Friday, February 12, 2010

1929 to 2008: Market Oscillations

The stock market seems to be going up and down. This agrees with Ben Bernanke's "Financial Accelerator" model, which indicates that when the market starts to move, it typically overshoots where it should be and then bounces back. It is a little like the spring in the animation on the right.

If we use the "mass on a spring" model, there is a clear formula for the frequency at which the mass goes up and down. The time between up (or down) cycles is proportional to the mass on the spring (The bigger the mass, the slower it moves).

If we think of the "mass" of the market, a good measure would be Market Capitalization. I had a hard time finding this value for 1929, so I decided to use GDP instead. To convert to 2008 dollars, I divided by CPI (consumer price index) to factor out inflation.

CPISqrt(m)Ratio to 1929

What this means is that 3.4 days today is equal to 1 day in 1929 (in terms of market momentum). So here's a plot of the stock market with 1929 scaled by value (using recent market highs) and by time (using here 2.8 days). The similarity is scary.


Kevin said...

And, according to Amity Shlaes' fascinating The Forgotten Man, one of the key reasons the Great Depression was "Great" was uncertainty in gov't policy and its relentless punishing of business, which caused the "Depression within the Depression" of 1937-1940. Those who do not study history are doomed to repeat it, e.g., our current Administration and Congress...

Dalan said...

So what you're saying is that by the time I am ready to buy a house (in a couple of years) it will be the perfect time! Excellent...