Is it really the end of the world when the market crashes?
13 Feb 2021
We all know what went down in 2020.
The world got hit with a pandemic, and global economic and trade was severely disrupted. The 2020 economic outlook took a sharp turn, and stock markets crashed globally.
There were many reports about the 2020 stock market crash all across social media back then. Even if you were not a finance junkie at all, you would have felt the effects of the stock market crash.
But what exactly is a stock market crash? Does it affect our everyday financial health? Is it the end of the world?
What is a stock market crash?
A stock market crash can be defined as a sharp drop in prices of stocks. Over the years, there have been several stock markets collapses, each with its own unique reason for why it happened.
Instead of worrying endlessly about a stock market crash, it would be useful to study the reasons behind historical market crashes.
We've compiled a few of the significant market crashes in the past to give you a glimpse of how things happened, and how the market eventually recovered.
1987 Black Monday Crash
- On 19 October 1987, all the major work markets experienced a sharp decline in price from 20 to more than 40%. The US Dow Jones Index fell more than 20% for the day. Prior to the crash, markets had been on a roar, as the Dow Jones more than tripled in value since 1982, leading to concerns of an overvalued market that was due for a major correction. (FOMO Investors who are at the same time worried about the market’s valuation)
- With market participants mostly jittery about market valuations, it also prompted investors to set “stop-loss orders” (automated orders to sell out of stock positions, if prices dropped to/past a certain point) As the market drop, these stop loss orders further exacerbated the speed and size of the market losses. To make matters worst, large institutional investors also partially hedged their portfolios by implementing portfolio insurance strategies- automatically increase short future positions if there was a significant decline in stock prices.
- Markets only recovered back to levels before the crash in March 1989. (17 months)
Dot-com Bust (2000 - 2002)
- Termed as the internet stock bubble, US tech heavy index, Nasdaq, hit an a high of 5,132 in March 2000. By Oct 2002, the Nasdaq has fallen by more than 70%. Prior to the fall, the Nasdaq rose almost 4x driven by speculation on internet-related companies, as computers became a mass market product.
- Record amount of funds flowed into Nasdaq during the period, as the Fed Chairman then, Alan Greenspan, warned the markets of “irrational exuberance” in 1996. However, he only tightened monetary policy in 2000, bursting the internet bubble.
- It took 15 years for the Nasdaq to rebound back to levels before the crash, in April 2015. (15 years)
11 Sep 2001 Attacks
- On 11 Sep 2001, 2 planes crash into World Trade Center in the US. Stock exchanges including the US and London were closed and evacuated in fear of more terrorist attacks.
- Markets went into risk off mode, with the US Dow Jones index falling more than 7% on the first day of trading, the largest loss in history for a trading then (before the flash crash during COVID-19). At the end of the first trading week following the accident, the Dow Jones was down more than 14%.
- Nonetheless this was a relatively short sell off, as markets subsequently rebounded and was back to the levels before the crash by November 2001. (3 months)
2008 Global Financial Crisis
- Often referred to as one of the most severe financial crises in recent times. The global financial crisis in 2008 was a result of excessive risk taking by banks (in the form of mortgaged backed securities) which threatened the financial system with the collapse of the US housing market. The bankruptcy of Lehman Brothers in Sep 2008 became the trigger for the crisis and the wakeup call to the world. Prior to that, investors have been speculating on the rising US home prices, with home mortgage debt rising from an average of 46% during the 1990s to 73% during 2008. The crisis which started in the US spread rapidly to the rest of the world in part as US accounted for more than a third of the growth in global consumption then, and large financial institutions were also linked due to derivates such as credit default swaps.
- The crisis saw central banks having to unleash huge stimulus to buy up mortgage securities and reduce interest rates to 0%, and to bail out “too big to fail banks”. Following the crisis, it also saw stricter regulations for the large banks including the Dodd-Frank act to ensure the stability of the financial system. Even after more than 10 years from the financial crisis, several banks have not fully recovered their lost market cap including Bank of America and Citibank.
- US markets peaked in Oct 2007 and bottomed only in March 2009. Markets recovered back to levels before the crash in March 2013. (5 yrs 6 months)
- COVID-19 brought about what was believed to be the worst recession since the Great Depression of the 1930s, as the pandemic brought about social distancing measures and lockdowns resulting in a disruption in economic activity. By April 2020, more than 3.9b people or half of the world’s population were ordered to stay indoors to prevent the spread of the virus, with recommended confinements and curfews in more than 90 countries or territories.
- In March 2020, markets around the world suffered one of their steepest and fastest fall in recent times. The US S&P500 index took just 22 trading days to fall 30% from its record high in Feb 19, making it the fastest drop of this magnitude in history. However, as markets grasp with the pandemic, and central governments around the world unleash unprecedented stimulus to boost the economy, markets rapidly rebound.
- After bottoming in March 20, markets recovered back to levels before the crash in November 20 (8 months)