A potted history of market crashes (and why they don’t matter)

29th June, 2020

From tulips to technology, railroads to real estate, asset price crashes are centuries old. Investors have been prone to getting very excited about innovation in the short-term, only to realise its limitations as time goes by.

Crashes take several different forms: either investors build up the prospects for a particular asset – tulips, railways, dotcom businesses – and inflate its value; or they start to worry about the impact of a large external threat on the future prospects for companies – higher interest rates, Covid-19. The effect is similar – a sudden and alarming deterioration in share prices.

The scale of these crashes varies considerably. Some, such as the 2010 ‘flash’ crash, may be little more than a technical glitch, or that in August 2015, where markets briefly fretted about declining commodity prices in thin trading, before quickly recovering their equilibrium. As the economist Paul Samuelson once said, “the stock market has predicted nine of the last five recessions.”

Then some are more serious and enduring – and the recent rout is certainly one of them. The FTSE 100 plunged 11% on 12th March alone, in line with ‘Black Monday’ in 1987 and over 30% in just a few days. According to data from Statista, the same day also saw the largest single-day percentage loss for the Dow Jones at 9.99%. The next closest was October 2008, when the index dropped 7.8% in response to the failure of Lehman Brothers.

Bouncing back

The more important question for investors is how long it takes to recover from these difficult market crashes. History is a little guide to how long it takes, with no real pattern to the falls, though it does suggest that falling a long way very quickly tends to see a faster recovery than a gradual decline.

Over the last four decades, the major crashes were in 1987 (‘Black Monday’), 2000 (the technology boom and bust), 2007/8 (the global financial crisis) and 2020 (the Covid-19 pandemic). In 1987, the FTSE 100 moved from 2367 to a low of 1,582 in December before bottoming-out. It recovered its previous value in a little over two years, and those investors that had bought at the bottom would have doubled their money within six years.

The technology boom and bust was more complicated. Although it appeared to take far longer to recover (particularly for the technology-heavy Nasdaq), the data was skewed by technology, media and telecom companies, which became a vast part of the index with bloated valuations. Vodafone, for example, was the largest stock in the FTSE 100 index and slipped from 460p to 113p. Most other companies were doing reasonably well. Nevertheless, an investor who had bought at the height of the boom in late 1999/early 2000 had to wait around seven years for the FTSE 100 to achieve its previous highs.

At the time, the global financial crisis felt like the end of capitalism as we knew it. Valuations were already high, with share prices bolstered by excessive debt. The FTSE 100 sunk from 6,730 to below 4,000 over the next 18 months. Having reached its nadir, it wasn’t until 2014 that it recovered its previous level.

In the most recent crisis, valuations were not excessive to start with, and markets have fallen a long way very quickly in response to the Covid-19 outbreak. Markets have already started to recover, albeit tentatively.

Should we be worried?

History suggests that stock markets, in aggregate, usually bounce back. However, individual companies do not. There will be some business casualties as lockdown measures come and go and then, potentially, come back again. However, as long as investors are not exclusively invested in those companies, their portfolio should recover over time.

Equally, just as most people will not have invested right at the top of the market but gradually through the cycle at different prices if they keep investing they will be putting more money into the market at lower prices. As such, over time, the highs and lows will even out.

History shows that markets have always recovered from a crash, but it takes time. Investors can minimise the impact by saving regularly, avoiding panic selling and keeping a diversified portfolio. It doesn’t sound like rocket science, but it works over time.

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This article was sourced from Adviser-Hub.co.uk.

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