Shadow of '70s Bear Looms, but Was It Really as Bad as We Think?

Probably the best indication that the 1990s stock bull market isn't over is that Wall Street professionals spend so much of their time talking about its demise: how it might end, how much the market could fall, how long the decline could last.

It's a logical exercise, one supposes, given that stocks have been moving mostly up for six years now. This won't go on forever, and everybody knows it--or should.

But discourses about what might trigger a severe bear market, and what that bear cycle might look like, inevitably rely on history for points of reference.

And what we know of history is that it doesn't repeat itself--not exactly, anyway.

If you somehow could know that the U.S. market was headed for a 1930s-style collapse--which saw the Dow Jones industrial average peak at 381.17 in 1929, lose 89% of its value in three years, then remain below the 1929 peak until 1954--you might well decide it was time to sell some or all of your U.S. stocks.

But barring a disaster of that magnitude, many investors believe they have no compelling reason to sell now. The average bear market since 1950 has lasted eight months and slashed 28% off the typical blue-chip stock. A lot of people believe they could ride out such a decline, at least if we trust the many surveys on the subject.

Averages, however, are what you get when you mix in a lot of numbers, big and small. And just as this bull market's numbers are big in historical terms, many veteran investors fear that the next bear market will also be about big numbers--as in very big losses, stretched over a long period.

The point of reference for many of the truly worried is the bear market of 1973-74. The Arab oil embargo of October 1973--and the subsequent surge in world oil prices--took what had been a typical market decline and turned it into the worst stock collapse since the 1930s.

From its peak of 1,051.70 on Jan. 11, 1973, the Dow plunged to 577.60 by Dec. 6, 1974, a stunning loss of 45% that ruined countless fortunes, not to mention countless Wall Street careers.

For the minority of investors who were bearish even before the oil embargo set off the vicious global inflation cycle of the mid- to late 1970s, stocks' dramatic slide in 1973 and 1974 was the logical conclusion to what they viewed as a period of absurd overvaluation in the market, particularly for the era's blue-chip companies.

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Today's bears, of course, also point to overvaluation among blue-chip stocks, and see a similar comeuppance on the way. And the one bit of historical data they love to throw in the face of impressionable investors is this one: From the Dow's 1973 peak of 1,051.70, it took nearly 10 years for the index just to get back to that level.

The implication is that many stock investors didn't make a dime from 1973 until 1982, when a new bull market finally was born.

On the surface, it would seem quite plausible that stocks were dead money for 10 years. The continuing oil crisis caused inflation to soar into the double-digit range in the late 1970s, and high inflation always ravages financial assets. Inflation was only corralled after the Federal Reserve Board jacked up interest rates to the 20%-plus range in 1979 and 1980, triggering two recessions in a 24-month period.

Looking back, you wouldn't think most investors would have wanted to mess with stocks then. And people who were active in that period will probably remember that the hot investments were things like money market mutual funds (which at their peaks paid short-term yields of about 20%), oil and gas limited partnerships and, naturally, commercial and residential real estate.

For investors today, many of whom are planning to retire within five to 10 years on their spectacular stock market gains of the 1980s and '90s, it's a chilling thought to imagine their portfolios falling 45% over the next two years, then taking another eight years just to get back to even.

But here's the problem with the bears' romantic notion about the post-1974 stock market being a basket case for a decade: It just isn't true.

In fact, many investors made very good money in stocks from 1975 through 1982, even though the Dow index's performance in that period doesn't reflect it.

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First of all, consider what happened after the carnage of 1973-74: Even though oil prices stayed up, as did inflation and long-term bond yields, stocks simply got way too cheap in 1974 as panic selling set in. The result was a furious Wall Street rally in 1975 that carried into 1976, with the Dow up a total of 63% from Dec. 31, 1974, to the end of 1976.

After that, however, blue-chip shares struggled as many U.S. multinational companies' fading competitiveness with the rest of the world was worsened by the oil shock. Charles Allmon, a Maryland money manager, used to rail against blue chips of the day, saying they had turned into "blue gyps" with their lousy profits and poor stock-price performance.

But even as big-name stocks overall stagnated from 1976 to 1982, the market for smaller stocks was vibrant as investors turned to younger firms that could react much faster to changing economic conditions, including the then-growing inflation threat. In fact, rising inflation was a help to some smaller companies because it gave them significant pricing flexibility for their products.

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Whereas the Dow index fell in 1977 and 1978 and rose only slightly in 1979, the Nasdaq composite index of smaller stocks rose every year from 1975 through 1980.

If you could have purchased the entire Nasdaq market at the end of 1974, your gain by the end of 1980 would have been 238%, versus just 56% for the Dow.

What's more, even within the blue-chip universe there were plenty of stocks that did well in the late 1970s. In particular, "value" stocks--those selling for relatively low price-to-earnings ratios and boasting high dividend yields--were in demand, as blue-chip buyers favored lower-risk stocks after the debacle of 1973-74.

"The overall [big-stock] market didn't go anywhere from 1976 to 1980, but it was a great value market," recalls David Dreman, a veteran investor who heads Dreman Value Advisors in New York.

Standard & Poor's Corp.'s data show that the S&P; 500 index stocks classified as value issues substantially outperformed the index's growth issues in five of seven years between 1975 and 1981.

The point of all this isn't to downplay the losses of 1973-74. They were awful. But two lessons stand out from the 1970s market: One, that selling into a panic, as in 1974, is almost assuredly the worst thing to do--you should be buying, not selling, at that point.

And two, even if one large sector of the stock market goes out of style for an extended period, as blue chips did in the late 1970s, that doesn't mean there won't be great opportunities in other sectors. That's the reason to be diversified among big and small stocks, growth and value stocks, and foreign issues.

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Could we have a bear market different from most others in history--something more along the lines of the 1930s experience but without the Great Depression? Japan's stock market since 1989 suggests that is possible: Big-name shares crashed there in 1990 and remain off 47% from their peaks seven years later. Smaller stocks haven't done any better.

Japan's problem has been a massive asset deflation across its entire economy. As Barton Biggs, investment strategist at Morgan Stanley & Co., puts it, Japan's bull market wasn't done in by the traditional killer of "fire"--meaning higher inflation and tighter credit--but rather by "ice," which he describes as "a slumpish slowdown, falling asset prices and collapsing profits."

Could it happen here? Perhaps. But a major difference between America and Japan is that our capitalist system tends to purge problems fairly quickly--albeit with a lot of pain. Japan's tendency is to deny that a problem exists (e.g., with its banking crisis) with the result that the pain goes on and on.

Capital moves fast in America, and when the next bear market comes, that may mean a violent and rapid downturn. But it also may mean that the next bull market won't be too far behind.

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Post-Bear 1970s: A Split Market

The stock market plummeted across the board in 1973-74, the worst bear market since the 1930s. But once that carnage was over, smaller stocks as measured by the Nasdaq composite index enjoyed six straight years of gains, from 1975 through 1980, even though blue chips continued to flounder.

* Source: Securities Industry Assn.

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