Stock Market Crashes

 The stock market has crashed several times throughout history with the most recent in 2020. A stock market crash happens when stock prices decline significantly all at once by more than 10 % and might last for years until it fully recovers. The chart below shows the most famous crashes in history.

 

The worst crash called "The Great Crash" also known as the "Wall Street Crash" was in 1929, and it was a main stimulus for the Great Depression. The crash followed the Roaring Twenties when the economy was booming, and investors were heavily depending on trading on margin. The Dow Jones Industrial Average Index (DJIA) increased from 63 in August 1921 to 381 in September 1929. Following the Federal Reserves' decision to raise the discount rate in early August to 6%, the DJIA increased by 27 % y-o-y by Sep 3rd. On Black Friday on October 24th, investors traded 3 times the normal volume losing around USD 5 B, and then on Black Monday, the stock market fell further by 13 %. A month later on October 29th, the NYSE collapsed, and by mid-November, the DJIA lost almost half of its value, and it took the DJIA around 25 years to recover from the crash, as seen below.

 

Source: Federal Reserves Public Data

 

The second crash was the Black Monday Crash on October 19th, 1987. A bull market due for a correction as the market was going strong rising by around 44% solely in 1987, computerized trading that enabled higher trading volumes, and portfolio insurance where investors and large institutions hedged their portfolios by shorting positions in S&P500 Futures, and on Black Monday, as stock prices fell, more futures contracts short-selling occurred down pressuring the market furtherly, as well economic issues such as high oil prices, interest rates, and inflation were the main causes of the crash. Not only the US Stock Exchange has suffered at that time, but also the market carnage has spread all over the global markets affecting Asian Markets and Europe even before reaching the US. On October 16th, the Friday before Black Monday, the London Stock Exchange suffered a 5 % loss coinciding with the Great Storm of 1987, an unprecedented fatal hurricane in the English Channel. On Black Monday, Hong Kong dropped by around 45.8% accounting for its biggest single decline in which the Hang Seng Index dropped 420.81 points losing around 10% of its value and the DJIA dropped by almost 22 %, the S&P 500 Index plummeted by 20.4% which marks one of the largest single-day declines in the history of the stock market. But its effect was short-termed as the markets recovered in just a few days and in almost 2 years, the market was bullish and recovered fully where the DJIA reached 10000 by the end of 1999.

 

The third one was the 1999-2000 Dot-com Bubble when the internet-based stocks' value surged massively in which more than 40% of the dot-com companies were overvalued, and the bubble was burst by tightening policies by the Fed constraining the money supply. The NASDAQ Composite Index rose by 582% from 751.49 to 5132.52 from 1995 to early 2000. During the crash, the NASDAQ plummeted by 75% from early 2000 to late 2002 wiping the bubble's gains, and it took the NASDAQ 15 years to fully recover reaching its 2001 peak.

 

The fourth one was the 2008 Great Financial Crisis. The increased subprime mortgage debts in the housing sector triggered financial institutions to go into bankruptcy, and major indices to lose around 20% of their values causing the Great Recession. The Dow reached 54% below its peak in 2009, and it took it 4 years to fully recover from the crash.

 

The fifth market crash was on May 6th 2010 and it was called the "Flash Crash" where major indices plummeted, but rebounded in an hour. Although it was only one hour, the crash caused a USD 1 Trillion loss in market value. The Crash was triggered by economic reasons; the financial situation in Greece, and the elections in the UK.  The CBOE Market Volatility Index (VIX) increased by 22% in a day. Along with the drop in US Stock Market, other global Stock markets were affected as well; the Canadian TSX Composite Index lost more than 5% of its market value in half an hour.

 

Finally, the most recent was the 2020 Corona pandemic crash. With the increased uncertainty of the unknown virus, the Dow Jones and S&P 500 fell by 11% and 12% in late Feb of 2020, respectively, accounting for the biggest weekly plunges to occur since the financial crisis of 2008. The Dow furtherly dropped by 9.99% on March 12, the largest one-day drop since Black Monday of 1987 trailed by a larger drop of 12.9% on March 16, the S&P500 fell by around 12% in March 16 as well, and the VIX rose sharply reaching the 2008 level, as seen below. However, with government stimulus packages and easing monetary policies, the stock market rebounded quickly in a month.

 

Source: Bloomberg

 

For history not to repeat itself, the U.S. Securities and Exchange Commission (SEC) issued a circuit breaker along with other mandates to curb huge market losses following the Black Monday Crash in 1987, and they were revised in later years. Circuit breakers have 3 levels:

  1. A drop of 7% from the prior day's closing price of the S&P 500 mandates a 15-minute trading halt, and trading is not paused if the fall occurs at or after 3:25 p.m. ET.
  2. A drop of 13% causes a 15-minute halt, and again trading is not paused if the drop occurs at or after 3:25 p.m. ET.
  3. A drop of 20% suspends trading for the rest of the trading day, and trading resumes the following day.

 

Everything has its ups and downs, and for something to reach a higher peak, it needs to pass by a trough first. Therefore, a market crash doesn't mean a failure of the system but rather an end of a cycle, and a beginning of another. An investor should be careful with margins, short selling, and diversify his portfolio with assets with different grades of risk in order not to fall into a bubble trap, especially at times of geopolitical tensions and global unrest.  

 

 

The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice.  Any view expressed does not constitute a personal recommendation or solicitation to buy or sell.  The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI.  Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.