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stock market crash

Disclaimer: The products or services discussed in this article may not be offered by Taurex and may only be listed here for educational purposes.

 

The end of the Roaring Twenties (1920s) marked the beginning of a monumental economic downturn that had a lasting impact on the global stage known as the Great Depression.

This point in time saw businesses fail, people fighting for scarce job opportunities, and a low money supply. But how did this dark point in our history happen? While multiple factors contributed, many historians point to one event— the stock market crash of 1929.

To that point, what is a stock market crash? How did one lead to society’s almost collapse? What are the reasons that could cause the stock market to crash? What are the possible effects of one happening today? What can we learn from previous market crashes, and how can one impact our everyday lives?

In this article, let’s look at a quick overview of stock market crashes, insights into market behaviour, and practical guidance on preparing for a stock market crash, such as financial opportunities and navigating market volatility.

Overview: What Is a Stock Market Crash?

A crash occurs when stock prices take a sharp and sudden nosedive, causing a widespread loss of investor confidence. It’s when the overall market value of stocks takes a significant hit, setting off a chain reaction of panic selling and a downward spiral in financial markets.

Is the Stock Market Crashing?

As of June 6, 2023, the stock market is going through a bumpy ride with increased volatility. While these occasional dips and swings in stock prices can indicate a potential crash, they don’t always mean a full-blown disaster is on the horizon.

Nevertheless, these movements in the stock market remind us how vital it is to keep an eye on market conditions and be ready for possible changes. We’ll delve deeper into this topic in the upcoming sections of this article.

Why Does the Stock Market Crash?

Stock market crashes usually happen due to a significant incident, such as a world war, natural disaster, pandemic, economic crisis, or a financial bubble burst.

That said, there’s no one-size-fits-all definition of a stock market crash. Instead, it’s typically identified as a situation where the major stock indexes lose more than 10% of their value quickly.

Will the Stock Market Recover?

Historically, the stock market has displayed an impressive ability to bounce back from crashes. Yes, the time it takes to recover can differ. However, the stock market works in cycles.

In other words, we can expect an upward swing for every downward spiral. However, predicting the recovery’s exact timing and extent can be challenging, like trying to hit a moving target.

Key Takeaways

  • Stock market crashes involve a significant drop in stock prices.
  • Numerous factors, such as economic downturns and geopolitical events, can lead to stock market crashes and escalate their effects.
  • While we’ve seen stock market recoveries, it’s tough to predict the precise timing and scale of the recovery.

Timeline of U.S. Stock Market Crashes

Throughout history, the U.S. stock market has experienced several notable crashes that have significantly impacted the economy and investor confidence. Here’s a chronology of the most significant stock market crashes in U.S. history:

  • Panic of 1901 (May 17, 1901)
  • Panic of 1907 (October 1907)
  • Wall Street Crash of 1929 (October 24, 1929)
  • The Recession of 1937-1938
  • Black Tuesday (October 29, 1929)
  • Souk Al-Manakh stock market crash (August 1982)
  • Black Monday (October 19, 1987)
  • Dot-com bubble crash (2000-2002)
  • The global financial crisis (2008-2009)
  • COVID-19 pandemic (2020)

Stock Market Crashes in History: Early U.S. Stock Market Crashes

In the stock market’s early days, several significant stock market crashes impacted U.S. history. A mix of factors, including speculative booms, the downfall of financial firms, and questionable banking practices, triggered these crashes.

As a result, the nation endured economic depression and faced widespread market turbulence. Here are some of the early U.S. crashes that helped shape the trajectory of the financial landscape:

  • The stock market crash in March 1792
  • Panic of 1819: Collapse in cotton prices, credit contraction, and over-speculation in stocks, commodities, and land
  • Panic of 1837: Real estate bubble and erratic banking policy
  • Panic of 1857: Failure of the Ohio Life Insurance and Trust Company
  • Panic of 1884: Failure of financial firms in New York, primarily Metropolitan National Bank
  • Panic of 1893: Run on gold and slowed economic activity

Contemporary U.S. Stock Market Crashes

Let’s explore some recent market turbulence, the impact of economic factors, and how the Federal Reserve’s (FED) policies play a role in stock prices.

Stock Market Crash of 1929: October 1929

Known by the ominous names “Black Thursday” and “Black Tuesday,” the 1929 stock market crash sent stock prices into a sharp decline and panic selling. By 1932, stocks lost almost 90% of their market value.

