Why It Is Essential to Study Market History
It was one of the exciting times in history to be an investor.
Stocks were soaring to new highs. Investors were pouring money into stocks on the idea of an improving economy. Optimism was exceptionally high. Unemployment was at historic lows. Thousands of people were becoming millionaires every day.
Investors were operating on the idea that fundamentals were strong enough to support the stock market boom. Some were even mortgaging their homes just for a piece of the market action. In fact, stocks essentially became a “sure thing.”
It sounds a lot like 2017, right?
Would you be shocked if I told you that all took place in 1929?
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At the time, rampant speculation sent the Dow Jones up 300% between 1923 and 1929. Traders and investors believed stocks could only go up. Such speculation forced stocks to unbelievable highs with unjustifiable valuation. Then, it all fell apart.
Between 1929 and 1932, the Dow Jones lost 86% of its value.
Eighty-eight years later, we’re right back where we started.
Stocks were soaring to new highs in May 2017. Investors were pouring billions into stocks on an idea of an improving economy. Optimism was exceptionally higher. Unemployment was at historic lows. And up to 1,500 people are becoming millionaires each day. Just like 1929.
By knowing this information about the past, we can prepare for the future.
All we’re doing is drawing parallels to the past for an understanding of what could happen. Neither fundamental or technical analysis is a crystal ball, but both offer us insight into the future based on previous events.
In May 2017, markets were severely overvalued, just as we saw in 1929.
In fact, at 29.3, the Shiller P/E ratio – which examines company valuations over 10 years and adjusts for inflation – is the highest it’s been since he 2000 and 1929 crashes.
In May 2017, market optimism skyrocketed, just as it did in 1929.
In fact, according to the Yale University Stock Market Confidence Index in early 2017, more than 90% of investors believe the market could run higher over the next 12 months.
We can draw technical parallels as well. Unfortunately, many are ignoring it. Just as we’re seeing right now in the markets, there were warning signs that markets overheated a month prior to the sell-off. Relative strength (RSI) was above its 70-line. Money Flow spiked well above its 80-line. We’re seeing the exact same thing now.
Granted, it’s impossible to predict disasters of the future, but the past does give us clues.