Home >Markets >Stock Markets >The stock market barely faltered in the 1918-20 pandemic. Is history repeating itself?

In February and March, when the Covid-19 pandemic was just gathering steam, investors began scouring the historical record for precedents: How do you forecast the market in such a global crisis?

Many zeroed in on the 1918-20 Spanish flu pandemic. On the surface, it bore many similarities to the Covid-19 emergency, involving a lethal virus with fast-spreading global contagion. And so it was encouraging to investors that the U.S. stock market was impressively resilient throughout that health crisis.

Now, half a year after the current crisis began, it is clear that this “Covid market" is writing its own playbook.

According to several economists, the similarities that were initially identified have turned out to be misleading. Yes, the markets have bounced back, just as they traded higher in the months after the pandemic’s start 100 years ago. But a careful analysis of the two periods shows that economic uncertainty has been far higher during the current pandemic than it ever was then. To learn more about what the future may hold, we must examine periods other than the Spanish flu pandemic—ones that weren’t as deadly, but had much higher economic uncertainty than that crisis.

Difference in lockdowns

The biggest supposed similarity between the two pandemics has been the strength of the markets. But a closer look shows that the market performance of the two eras has been different.

During the two-plus years of the Spanish flu pandemic, the Dow Jones Industrial Average was never more than 5% lower than its level on March 4, 1918, the date some have given for the start of the crisis. In November of that year, in fact, at the height of the pandemic’s second and deadliest wave, the Dow was 11% higher.

The market in this pandemic has followed a different script. Even though stocks have roared back from their initial fall, that fall was much deeper than during the Spanish flu. At its low on March 23, the Dow was 37% below where it had stood at its February peak (which was an all-time high). Since then it has risen in a nearly straight line, and through Friday it is 5% below that high. The S&P 500 is 1% above and the Nasdaq composite is 15% above their highest levels in February.

To some economists, the difference between the two markets is significant. One big reason the stock market fell so much this time around, according to Nicholas Bloom, an economics professor at Stanford University, was the policies pursued to slow or contain the virus. These were far more aggressive and widespread than those introduced during the Spanish flu pandemic: People in 1918 were told to wear masks, but there weren’t lockdowns.

The lockdowns have led to an extraordinary increase in the uncertainty that businesses are facing—an uncertainty that for the most part wasn’t present in 1918—which in turn is preventing the economy from fully recovering. U.S. GDP declined at a 5% annualized pace in the first quarter of this year and 33% in the second.

In contrast, the recession of 1918 was “mild and brief," according to research conducted by François Velde, a senior economist at the Federal Reserve Bank of Chicago. Though precise numbers aren’t available, since national-income accounting wasn’t even invented until the 1930s, he further concludes that what decline in economic activity did take place was “likely due to the end of the war [World War I] rather than the pandemic itself."

Andrew Lo, a Massachusetts Institute of Technology finance professor, agrees with the idea that we’re in a period of much greater uncertainty. He argued back in March that analogies to the century-ago pandemic were misleading, and says in an interview that what the government did this spring was to “put the economy into the equivalent of a medically induced coma."

Pointing out the economic effect of health policies isn’t intended as a criticism, both Prof. Bloom and Prof. Lo emphasize. Those policies undoubtedly saved lives.

But they leave businesses facing many questions that must be answered before the economy can erase its losses. Will businesses be allowed to reopen and when? And might they subsequently be forced to close again? How soon will an effective vaccine be widely available, and what if a major portion of the population refuses to take it?

These are a few of the known unknowns. Businesses are also facing the uncertainty that derives from a large number of “unknown unknowns," Prof. Lo says.

Economic-policy uncertainty

Prof. Bloom argues that this uncertainty is the key to drawing historical lessons that could help us understand our current situation. Though there has never been another pandemic quite like Covid-19, there have been many other occasions in which economic uncertainty has suddenly soared—such as after the 1987 stock-market crash and the Sept. 11, 2001, terrorist attacks.

So, he and a number of colleagues analyzed how the economy behaved on those past occasions, focusing on factors such as manufacturing employment and industrial production. From that, they created a forecasting model to predict how the economy would react to future surges in economic uncertainty.

Prof. Bloom presented this model at the Federal Reserve’s Economic Policy Symposium, held online in late August.

Prof. Bloom and his colleagues found that the model “reasonably well" predicted how the economy has reacted so far. The model forecast an “abrupt, short-lived contraction in industrial production and at least a partial rapid bounce back." Before this year, the model had only one other real-time test, during the financial crisis of 2008, when it also performed well, according to Prof. Bloom. Based on these two events, and other research he has conducted, he declares that the model does a significantly accurate job predicting drops in economic activity.

So far, so good.

Unfortunately, Prof. Bloom continued, the model doesn’t forecast a significant continuation of the economic recovery that has taken place over the past couple of months. An index he and his colleagues created to measure uncertainty has declined but remains well above its historical average. Until it recedes a lot further—and that depends on unpredictable factors such as when an effective vaccine becomes available—the model doesn’t forecast that the economy will completely make up its losses.

Overheated stocks

Prof. Bloom therefore concludes that the stock market has gotten too far ahead of the economy, and must remain in a trading range or fall back until the economy has the chance to catch up. For this reason, he says, he has sold all the equity holdings from his pension and his “529" education-plan portfolios.

Prof. Lo agrees with Prof. Bloom that policy uncertainty is a key to understanding the future course of the economy and the stock market. And he agrees that the disconnect between the stock market and the economy needs to be narrowed, one way or the other. However, he is optimistic that the economy will grow far enough and fast enough in coming months to catch up to the stock market.

Nevertheless, Prof. Lo acknowledges, this “economically bright future on which the stock market is betting is ours to lose. We could still screw it up. For example, a contested election could cause huge and lasting damage. Leadership is crucial to this bright future. Lack of leadership can be disastrous."

Mr. Hulbert is a columnist whose Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at

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