The Stock Market Barometer, Chapter 10:

"A Little Cloud Out of the Sea, Like a Man's Hand" - 1906

The San Francisco Earthquake and Stock Market Panic

In discussions such as these it is necessary to anticipate objections and explain apparent discrepancies. There is nothing more deceptively fascinating than a hypothesis which holds together too well. Out of that sort of theory much obstinate dogma arises, which seems able to continue its existence after time has proved the theory unsound or inadequate. We have established what is called Dow's theory of the price movement - the major swing, the secondary reaction or rally, and the daily fluctuation - and out of it have been able to evolve a working method of reading the stock market barometer so constituted. But we are to guard ourselves against being too cocksure, and to recognise that while there is no rule without an exception, any exception should prove the rule.

The San Francisco Earthquake

The year 1906 presents an interesting problem in this way. It is the problem of an arrested main bull movement or an accentuated secondary reaction, according to the way you look at it. It has been said that major bull markets and bear markets alike tend to overrun themselves. If the stock market were omniscient it would protect itself against this over-inflation or over-liquidation, as it automatically protects itself against everything which it can possibly foresee. But we must concede that, even when we have allowed for the further established fact that the stock market represents the sum of all available knowledge about the conditions of business and the influences which affect business, it cannot protect itself against what it cannot foresee. It could not foresee the San Francisco earthquake of April 18, 1906, or the subsequent devastating fire.

Tactful to Call it a Fire

If you want to make yourself popular with that somewhat strident individual, the California "native son," you will not even allude to the San Francisco earthquake. In California it is considered bad manners to do anything of the sort. All that is conceded there is the fire. For our purpose the earthquake admits of no argument. Chronic California boosters, however, cannot permit a general impression that there might be, for instance, another earthquake in San Francisco as bad as the last. A fire, on the other hand, might occur to any city, anywhere, without detracting from those natural advantages of climate and other things of which California is so proud. There is nothing more charming than the naivete of the Los Angeles native, who says "It is a fine day, if I say so myself." But earthquakes are different. They put the Pacific coast in a class by itself, and a class not at all to the taste of the inhabitants. As Beau Brummell, the great English dandy of the early years of last century, said: "A hole may be the result of an accident which could happen to any gentleman, but a darn is premeditated poverty."

Effect on the Stock Market

But the San Francisco earthquake came up in a clear sky, and took an already reactionary stock market by surprise. You will remember the clause in the Lloyds ship insurance policies which excepts "the act of God and the King's enemies." This aberration of Nature was an exception, and it went far to explain an exceptional year in the record of the stock-market barometer. There was an undoubted bull market from September, 1903, reaching a high point in January 1906. It did not hold that point without recession; and it may be said that as a general rule there is often no marked warning line of distribution at the top of a major bull swing, especially when that bull swing has overrun itself, as, for instance, it did in 1919. The market in the spring of 1906 was declining, but with no such precipitancy as to indicate the bull market would not be resumed, or had even been much overbought when the earthquake occurred. We must remember how serious the losses were. The convulsion set up a fire in the ruins of the immense number of collapsed houses or those shaken to their foundations, and this fire rapidly assumed the proportions of what the insurance companies call a conflagration. The American companies, without exception of consequence, and the English companies, paid up promptly, to help the sufferers, although they had an excellent fighting case over the earthquake itself. We might have learned a little of German methods from the action of Hamburg companies, who adopted the opposite policy and repudiated their liability. It might have taught us something of the German methods in the conduct of war and diplomacy, of the German conceptions of the spirit of a contract and of sportsmanship. At least after that time the fire insurance companies of Hamburg wrote little insurance in America.

Sound Prediction Under Difficulties

When the stock market is taken by such a surprise there is a violent break closely akin to that of a panic. The basis of a panic, when analyzed, is essentially surprise. It cannot be said that the stock market of 1906, in the last days of April, got out of hand. But the decline had been sufficiently serious. The twenty railroad stocks which sold at 138.36 on January 22, 1906, on May 3d had declined over eighteen points; the twelve industrials then used had reacted from one hundred and three on January 19th to 86.45 on the later date. There seems to be some sort of uniformity which obtains in breaks like this. Experience records a recovery of part of the panic break, with a subsequent and much slower decline which really tests the strength of the stock market. In fact, The Wall Street Journal of July 6, 1906, called attention to this fact in predicting a general recovery from the showing of the averages. It said:

It is a uniform experience, over the years when such averages have been kept, that a panic decline is followed by a sharp rally of from 40 per cent to 60 per cent of the movement, and then by an irregular sag ultimately carrying the price to about the old low point. It seems to need this to bale out the weak holders who were helped over the panic. It could hardly be said that the break on the San Francisco disaster was exactly of the panic class, and the market in rallying recovered to 131.05 in the case of the railroad stocks, which is only 1.61 below the price at which the earthquake decline started. The rally, however, does represent about 60 per cent of the decline since January 22d, and the course of the market since has been curiously parallel to the movement observed after a panic rally. It seems fair to infer that liquidation of very much the same kind as that following a panic has been necessary."

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From The Stock Market Barometer by William P. Hamilton, published in 1922