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Parallels in the History of the S&P 500 Are a Good Omen

If the price of gold is used as a reference for the Standard & Poor's 500, interesting parallels can be drawn between the Great Crash of 1929 and the dot-com crisis of the year 2000. This article looks at what can be learned from history and what this means for the future. An analysis.

International financial market developments are sometimes obscured by the “nominal illusion” created by fluctuations in exchange rates. For example, measured in US dollars, the S&P 500 Index has gained about 21% this year. However, measured in Swiss francs, the increase was only about 17%, and in euros, a mere 11%.

So which is right? The problem of the nominal illusion is as old as floating exchange rates. This is why many share statistics are listed in local currency and in US dollars. But is the US dollar the best common denominator for international investors? From a Swiss viewpoint, the USD has shed 20% of its value over the last ten years, and 80% over the last 50. Such figures are sobering.

Using the Price of Gold As a Reference Instead of the US Dollar

One approach to adjusting stock market performance for the influence of floating exchange rates is to convert to gold prices. After all, until the 1973 dissolution of the gold standard as established by the Bretton Woods agreement, international exchange rates were fixed and the US Federal Reserve Bank guaranteed all participating countries that it would trade dollars for gold at a fixed rate of USD 35 per pure ounce. Once this international standard was abandoned, exchange rates floated in a manner that often created confusion on a Babylonian scale.

So if we were to calculate share indices in gold prices, we would have an indicator that was, to a certain extent, internationally and historically comparable. This analysis was recently presented by John Authers in the Financial Times. Interestingly, from this perspective, the trend in American shares only changed direction in 2011 (not, as often cited, in 2009), after US Treasuries lost their AAA rating and the euro crisis was brought to an end by Mario Draghi’s assurance of “whatever it takes.”

development-of-the-sp500-in-the-price-of-gold

Then and now: S&P 500 performance in gold prices after the Great Depression in 1929 and since the dot-com crash in 2000

Change in the volume of gold that the S&P 500 can purchase
Sources: Bloomberg, Financial Times

Monetary Policy Led to Second Stock Market Crisis

The parallels between the two stock market patterns are striking. Just as the US market crash in 1929 was succeeded by a second recession in 1937, the dot-com crash of 2000 was followed, eight years later, by the 2008 credit crisis.

Just a coincidence? Although the historical background is obviously different in the two cases, there are subtle similarities. After 1929 – and after 2000 – an initially accommodative and then (too) restrictive monetary policy ushered in a second market crisis, eight years later – in 1937 and 2008, respectively. The first case saw the second crisis followed by 30 years of accommodative monetary policy and rising stock markets.

A Good Omen Is Revealed by Analyzing the S&P 500

In a chronological comparison, the US stock markets would now be in a position corresponding to the year 1945 or so. Then, as now, US capital market yields stood at 2.5%. In contrast to the rhetoric of the time, they remained at a low level, thanks to accommodative monetary policy, for the next 20 years, until about 1967. During this long phase of low interest rates, the S&P 500 Index rose six-fold, and the Dow Jones Index ten-fold.

Does history rhyme? If so, it would augur well for the next 20 years.