The Last December Crash: 1899

November 29, 2015

More and more market analysts and commentators are observing that December may well prove to be a make-or-break month for the market. The S&P 500 has almost ground to a halt as we finish November, spending the last six trading days in the extremely tight range of 2080-2090. But this coming week we have the European Central Bank meeting, the OPEC meeting, and the November jobs report, all of which sets the table for the highly anticipated Fed decision on interest rates on December 16. One way or another, investors in the sideways market of 2015 will have big decisions to make over the course of the next 30 days.

As is clear from all of the material on this blog, Dr. Strangemarket believes the US economy is in much, much weaker shape than the prevailing mainstream opinion on Wall Street believes. So the expectation here is that negative economic data, whether in the jobs report, weak holiday retail sales, or something else, will sour investor sentiment and drive the stock market significantly downward in December, probably before the Fed decision.

December is not a month that is usually associated with stock market crashes. Almost all of the most famous stock market crashes have happened in October: in 2008, 1987, 1929, and even 1907. December is traditionally a good month for stocks on average, and it is often associated with a feel-good "Santa Claus rally" leading into the holiday period at the end of the month.

So Dr. Strangemarket would like to give readers an overview of the last time a big crash shook up the stock market in December: 1899.

The Economy in the Late 1890s

The financial markets of the 19th century get little attention today. It has become common to compare the financial crisis of 2008 to the stock market crash of 1929, the Panic of 1907 is a fairly well-known historical example among knowledgeable investors and traders, and many long-term historical charts go back to 1900. But it's not so easy to find charts, examples, and comparisons that go back before 1900.

Sure, people have heard of the Panics of 1873 and 1893, and may know some of the history around them, but how much did the stock market crash in those years? Indices like the Dow Jones Industrial Average didn't even exist in the 1870s, and from 1885 to 1896 there was just the "Dow Jones Average". You won't find many stock market charts that go back to 1893.

And yet, the end of the 1890s and the turn of the 20th century is a period that has a number of similarities to financial conditions today, and it may hold valuable lessons that help explain what is going on in the economy and the market in 2015 and going forward.

Above all, the end of the 1890s represented the culmination and conclusion of a prolonged period of deflation and falling interest rates that had lasted decades since the end of the American Civil War in 1865. Compared to 1865 prices in the United States, prices were 33% lower in 1875, 41% lower in 1885, and 48% lower in 1895. This deflation bottomed out in 1897-1899 at 49% lower prices than 1865. 

The falling yield on the 10-year US treasury bond from the 1860s through the 1890s confirmed this long deflationary trend:

Notice that the yield below 3% in the late 1890s and early 1900s was by far the lowest in history at the time. In those circumstances, the search for yield drove investors into new assets and speculative securities:

"As interest yields fell on high-quality bonds...traders produced new assets for investors who were searching for higher returns....[S]pecialized securities appeared in each exchange. Financial crises often, but not always, fell most heavily on the newest, most speculative securities." -from summary of "Deflation, the Financial Crises of the 1890s, and Stock Exchange Responses in London, New York, Paris, and Berlin" by Lance Davis, Larry Neal and Eugene White, in Deflation: Current and Historical Perspectives.

Doesn't this situation sound awfully familiar today? Of course we no longer have nominal wage and price deflation in recent times, because governments and corporations figured out that workers will not tolerate nominal and visible wage cuts. So instead we have stagnant wages, falling in real terms, and very low inflation rather than outright deflation. But the falling Treasury bond yields show us that the effect is very similar.

The US Treasury's 1899 Version of Quantitative Easing

In fact, in the fall of 1899 the US Treasury was engaged in the purchase of bonds to boost the money supply and prop up credit and stock prices, a kind of late 19th century version of the Fed's quantitative easing of recent years. Although the $25 million bond purchase on November 15, 1899 pales in comparison to the trillions of dollars of QE today, it was quite significant for its time and attracted enough attention and controversy to prompt this political cartoon to appear in the New York Herald on November 19, 1899:

In early December 1899, bills in Congress promised an additional $100 million to $500 million increase in the money supply. The bills were designed to assure bankers that credit would hold up for at least another 10-12 months. Again it sounds an awful lot like the way the markets reacted to the Fed's QE, bidding up stock prices with the confidence that the Fed had their back at least long enough to earn short-term gains, and not worrying about what will happen after that.

But the stock speculators' luck ran out after December 2, 1899. Over the next two weeks, the stock market began to decline steeply, the Dow Jones Industrial Average falling from 55.44 on December 2 to 46.77 on December 16. The downturn culminated in a panic and crash on Monday, December 18, 1899, when the Dow Jones fell all the way to 42.69.

