On this day in economic and business history...
The Dow Jones Industrial Average (^DJI 0.13%) closed at 381.17 points on Sept. 3, 1929. It was the last day of the greatest uninterrupted bull market the United States has ever seen. Most popular accounts take one of two perspectives to explain the 500% rise in America's most closely watched market index over the span of eight years. One focuses on the technological innovations, and deservedly so. The other points out that financial innovation went too far, too fast, creating too great an imbalance in the distribution of America's new prosperity. This criticism is also well-deserved.
We'll examine both today, touching first on the rapid advances in technology that drove America forward, and later examining in detail the schemes and dreams that brought about a market crash unmatched in history. You might find a few eerie parallels to recent events, but it's important to remember that each economic cycle is unique, even if some themes crop up more than once. History doesn't repeat itself, but it does rhyme.
Manufacturing a boom
Certainly there were sound fundamental reasons for stocks to rise for so many years in the 1920s, as many "wise men" reiterated during the market's mad dash to the end in 1928 and 1929. The flood of new technological products into the marketplace during this time was unprecedented in American history, and at the same time, Americans were becoming more productive than ever before.
A rising tide of productivity seemingly lifted all boats in the Roaring '20s. Annual total-factor productivity growth (attributed to new technologies and processes), as calculated by Robert Shackleton of the Congressional Budget Office, advanced 3% per year throughout the 1920s, which is roughly triple the annual growth seen in the 1990s. Shackleton's figures show that the 1920s experienced a higher rate of growth than any other period of American industrial history. Other analyses have similar findings: J.W. Kendrick found that total-factor productivity in the manufacturing sector grew by 5.3% per year during the Roaring '20s -- more than twice the rate of any other major industrial period in American history. Real GDP thus advanced farther during the '20s than it did during the dot-com decade, even though the average nonfarm employee of the 1920s actually worked slightly fewer hours at the peak of the boom than in the early '20s.
Automobiles, which had been a niche product during the first decade of the 20th century, had 619,000 recorded registrations nationwide in 1911. Registrations rose to 9.2 million in 1921, and from there to 23.1 million registrations at the end of 1929. With trucks included, the total rises to 26.7 million registered vehicles on American roads at the peak of the boom. Ford (F -0.90%) had such an outsized impact on the nation's manufacturing productivity that its 1927 factory shutdown -- which allowed it to finally convert its assembly lines from the venerable Model T to a fresher design -- caused measures of American industrial productivity to drop, briefly stoking fears of a recession.
Because Ford remained a privately held corporation until 1956, it fell to General Motors (GM 1.23%) to carry the torch for investors during the Roaring '20s, and it performed its task admirably. GM shares began the bull market in August of 1921 priced at $9.63. By August of 1925, the company had become part of the Dow, and its shares had risen to $22.25 apiece. In 1928, GM surged from $68 in April to $97.94 at the end of the year, when the market finally caught its breath.
In 1929 General Motors became a stock of the people, to the extent possible in those days. A stock split at the start of that year (prices are calculated based on the combined value of all shares resulting from stock splits) drove aggregate ownership in GM shares to a record-breaking 82,415 shareholders by mid-March. The company was then worth $3.9 billion, and a single share bought at the start of the bull market was worth $111.25. GM finally closed the last day of the bull market, Sept. 3, 1929, with a share price of $89.85. Shareholders who had purchased in 1921 had earned returns of 833%, or 32.2% per year. GM continued to pay hefty dividends throughout this period -- its 1925 dividend yield was nearly 12%, and its 1929 dividend yield remained at 5% even on Sept. 3.
The company began the bull market with sales of 215,000 cars and earnings of $13.3 million before taxes and interest (but an ultimate net loss of $45 million) for the 1921 fiscal year. In 1929, GM reported net earnings of $248.3 million on sales of 1.9 million automobiles -- a 765% increase in production that led to earnings growth of 1,750%. General Motors, if anything, deserved more share-price growth than it enjoyed during the Roaring '20s.
The first tech bubble
Manufacturing was aided enormously by the electrification of the country, and electricity use more than doubled during this decade. In 1920, 35% of American homes were wired for electricity. By 1929, 68% of the nation's homes were electrified, and these homes used 117 billion kilowatt-hours of electricity, up from just 52 billion kilowatt-hours a decade earlier.
The spread of electricity also enabled the spread of an incredible range of new electrically powered devices. Anyone familiar with a more recent "tech bubble" knows what came next: Interest in the next big thing quickly outpaced the corporate fundamentals of leading "technology" enterprises.
