, and because the rest of the world economy was kind of coming back online from World War II, a lot of that spending and debt that was being taken out for Vietnam started to trigger inflation, which the U.S. really hadn't experienced at all since the 1920s, so it had been half a century at this point since you dealt with inflation, which set up a lot of complacency. It's just a long way of saying inflation really started picking up in the early 1970s, and that has all kinds of impacts on all kinds of investments in the stock market.
Southwick: Yeah, this is, when we were talking about planning for this series, this is the longest span between episodes in time, right?
Housel: Yeah.
Southwick: So we had the Great Depression, and then fast-forward 30 years later. That is the sound of nothing fast-forwarded. It sounds like it worked for a really long time until it didn't. When are we going to start talking about energy, because I thought this was about energy?
Housel: Yeah, that's one of the big things.
Southwick: Because we bought big cars? That's it.
Housel: That's a really great point. As oil prices started rising in the 1970s, it had a huge impact on the U.S. economy, more so than it would today or it did in 2008, the last time that oil prices spiked. Energy efficiency in the 1970s was awful. Your average car was getting 7 miles per gallon, and semi-trucks were getting 3 miles per gallon. It was just so inefficient.
And when oil was cheap in the '50s and '60s, when the U.S. just owned the world economically, it wasn't that big of a deal because oil was cheap and it didn't matter. But as you get into the '70s and oil prices started rising and then oil prices doubled and then tripled, it had a far bigger impact on the economy than it would today, just because oil as a share of most people's spending was much higher back then than it is today. Even when oil prices doubled in 2008, the share of most people's income that went to gas was still a fraction of what it was in the 1970s, so it just had a much bigger impact on the economy back then.
And also, because we had been, at this point, 30 or even 40 years since the economy was in really bad shape during the 1930s and the Great Depression, you get not only complacency but just a sense of shock among consumers who have never seen a really bad economy. And I think it causes a lot of retrenchment both for companies that say, "Whoa, maybe we shouldn't hire as many people because we don't know what's going to happen next," and among consumers who start forming a mentality that, "I don't know if my job is going to be here next month, so we should slash our spending this month."
And, you know, then you have high inflation coming in from the energy markets, which was a lot of geopolitical instability in the Middle East, Egypt, and Iran. Then you mix that with a lingering recession in the United States, and it all came to a head in the mid-1970s, with both recessions and a pretty bad market crash.
Brokamp: Just to put some numbers on it, when you look at the '70s as a decade, U.S. large-cap stocks averaged 6% a year. That's significantly below the 10% you always hear about. But on top of that, inflation was 7.5% a year, so even though your portfolio was growing on a nominal basis, you were losing purchasing power each and every year.
Housel: And that was not only true for the stock market, but especially true for Treasury bonds, which back then and today are seen as the safest asset, or even a riskless asset. If you invest in Treasury bonds, there's no risk involved in that. But during this period from like the late 1950s to the early 1980s, let's say, Treasury bonds lost so much money to inflation that if you invested in Treasury bonds in the late '50s, by the early 1980s you had lost half your money in real terms, adjusted for inflation. And that's, I think, really easy for investors to overlook, because they often don't subtract inflation from their investments at the end of the year to really get a sense of how much wealth did I actually gain this year? It had a huge impact on investing during this period.
And then the other thing is that as this feeds into the stock market, stocks compete with other assets for returns. It's just a big competition among stocks and bonds and real estate of what asset class is offering the best returns, and that's where investors are going to put their money. So as interest rates start rising, they become more attractive relative to stocks. And because of that, when you have a period where, now that interest rates are rising in the '70s, so that you can buy government bonds that yield 7%, 8%, 10%, now stocks look way less attractive because you can earn a 10% return in bonds.
So stock prices needed to fall, and fall a lot, just to make up the parity by comparison with bonds. And so that's what really dragged stock prices down in the 1970s, was the fact that bonds got way more attractive because interest rates were rising.
Southwick: It was a slow drag, right? There wasn't a major market crash. We're going to talk about Black Monday here, later. Or was there a major market crash?
Housel: Not the one-day crashes that happened in 1929 or in 1987, but 1974 was a really bad year for stocks. You had some bad years, but no overnight crashes like the other periods. But it was bad year after bad year. And in the 1970s there were a couple of really good years. It was a period of pinballing back and forth. You had years where the market would be down 40% one year and then up 30% the next year and then down 20% the next year. The 1970s was a pretty chaotic time all around, and then on top of those returns or lack thereof you had...
Southwick: Disco...
Housel: ...not only high but rising inflation.
Brokamp: Disco!
Housel: I mean, come on.
Brokamp: Which is awesome, by the way.
Housel: Can you imagine seeing your portfolio and then going home to disco? I don't know how people did it.
Southwick: Just one day at a time.
Housel: Just a time to shrug through.