The Stock Market Crash of December 18, 1899

If you look at a list of the largest one-day percentage declines in the history of the Dow Jones Industrial Average, after the famous October 1987 and October 1929 crashes, you will find the -11.99% crash on Monday, December 18, 1899. Yet the event is almost entirely forgotten by history. You will not find "The Panic of 1899" or a "Black Monday" of December 1899 in the history books. History records a mild recession from June 1899 to December 1900, but it receives little attention compared to the Panic of 1893, the Panic of 1907, or even the Panics of 1896 and 1901. Charles Kindleberger's classic book Manias, Panics, and Crashes: A History of Financial Crises cites 37 financial crises before 1929 in its detailed appendix, from 1618 to 1920-1921, but the list does not include the crash of December 1899.

Yet on Wall Street, December 18, 1899 was actually the biggest one-day crash in history until 1929.

And it followed dramatic all-time highs of the Dow Jones earlier in 1899: The average had previously peaked around 45 in 1890, fallen below 30 in the Panics of 1893 and 1896, but in 1899 it soared all the way to 56.61 on April 25 and 56.85 on September 5.

It is worth noting that in the middle of 1899, the Dow Jones dropped about -12.5% from its late April high down to 49.46 on May 31, made a small bounce and near re-test of the low at 50.43 on June 22, then rallied through July and August back to the level of the April high in early September. This pattern of market movement is strikingly similar to what we have seen in 2015 with the August decline of about -12.5%, a small bounce and near re-test of the August low in late September, and the strong October and early November rally almost back to the level of the previous high.

Any one similarity in market patterns can be a coincidence of course, but given the similar background of decades of deflation/disinflation, falling yields, and the search for yield driving investors into riskier assets, I argue there is a case that this is not just a coincidence. The all-time highs of the spring and fall of 1899 reflect investors rushing into the stock market to chase returns no longer available from bond yields.

The crash of December 18, 1899 was specifically precipitated by the failure of the Produce Exchange Trust Company. The New York Times article of the following day explains the situation well: <http://query.nytimes.com/mem/archive-free/pdf?res=9F0CE0DF103DE633A2575AC1A9649D94689ED7CF>. The article outlines some of the history of this trust company, which is well worth reviewing. It only came into existence in March 1898, founded by members of the New York Produce Exchange. But the company's first President, Dr. J. H. Parker, the ex-President of the United States National Bank, left the company in January 1899 because he "found his methods encroached on by the junior element in the company," according to the article, which quotes Parker:

"I did not like the new people or their ways. They wanted to do business that in my opinion was inconsistent with the capital and resources of the company. They wanted to make loans that in my opinion were too large. I thought the concern was going too rapidly, and that ultra conservatism was its best policy."

In September 1899 the Produce Exchange Trust Company withdrew from bank Clearing House privileges in order to avoid new rules about check collections. The company instead attempted to do its own nationwide check collecting. This effort to avoid Clearing House fees may be seen as a symptom of the chase for yield in a low-rate environment.

The New York Times article explains that the new rules were first adopted by the New York Clearing House Committee in April 1899 and that the initial reaction of bankers in the rest of the United States was negative. Presumably the Produce Exchange Trust Company felt this sentiment gave them an opening to avoid the new rules. But in November 1899 a committee of Clearing House officers outside of New York endorsed the new rules, and this placed a large obstacle in the way of the company's scheme to do its own nationwide check collection outside of the Clearing House rules.

When the Produce Exchange Trust Company failed on December 18, 1899, stock prices of commodity and industrial companies in particular crashed: American Sugar, American Tobacco, Continental Tobacco, Tennessee Coal & Iron, Federal Steel, Consolidated Gas, People's Gas, and railroad stocks such as Baltimore & Ohio, Great Northern, New York Central, Southern Pacific, and St. Paul.

The Aftermath: Turn from Deflation to Inflation and Extreme Market Volatility 1899-1907

Examining the long-term historical trends of prices and bond yields, December 1899 proved to represent a major turning point. From 1865-1899 deflation and falling yields predominated. Only a single year in that period, 1880, saw inflation in the US, but that was an isolated occurrence that happened after many years of much more significant deflation.

But in 1900, 2% inflation occurred, and this was the beginning of a new long-term trend. Inflation and rising bond yields now became the predominant trend from 1900-1920. There were a couple years of modest deflation in 1908-1909 in the wake of the Panic of 1907, but now they were the isolated occurrences within the dominant inflationary trend.

Along with the turn from deflation to inflation came extreme growth in market volatility. The previous chart of 1885-1899 showed how the market in 1899 was far more volatile than it was at any time in the preceding period. But a look at the chart of the Dow Jones Industrial Average in the period 1899-1907 shows how the market volatility to follow dwarfed even that of 1899:

We see lower lows in 1900 as the recession continued, a rally and crash in 1901, a far deeper crash in 1903 (a year of 4% inflation, the greatest to date at the time), followed by a stunning market rally in 1904-1905 that reached previously unheard of highs in early 1906. All of this set the stage for the famous crash in the Panic of 1907.

No one can predict the future, least of all in the financial markets, but given the striking similarities in the macroeconomic features as well as in the financial market trends between 1899 and 2015, Dr. Strangemarket would not be surprised to see the coming 5-10 year period unfold along similar lines to the 1899-1907 period.