The Dow Panic of 1907 and the 2008 Financial Crisis

Note from dshort: This morning I received a request to update a chart set from an article I posted nearly two years ago. The request comes from a student in an online course covering the staggering expanse of world history since 1300. Apparently the Financial Panic of 1907 was an included topic.

The charts illustrate the dramatic market behavior during the Panic of 1907 and the Financial Crisis of 2008. A century separated these two momentous market episodes, and the underlying causes were quite different. However, the overall volatility and general patterns of decline and rally were remarkably similar. In response to the request, I've now updated the charts through yesterday's close.

The first chart is a nominal view of the two periods showing the percentage declines over time from their peaks in 1906 and 2007.

Now let's adjust for inflation, which had a significant impact on the earlier period. During the first half of the 20th century, episodes of high inflation and deflation were commonplace. See this chart for an illustration of those early inflationary/deflationary cycles.

Was the 1907 low the historic bottom for the Dow? Unfortunately, no. The secular bottom occurred nearly 15 years later — a year after Germany signed an armistice with the Allies to mark the official end of World War One.

Both periods involved a financial crisis. The pre-Federal Reserve 1907 Bankers' Panic was dampened by a bailout of the system by J. P. Morgan, who put up his own money, and persuaded other New York bankers to do likewise. The Federal Reserve has introduced a number of tactics to shore up the modern banking system. Naturally there are many differences between the two eras. But one inference we can make from the earlier period is that secular bear markets can last for very long periods of time.

In fact, when did the real Dow permanently regain the 1906 high? In September 1985 — a few months shy of 80 years later.

Of course, investors had many opportunities to create wealth in the market over those eight decades. The bottom in 1921 was followed by the Roaring Twenties. And even during the Great Depression, dividends in the vicinity of 5% were coveted source of income. A few years after World War II, the secular bull market that began at mid-century would provide a sound opportunity for wealth creation.

Bottom line: Bear markets run their course and the Bull eventually returns. But history tells that, especially during those secular declines, patience and risk management are definite virtues.