Radio was the hot new connective technology of the age, and like the Internet decades later, it also became the pre-eminent speculative investment of the 1920s. At the start of the bull market there were only five radio stations operating in the entire country, and the number of listeners likely numbered in the thousands. By the end of 1929 an astounding 606 stations were broadcasting across the country. Americans spent more than $840 million on radio equipment to listen in that year -- 14 times the amount spent in 1922 -- and the barely formed broadcast advertising industry spent $27 million to reach them.
Radio -- or, more specifically, the Radio Corporation of America -- was, in the words of John Kenneth Galbraith, "the speculative symbol of the time." Often referred to in shorthand as simply "Radio" due to its dominant technological position, RCA began as an offshoot of General Electric (GE 0.30%) in 1919 following the seizure of key patents from foreign interests during World War I. At the beginning of the bull market, its stock traded at $1.63 -- so far into penny-stock territory that it only traded on the curb exchange, and thinly at that: Only 500 shares of RCA sold on the first day of the bull market.
By the end of 1925, RCA was already valued at $42.25 per share. The company reported earnings of $2.8 million for that year, or $1.26 per share -- good for a P/E of 33.5, which was well into bubble territory at a time when the larger industrial stocks traded at P/Es of about 10. By the peak of the bubble on Sept. 3, 1929, one share of RCA was worth $490.65. This was good enough for a P/E of 41.6 based on earnings of $11.80 per share for the 1928 fiscal year. RCA, unlike many of its notable peers, did not pay any dividends during this time. Shareholders ought not have minded too much, as they earned a total return of 30,000% on RCA shares purchased at the start of the bull market.
General Electric also participated in the boom. It stood at the heart of America's electrical expansion, manufacturing both consumer gadgets and the turbines many utilities used to power the nation. It was also one of eight Dow components to remain on the index throughout the Roaring '20s, and it was arguably the most closely watched of those components outside of U.S. Steel. At the start of the boom, GE's shares were worth $112 apiece, and the company would later report net income of $28.2 million for the 1921 fiscal year. In 1929 the company reported net income of $67.3 million, equal to $35.88 per share. Shares were worth $1,564 on Sept. 3, 1929, so General Electric wound up with an even higher P/E than its spinoff despite posting total share-price growth (before dividends) of only 1,300% during the Roaring '20s.
Leader of the free world
One final factor gave the Roaring '20s a rationale for long-term sustainability. The U.S. was unique among the world's major economies in that it was never seriously affected by a World War. The devastation wrought upon Germany and Japan after World War II is well-known, but less remembered is the long-term damage left behind by World War I.
Losing nations were saddled with punitive reparations, and victorious nations still had to contend with the loss of millions of prime-age workers just as industrialization kicked into high gear in the U.S. The interconnected European economies all tended to suffer together. As a result, the U.S. alone, with its largely intact workforce and ample natural resources, was able to press toward new economic highs.
Bryan Taylor, writing for Global Financial Data, found that only four major European markets reached all-time highs within five years of the United States' 1929 peak. Many suffered worse declines for longer periods of time than the Dow -- Germany's market peaked in real terms near the end of World War I and did not recover until 1951. Poland never recovered from a 1923 peak; after the Second World War, Soviet occupiers simply shuttered the exchange. As the U.S. was the last, best hope to make a decent return for many international investors, billions of dollars of gold and other assets flowed into American banks for investment purposes. This was ultimately one of several key factors behind the market's collapse, as you'll see in the second part of this series.
How will this end?
The Roaring '20s had all the elements of a great technology-driven economic expansion. Up to the fifth anniversary of that decade's great bear market, the Dow increased at a brisk but not astounding rate of 21.8% per year. This is an enviable growth rate, to be sure, but in more than a century in operation, the Dow has posted better annual returns on 25 occasions, five of which occurred before the start of the 1920s bull market. However, real earnings grew even faster. Over the first five years of the bull market, the 500 largest stocks on the market combined to produce annual real earnings growth of 22.4%! Until this point, investor exuberance might have been running high, but it was hardly irrational.
The end, as is often the case, experiences the frenzy. In the last three years before the peak of Sept. 3, 1929, the Dow grew at an annualized rate of 30.5%. The bull market's accelerating growth is also reflected in the marketwide cyclically adjusted P/E ratio. This long-term measurement of valuation increased by 140% in the bull market's first half-decade but went on to grow by another 160% in its final three years. Real earnings growth slowed down dramatically, and in the last three years of the bull market the nation's 500 largest public companies grew their earnings at a far tamer rate of 7.9% per year.
Why did gains accelerate in the later years of the boom, even as growth began to taper off? Why did the merry-go-round screech to such a sudden and catastrophic stop in October of 1929? Click here to read part two of our look at the Roaring '20s and the Crash of 1929.