Market Crashes: The Good, the Bad and the Ugly

Just as night follows day, it seems part of the regular cycle of the world’s share markets that good times and rising prices are always followed by downturns and downturns are always followed by good times and rising prices.

The impact of the Covid 19 Global Pandemic was typical of such downturns, prompting a 35 per cent sell off in world share markets and a dramatic fall in economic activity. Tourism and hospitality industries in particular, were brought to their knees by sudden and prolonged closures.

For many, it has prompted memories of other equally, and sometimes more devasting, downturns in the world’s share markets.

The most famous was “Black Thursday” in 1929, which lead to an 80 per cent collapse in share prices and sparked the Great Depression, which lasted for more than 10 years. It created widespread misery and sustained, world-wide unemployment rates in excess of 30 per cent.

What caused it? The wild excesses of the roaring twenties when consumer confidence was at a record high and the introduction of margin loans, where people could borrow up to 80 per cent of the value of shares.

This created a classic investment bubble, where optimism overwhelmed caution and people started buying shares in the mistaken belief, they would always increase in value. A drop in agricultural production due to droughts and a fall in economic production, caused a sudden reversal in sentiment.

A similar situation was created some 60 years later, when in 1987, panic selling on Black Monday, wiped some 30 per cent from the value of the key US market index, the Dow Jones – its biggest one day fall.

It put an end to the ‘Greed is Good’ mentality of the eighties and prompted a review of the relatively new, computerised share trading systems. This in turn led to the introduction of circuit breakers to stop panic selling and exaggerated market movements caused by sudden sell-downs.

Yet it seems investor’s memories are short.

Not long after this, markets got caught up with a new investment bubble prompted by the development and growth of the Internet. Companies raced to find their place on-line and suddenly, all Internet companies were seen as a sure bet.

This speculative buying ran out of steam when the Dot Com Bubble finally burst in 2000, wiping 45 per cent off the value of shares. It’s believed 130 internet-based companies went broke in the United States that year, creating widespread unemployment.

While much the same as earlier market falls, the Global Financial Crisis of 2008, was also in many ways unique. It was the direct result of dodgy lending practices in the US housing market, which created a toxic class of home loans, commonly referred to as ‘sub-prime loans’.

Typically, these lenders ignored the individual’s ability to repay the loans and instead focused on the belief property prices would always rise and that there would always be people prepared to rent these properties.

It created a typical investment bubble in the US housing market, where greed and optimism overrode common sense. Eventually, people found they could not meet their repayments and as the bubble burst, nor could they sell the properties held as securities.

The sudden realisation that many home loans in the US, once considered to be literally as “safe as houses”, were not worth the paper they were written on, caused enormous problems within the US banking system and the collapse of several international banks.

It took a prolonged economic downturn and the introduction of tighter lending practices to correct these difficulties.

The lesson to be learnt from all these devasting crashes is that while no two are the same, they all identical in nature. All were created by an exaggerated investor belief that prices will never fall. Where greed outpaced fear.

The big lesson from all these market downturns is for investors to think carefully before they make any investment, to only invest with a long-term time horizon of at least five years and never to be panicked into selling by a sudden correction in the market.

As history has shown, market downturns are always followed by prolonged upturns and as long as the investment is fundamentally sound, it will fully recover any lost value.

Published : 15 Jan 2021

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