Hamish McRae: Welcome the market gloom for putting the focus on real company value

If you are thinking of security of people's pensions and impact on consumption, this is nothing like 1929

The tech-wreck continues, but is it Wall Street in the 1930s or Tokyo in the 1990s? Or neither?

The broader market, which had actually not performed too badly until the last few days, is now being pulled down by the relentless declines in technology stocks. The analysts who had puffed the shares on the way up have either been sacked or pardoned and are now piling gloom upon gloom – helped, to be sure, by the periodic accounting scandal and the rumours of many more to come.

When a solid bear market gets dug in it takes quite a bit to shift it. We don't really have much folk-memory of bear markets here, for not enough of the people who were around during 1974 are still in harness. And there is even less of a memory in the US, where their 1970s experience was more one of sideways movements than a sudden plunge followed by a serious (and if you got your timing right, hugely profitable) bounce.

So I am grateful to Don Straszheim, the ex-Merrill economist who now runs his own consultancy out in Santa Monica, for some long-term comparisons. He has taken two previous equity bubbles, that of the Dow, which peaked on 3 September 1929, and of the Nikkei, at its peak on 29 December 1989, and compared them with the Nasdaq, which peaked on 10 March 2000. The story is told in the graphs.

The top one looks at the run-up to the peak and the next four years afterwards. As you can see both the Dow and the Nikkei climbed more gently than the Nasdaq, while the Nikkei fell more gently than either. The profile of the decline of the Nasdaq and the Dow is chillingly similar so far: steep, steep, steep.

But remember it was not Black Monday that bust people in 1929. It was the relentless fall for the next three years. Just suppose for the sake of argument that the Nasdaq does follow the pattern of the Dow – and in psychological terms there was probably quite a close parallel on the way up – then there is another year's decline for tech stocks.

Glum? Well, in one sense yes. If Wall Street as a whole will be hard put to recover until it feels all the bad tech news is out of the way, then there will be another year of decline. But look on the bright side. Technology is only part of the US investment scene. If you are thinking of the security of people's pensions and the impact on consumption, this is nothing like 1929. In any case we are now two-thirds of the way through the bear market. In the next year or so there will be wonderful buying opportunities for the brave. On the grounds that it always better to be a bit too early than to be too late, rule one would be to start buying tech stocks gradually in the next few months, though with the expectation that the real recovery will not take place until next year.

What about the longer view? The deeper the market falls now the greater the scope for an early recovery. As the bottom graph shows, it took 25 years for the Dow to get back to the level of 1929, a whole generation and a world war later – in 1954. The Nikkei, on that basis, will not get back to its end-1989 peak until Christmas 2014, and the Nasdaq until spring 2025. But if those sound profoundly depressing dates, note that were great investment opportunities, along the way at least in the US, the first bout coming in 1933, only three years into that quarter-century.

There have not, however, been great investment opportunities yet in Japan. The slide has been more gradual, with share prices helped up in the early 1990s by the authorities advising the investment institutions that it was their patriotic duty to support the market. The red line fell by less than the blue. So by insisting that there should be less pain early on, the Japanese inflicted more pain later. But the sum total of the pain, as the bottom graph shows, is pretty similar.

Does that mean that the time might now be right to invest in Japan? That seems to be the view that is building, for Tokyo has been the best-performing of the large equity markets this year. Of course there is no reason why the red line should not dip below the blue line and Japanese shares have yet another bad year. The fact that graphs happen to fit reasonably well together does not mean that they will continue to do so. But as a common sense approach, it would certainly be sensible to start buying Japanese stocks this year.

Are there further lessons we can draw from the experience of the US in the 1930s and Japan in the 1990s? I suggest there are three.

The first is that the key thing to avoid is anything that might erode the stability of the banking system or the vigour of the international trade system. In the 1930s it was the collapse of many banks that made it so difficult for the US domestic economy to recovery, but this was greatly compounded by the collapse of international trade. The anti-globalisers won then, at huge cost to humankind.

In the US in the 1930s much damage was done by allowing US banks to fail. In Japan in the 1990s, paradoxically, the damage has been done by not allowing the banks to fail. The difference is that in the US depositors suffered, whereas in Japan it has been potential borrowers who have suffered. The banks have been so hobbled by existing bad debts that they have been unable to make potentially rewarding new ones. Had they been allowed to collapse, with most small depositors at least being protected, then the banking system could have been recapitalised and the recovery underpinned. As it is, everything has been terribly slow.

Might the tech-wreck cause similar problems? In other words, might the accounting errors we now know about, plus the ones to come, do as much damage to the US financial system as the errors of the 1930s and 1990s?

A couple of months ago the easy answer would have been no. Equity-based financial systems are inherently more robust than bank-based ones because the pain can be more widely spread and companies under pressure can pass a dividend with much less damage than missing a loan repayment.

I think that is still right. What has been alarming is the extent to which US businesses have been cooking the books to try to make their profit figures look better. Faith in large US companies has declined almost as fast as faith in Japanese banks. Still, all the experience of market psychology is that markets can only recover when bad news is out in the open: they hate uncertainty.

If that rather basic lesson holds as true now as it has in the past, then we will need to reach a "no more surprises, please" period of calm before the recovery will take hold. The good news this time is that the world's banking system, Japan apart, is pretty tough.

In a way, we should welcome the present despair because it stems from the fact that more and more rubbish is being uncovered.

Greed is bad: that encourages people to cook the books. Gloom is good: it forces investors to focus on real value. I find those graphs rather comforting really. On the experience of past bubbles it would be pretty surprising if better times were not upon us next year.