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Investing during a Great Depression

Chris Farrell Sep 30, 2008

Question: How do you depression-proof your assets. My husband says there’s no way; that’s what a depression means. My grandmother who survived the Depression said to just keep working and hang onto what ever real property you can; she never has believed in stocks, bonds, or anything “that I can’t see”. Nancy, Columbus, OH

Answer: I don’t think we are going into another Great Depression. That said, it’s a question I’ve been getting more and more. The bottom line is that if we were heading into another deflationary depression the best assets to own are default-free Treasury bills and Treasury bonds, with some other very high quality fixed income securities thrown into the mix.

In my book, “Deflation: What Happens When Prices Fall”, I looked into what investments did well during the Great Depression. Here’s what I found out:

Now, mention deflation and the markets, and most people will recall the stock market crash of 1929. Stocks had been lurching lower after reaching a peak in September, and on October 29th the Dow plunged by 30%. Volume reached a record 16.4 million shares, an infamous benchmark that held for 40 years. From its 1929 peak of 381.17, the Dow Jones industrial average plunged to 41.22 in July 1932. At the end of the decade the Dow stood around the 150 mark, and equity investors had earned a mere real 1.43% from 1929 to 1939. It wasn’t until 1954 that the benchmark index passed the level it had reached before the 1929 Crash.

Like the 1990s, the stock market seemed everywhere during the go-go years of the 1920s. Yet despite colorful tales of cab drivers, bootblacks, clerks, housewives, doctors, lawyers, and other ordinary folk gambling their life savings in the stock market, historians now believe that no more than 8% of the population owned stocks, and most of those investors were well heeled. Wealthy or not, many investors lost fortunes. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn’t heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America’s greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached “a permanently high plateau.” Worse, a large part of his wealth disappeared in the crash.

Again, reminiscent of Enron, WorldCom, Global Crossing, and other current examples of corporate greed and malfeasance, the reputations of Wall Street’s leading lights were also tattered. Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife’s trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as “Sunshine Charley” and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.

Obviously, stocks did horribly during the Great Depression. But bonds did well. Interest rates and bond prices are two ends of a seesaw. When bond yields are rising (usually from investors anticipating higher inflation), bond prices go down–and vice versa. Bond prices soared as bond yields came down sharply during the depression. For instance, the prime corporate bond yield average went from 4.59% in September 1929 to 3.99% in May of 1931. By June of 1938 the average corporate bond yield fell to a new low of 2.94%. Bonds returned 6.04% during the 1930s. Short-term fixed income securities or bills returned 3.39% over the same time period. But even fixed income investors are wary of deflation since unwary creditors absorbed huge losses during the 1930s as cash-strapped corporations and municipal governments defaulted on their debts.
Two Wall Street tycoons that ended up with “pockets full of money” after the Crash were Alfred Lee Loomis and his partner and brother-in-law Landon Thorne. The two had been leading financiers for the new electric power industry in the 1920s. Loomis was also a scientist, and he became a major supporter of some of the century’s greatest scientific minds at his Tuxedo Park home. By early 1929, the two partners had liquidated all their stock holdings and put the gains into long-term Treasury bonds and cash. The reaction by their peers, so many of them forced out of business, seemed more like envy than admiration since “in the midst of so much despair, with the economic situation deteriorating day after day, Loomis and Thorne continued to profit handsomely,” writes Jennet Conant, author of the Loomis Biography Tuxedo Park: A Wall Street tycoon and the Secret Palace That Changed the Course of World War ll.

How do you depression-proof your assets.

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