A 1930s road map for equity markets

Massive government support following the 1932 market bottom defined most of the backbone for the economic recovery through to 1937. But when governments were forced to cut back as WWII started, the economy and stocks turned down in tandem.

It was not until the U.S. entered the war after Pearl Harbour that the US economy started to recover and the equity market jumped back. From 1927 to the peak at the end of the war, equity markets in the U.S. had no net return and lost more than 2% per year after inflation.

We believe we are about at the half way point of the current cycle that started with the peak of the tech bubble in 2000 and has been supported by artificially low interest rates and consumer and government deficit spending since Sept 2001.

We suspect that it may take another decade for debt levels relative to income to return to longer-term averages. Government support can inflate asset prices for some time, but eventually taxes will need to rise and a double dip is likely. Stock markets will likely fall considerably when this next cycle takes hold. Until then, Goldman Sachs recent forecast sees the S&P 500 going to 1,450 in 2011 and 1,600 in 2012.

Three cheers for Helicopter Ben...for now.

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