Attempts to rein in market speculation, the rapid expansion of investment trusts and public utility stocks, and a vulnerability in the public utility sector to regulatory news were significant factors that led to the crash.

The Conventional View

The years following the crash of 1929 were significantly challenging to not just investors, but the general public as well. After all, they caused a prolonged depression and raised doubts about the high stock prices.

During these years, many pointed fingers at speculators and expressed concerns about inflated values and excessive speculation. However, the conventional interpretations of the crash received their fair share of criticism.

The market losses didn’t stop in October 1929. While some economists believed the crisis was over by December, it was a matter of debate. In hindsight, it seemed logical to hold or buy stocks in 1929. However, the outcome could have been more successful for many investors.

What Was the Wall Street Crash of 1929?

The Great Crash of 1929 was a massive dip in the stock market in autumn. The consequences weren’t pretty, as share prices on the New York Stock Exchange (NYSE) received a substantial hit.

Several factors at play exacerbated the “Great Crash,” like the ongoing stock market bubble, high levels of consumer debt, and falling prices in the agricultural sector.

Unfortunately, this crash didn’t just impact the United States. It had a global ripple effect. The Dow Jones Industrial Average (DJIA) plummeted 89% from its peak, making it the biggest bear market in Wall Street’s history.

Were Stocks Obviously Overpriced in October 1929? Debatable — Economic Indicators Were Strong

Whether the overpricing of stocks occurred in October 1929 remains a subject of debate among experts. While the crash certainly triggered a severe economic plunge, there are differing viewpoints on valuations.

Some argue that solid economic indicators at the time, such as robust growth, high corporate profits, and low unemployment rates, contradict the idea of overvalued stocks.

Events Precipitating the Crash

Before the crash, several factors stirred up unease and volatility in the stock market. Excessive speculation, where investors took significant risks to make quick profits, was one major factor.

Margin buying, which allowed investors to borrow money to purchase stocks, also fueled the fire. Additionally, the growth of investment trusts, which were investment vehicles pooling funds from multiple investors, was thrown into the mix.

All these events contributed significantly to creating an atmosphere that ultimately set the stage for the crash.

A Look at the Financial Press

The financial press significantly influenced investor sentiment and market dynamics, leading to the crash. Media outlets reported on market conditions, capturing investor sentiment and providing updates on regulatory actions.

Unfortunately, the media’s coverage profoundly impacted the perceptions and actions of market participants. Their reporting contributed to the overall apprehension among investors during that time.

Wednesday, October 16, 1929

On October 16, we saw another decline in stock prices, particularly in the 20 leading public utilities index. This decline followed previous drops that occurred on October 3 and 4.

Negative news surrounding public utility regulation fueled the turmoil and nervousness. This news overshadowed favourable factors like stable business conditions and low money rates.

Monday, October 21, 1929

On October 21, the stock market experienced another decline. According to The New York Times, several causes led to the downturn. One factor was large volume selling by margin buyers due to financial pressures.

Liquidation by foreign investors also played a role, as they sought to withdraw their investments from the market. Moreover, skilled short selling, a strategy where investors bet on falling stock prices, added to the dip.

Wednesday, October 23, 1929

Interestingly, if it weren’t for the events that unfolded the following day, October 23 would have been a significant stock market event. It was a day of crashing stock prices and heavy liquidation, causing investors a wave of concern and unease.

News outlets described the situation as a “near-panic” and a “collapse”. The market value took a hit, dropping by a staggering $4 billion, a 4.6% fall.

Thursday, October 24, 1929

On Black Thursday, October 24, the NYSE witnessed a record-breaking trading volume of 12,894,650 shares. Treasury officials attributed the downturn to speculation, while call money rates remained low at 5%.

On this day, New York bankers provided $1 billion of support for market stability, and the market showed signs of recovery the next day. However, Washington officials appeared to be relatively unconcerned about the news.

Tuesday, October 29, 1929

On October 29, also known as Black Tuesday, the New York City public utility investigating committee raised concerns and criticised the rate-making process for public utilities. This event further added to the unease in the market.

The next day, stocks experienced a collapse, with a staggering trading volume of 16,410,030 shares, setting a new record. Looking at the overall picture for October, stocks faced significant losses, amounting to nearly $16 billion.

The total loss represented an 18% decrease from the beginning of the month. Public utilities suffered the most considerable losses, reaching $5.1 billion among the most brutal hit.

An Interpretive Overview of Events and Issues: What Caused the Wall Street Crash of 1929?

