The Prediction That Doomed the Dow Jones Industrial Average (^DJI)

Babson was, if anything, far too conservative. An 80-point drop at that time would have merely brought the Dow Jones Industrial Average (INDEXDJX:^DJI) down to 290 points — a 25% decline from its Sept. 3 top. That level was breached at the end of October and, after a brief rally into the spring of 1930, was not seen again until 1953. Babson’s failure to appreciate the depths to which the Dow might ultimately sink have prevented his prediction from gaining wider notoriety in later years. His annual warnings of doom also undermined his seeming prescience on this occasion; if you predict a crash every year, you’re bound to be right eventually.

Irving Fisher, proponent of the permanently high plateau, immediately refuted Babson’s dire warning. In a statement to The New York Times, Fisher said:

Stock prices are not too high and Wall Street will not experience anything in the nature of a crash. …

The present high levels of stock prices and corresponding low levels of dividend returns are due largely to two factors: one is the anticipation of large dividend returns in the immediate future and the other is the reduction of risk to the investor, largely brought about through investment diversification made possible for the investor by the investment trusts.

We are living in an age of increasing prosperity and consequent increased earning power of corporations and individuals. This is due in large measure to mass production and inventions such as the world never before has witnessed. … This is a new and tremendously powerful factor in the industrial world.

It’s worth closing on an apt observation from John Kenneth Galbraith, who would write years later in The Great Crash, 1929:

Always when markets are in trouble, the phrases are the same: ‘The economic situation is fundamentally sound’ or simply ‘The fundamentals are good.’ All who hear these words should know that something is wrong.

The article The Prediction That Doomed the Dow originally appeared on Fool.com and is written by Alex Planes.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more insight into markets, history, and technology.The Motley Fool has no position in any of the stocks mentioned.

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