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The Krugman Rally

Yesterday the stock market was in the doldrums. It opened about sixty points down on the Dow from its previous day close and drifted downward from there to be off about 130 points at 12:30. It then struggled upwards, recovering about fifty points by 3:15. At that point it shot up seventy points in a few minutes and closed up fifteen points on the day.

What happened?

According to Bloomberg News it was a speech by Paul Krugman at the London School of Economics in which he predicted the end of the recession at some point this summer.

What makes markets rise and fall in the short term can never be known for sure. But, assuming causation and not just post hoc ergo propter hoc, this is highly reminiscent — except moving in the other direction — of the famous Babson Break of September 1929.

The market had reached an all-time high on September 3rd, 1929, closing at 381.17. No one knew it at the time, obviously, but that high would not be surpassed until 1954. Then, on September 5th, a perennially pessimistic financial advisor of no great note named Roger Babson told a luncheon group in Wellesley, Massachusetts, that “I repeat what I said at this time last year and the year before, that sooner or later a crash is coming.”

This rather innocuous remark crossed the broad tape at 2:00 PM and all hell immediately broke loose on the floor of the Exchange. By the time trading ended an hour later (the market closed at three o’clock in those days) major issues had plunged five percent or more and volume in the last hour of trading was a fantastic two million shares. It proved to be the start of the great crash that climaxed seven weeks later on October 29th.

Whether the Krugman Rally will prove to be a harbinger of things to come, as the Babson Break did, only time will tell. It might be noted, however, that the Babson Break occurred at a stock-market peak and the Krugman Rally follows three months in which the market has risen by fully a third from its dismal lows in early March.

In both cases, however, it was almost certainly not the influence of Krugman and Babson that moved the market. Rather it was a case of the market wanting to move and any excuse would do.