To truly understand the cause of the Wall Street Crash of 1929, you need a comprehensive analysis of the events and issues that occurred then.

Yes, speculative excesses and overvaluation played a role. However, buying on margin, investment trusts, and challenges within the public utility sector were other factors that helped create the fragile market environment that eventually gave way to the crash.

Contemporary Worries of Excessive Speculation

In the 1920s, credit was expanding at a furious rate thanks to lenders with loose lending practices and the widespread practice of buying on margin. Participants were increasingly enticed by the prospects of quick profits, leading to inflated stock prices and heightened market volatility.

Buying on Margin

During the 1920s, many investors bought stocks on margin using borrowed money. While it was a widespread practice back then, buying on margin magnified the impact of the market decline once share prices started falling.

Investment Trusts

Investment trusts influenced the stock market dynamics of the 1920s. Investment funds are where many individual investors pool their money together to create diversified portfolios.

While the premise of investment trusts was attractive initially, as you gain access to opportunities available only to large institutional investors, they caused a chain reaction when market confidence started waning.

The Public Utility Sector

Before the crash, the public utility sector faced numerous problems. These issues included ongoing debates regarding prices and control, which undermined investor confidence.

The investigations into public utility regulation in New York City didn’t help either. Those investigations further intensified concerns about the sustainability and profitability of utility stocks.

Straws That Broke the Camel’s Back

The eventual stock market crash was the result of multiple factors coming together. Excessive speculation, buying on margin, investment trusts, and troubles in the public utility sector all created a  fragile market sentiment that eventually led to the crash.

Edison Electric Of Boston

When the Massachusetts Public Utility Commission denied the stock split request for the Edison Electric Illuminating Company of Boston, it might not have caused a substantial economic impact.

However, it signalled that more significant concerns were at play. It raised issues about utility prices, public ownership, and control in general. It was a warning sign that made people worry even more about the state of the utilities and their future.

Public Utility Regulation in New York

In New York, regulatory bodies and officials also cast doubts on utilities’ profit levels and practices. The investigations and debates around public utility regulation in New York only added to the existing uncertainties and volatility in the stock market.

The Public Utility Multipliers and Leverage

The decline in utility stocks had a ripple effect on investment trusts, banks, and individual investors who had stakes in these securities. Since many investors used leverage through margin buying, it intensified their losses and worsened the market’s meltdown.

The Recession of 1937 to 1938

The economic downturn of 1937 to 1938 happened during the country’s attempt to recover from the Great Depression. It was a recession sparked by the Federal Reserve (FED) tightening its monetary policy and the government reducing its spending.

These actions caused a contraction in economic activity, meaning things started going downhill again.

Kennedy Slide of 1962

In 1962, the U.S. stock market underwent a significant downturn called the Kennedy Slide. The Dow Jones Industrial Average (DJIA) plunged 5.7% despite stock prices increasing by 27% the year before.

Black Monday

The widely known stock market crash on October 19, 1987, or Black Monday, goes down in history as one of the most significant single-day declines in stock market history. The DJIA plummeted by a staggering 22.6%, causing a loss of over $500 billion.

Many people blame the increased involvement of international investors as one of the main factors behind this dramatic event. The day shook the financial world and left everyone pointing fingers, trying to figure out what went wrong.

Friday the 13th

The stock market decline in October 1989, famously known as the “Friday the 13th mini-crash,” resulted in a significant 6.91% drop in the DJIA. The failure of leverage buyout deals related to UAL, the parent company of United Airlines, was the primary cause linked to this “mini” crash.

1973: The Oil Crisis and Economic Recession

While not a stock market crash in the traditional sense, the “energy crisis” of 1973 was a momentous event that profoundly impacted the global economy and stock prices.

The energy crisis saw the price of a barrel of oil nearly quadrupling, leading to widespread economic disruption. The soaring oil prices had far-reaching implications, affecting various financial markets and causing fluctuations in stock prices.

1990s Recession

The 1990s recession was considered a relatively minor downturn compared to some others.

Various factors contributed to the crash, including the savings and loan crisis that had emerged in the mid-1980s, the FED increasing interest rates in the late 1980s, and geopolitical tensions in the summer of 1990 arising from Iraq’s invasion of Kuwait.

Dot.com Bubble

In the late 1990s, we witnessed the rise of the dot-com bubble, marking a time of sky-high stock prices for internet-based companies. However, in the early 2000s, the bubble burst.

