cumstances, a temporary drop in dividends (or earnings) during a re-
cession should have a very minor effect on the price of a stock, which
discounts dividends into the infinite future.
When stocks are collapsing, worst-case scenarios loom large in in-
vestors’ minds. On May 6, 1932, after stocks had plummeted 85 percent
from their 1929 high, Dean Witter issued the following memo to its
clients:
There are only two premises which are tenable as to the future. Either we
are going to have chaos or else recovery. The former theory is foolish. If
chaos ensues nothing will maintain value; neither bonds nor stocks nor
bank deposits nor gold will remain valuable. Real estate will be a worth-
less asset because titles will be insecure. No policy can be based upon this
impossible contingency. Policy must therefore be predicated upon the the-
ory of recovery. The present is not the first depression; it may be the worst,
but just as surely as conditions have righted themselves in the past and
have gradually readjusted to normal, so this will again occur. The only un-
certainty is when it will occur.... I wish to say emphatically that in a few
years present prices will appear as ridiculously low as 1929 values appear
fantastically high.^15Two months later the stock market hit its all-time low and rallied
strongly. In retrospect, these words reflected great wisdom and sound
judgment about the temporary dislocations of stock prices. Yet at the
time they were uttered, investors were so disenchanted with stocks and
so filled with doom and gloom that the message fell on deaf ears. Chap-
ter 19 discusses why investors often overreact to short-term events and
fail to take the long view of the market.
THE SIGNIFICANCE OF MARKET VOLATILITY
Despite the drama of the October 1987 market collapse, there was amaz-
ingly little lasting effect on the world economy or even the financial mar-
kets. Because the 1987 episode did not augur either a further collapse in
stock prices or a decline in economic activity, it will never attain the no-
toriety of the crash of 1929. Yet its lesson is perhaps more important. Eco-
nomic safeguards, such as prompt Federal Reserve action to provide
liquidity to the economy and assure the proper functioning of the finan-
cial markets, can prevent an economic debacle of the kind that beset our
economy during the Great Depression.
286 PART 4 Stock Fluctuations in the Short Run
(^15) Memorandum from Dean Witter, May 6, 1932.