Academic journal article National Institute Economic Review

Comparing Bear Markets - 1973 and 2000

Academic journal article National Institute Economic Review

Comparing Bear Markets - 1973 and 2000

Article excerpt

In nominal terms, the fall in global share prices since 1999/2000 bears a close resemblance to that experienced worldwide in the years following 1972/3. This article seeks to compare the two periods of market weakness in the G-7 countries in terms not only of share prices but also focusing on macroeconomic trends, financial market developments, sectoral patterns of shareholding and potential wider economic consequences of falling share prices. It is shown that the earlier period was much more severe in terms of adverse economic developments, in particular high inflation. But the current situation also presents some risks, in particular a disruptive correction of US sectoral imbalances.

Introduction

A bear market may be defined as a prolonged period of falling equity prices, usually by 20 per cent or more over several years, accompanied by widespread pessimism about future economic prospects. In this context, the widely-analysed 1987 crash does not fit the definition of a bear market, given that the falls were concentrated in a short period, and were rapidly reversed in the context of a long-term uptrend. The period since 1999/2000 corresponds much more closely to the classic definition of a bear market. Indeed, the depth of the recent bear market in equities bears close comparison with the period following 1972/3, when the oil crisis, recession and financial instability combined to create the sharpest fall in global share prices since the Great Depression and World War Two.

In this article, we compare and contrast the two periods in the G-7 countries, in the light of equity valuation theory, with the aim of elucidating the causes, features and consequences of the current situation. We focus in particular on the periods 1972-75 and 1998-2001 which incorporate the peak of share prices and the decline towards a trough, adding data for 2002 where feasible and relevant. First, we show the relative changes in nominal and real share prices before going on to macroeconomic, financial and portfolio aspects of the crises. Before concluding, we also outline recent empirical work on the causal role of equity prices in the economies of the G-7 and show trends in relevant indicators.

Share price changes during the bear periods

The data used for share prices are from MSCI 'official price indices'. In most of the article, the data exclude dividends, given the main interest is in changes in share prices per se. We focus on the G-7 countries' experience, while noting that the other OECD and emerging market countries have generally experienced similar trends.

Tables 1 and 2 provide basic information on trends in share prices during the two bear periods. Looking first at the mid-1970s period in nominal terms, it can be seen that prices in the UK and Germany peaked first, with France and Italy peaking a year later. The pivotal market, the US, peaked in December 1972, as did the world index, of which the US is the main component. Whereas the peaks were dispersed in time, the troughs were much more closely aligned, between September and December 1974 as the oil crisis and other economic and financial events took their toll. Nominal declines were sizeable in all markets, with the UK experiencing the largest fall of 68.5 per cent (also at the time of the miners' strike, power cuts and the three-day week). The rest of the G-7 was in the range 33-53 per cent, with the US, France and Italy being relatively harder hit. Recovery of nominal share prices from the 1974 trough was rapid in Germany, where it only took 18 months, and also in the UK. Elsewhere, the recovery of nomi nal values to their 1972-3 level took 6-7 years to be completed.

Of interest as these nominal declines are, they ignore the fact that inflation was high in the 1970s, as shown in table 4 below. Measuring real share prices by the change in the index divided by the national CPI, the falls in many countries were much larger than the nominal declines. …

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