Stock prices of technology firms experienced a significant plunge, resulting in a staggering $5 trillion loss in market value. It was a wake-up call for the market, reminding everyone that sustaining trends indefinitely is impossible.

U. S. Bear Market of 2007 to 2009

The 2007-2009 bear market, widely recognised as the Great Recession, had a profound impact, with the S&P 500 experiencing a staggering 51.9% decline.

The economic decline began with a U.S. economic recession, initially sparked by the subprime mortgage crisis. However, the situation quickly escalated, evolving into a full-blown global financial crisis by September 2008.

The crisis put immense strain on financial systems, with the risk of bankruptcy looming over many institutions. It was a turbulent and challenging time for the economy, with far-reaching consequences felt worldwide.

2008 Recession Timeline: The Subprime Mortgage Crisis

On September 29, 2008, the stock market faced a historic plunge, with the DJIA dropping 777.68 points. It was the most significant single-day drop in history up to that point.

The downward trend continued, and by March 5, 2009, the DJIA had declined over 50% from its previous peak. Significant events leading to the crash included:

  • July 11, 2008: Collapse of subprime mortgage lender IndyMac.
  • September 7, 2008: Government takeover of Freddie Mac and Fannie Mae (federally backed home mortgage companies).
  • September 15, 2008: Bankruptcy of Lehman Brothers due to massive debt from subprime mortgages.
  • September 16, 2008: A government bailout of AIG, but not Lehman Brothers.

2010 Flash Crash

On May 6, 2010, a sudden crash happened. Major indices rebounded within 36 minutes following this rapid and dramatic collapse. Unfortunately, the crash wiped out around $1 trillion in market capitalisation from the DJIA.

High-volume E-mini S&P 500 futures trading, illegal manipulative trading, and reduced quotes from electronic liquidity providers were some factors linked to the crash.

August 2011

On August 8, 2011, the U.S. and global stock markets significantly declined. A weakening U.S. economy and a growing debt crisis in Europe primarily caused this.

Adding to the uncertainty, the U.S. received its first credit downgrade from S&P (Standard & Poor’s) following a deadlock over the debt ceiling, which lowered investor confidence.

2015 to 2016 Stock Market Selloff

The 2015-2016 stock market selloff marked a series of global sell-offs between June 2015 and June 2016. On August 21, 2015, the DJIA experienced a significant decline of approximately 3.1%.

The selloff originated in China but had far-reaching consequences worldwide. Economic factors influenced the crash, including the conclusion of quantitative easing in the U.S., the decline in oil prices, the Greek debt default, and the uncertainty surrounding the Brexit vote.

2020 Coronavirus Crash

The outbreak of the COVID-19 pandemic in 2020 triggered a worldwide stock market crash. The virus’s rapid spread caused economies to shut down and widespread panic selling from investors. Unfortunately, these events contributed significantly to the sharp decline in stock prices.

The DJIA lost 37% of its value, leading to several suspensions of NYSE trading. Fortunately, the stock market rebounded, and on August 18, the S&P 500 hit record highs.

Notable Downturns

Apart from the significant crashes mentioned above, the stock market has experienced numerous other downturns. These episodes of market decline highlight the inherent volatility of financial markets.

  • Crisis of 1772: The credit crisis in 1772 resulted from colonial planters’ inability to repay debt, causing bankruptcies in London.
  • Panic of 1796 to 1797: A U.S. land speculation bubble burst, leading to merchant firms’ collapse and special payments suspension by the Bank of England.
  • Panic of 1873: A European stock market crash and the bankruptcy of Jay Cooke & Company caused bank failures and the NYSE to suspend trading.
  • Economic Effects of September 11 Attacks: The attacks exacerbated a global recession, causing a significant drop in stock market values worldwide.
  • Stock Market Downturn of 2002: Stock prices declined globally after the September 11 attacks, with notable declines in the U.S., Canada, Asia, and Europe.
  • 2018 Cryptocurrency Crash: Most cryptocurrencies, including Bitcoin, lost significant value, with Bitcoin experiencing a 65% decline from January to February 2018.

Are Stock Market Crashes More Common During Certain Times of the Year?

Stock market crashes don’t follow a set schedule or happen exclusively during certain times of the year. Yes, events like the Wall Street crash of October 1929 and Black Monday may suggest that stocks tend to decline in October. Still, these events are outliers.

Crashes can occur anytime, and economic, geopolitical, and market-specific factors typically drive them. Despite historical data, October has shown positive stock growth over the past 20 years.

Where Should You Invest Your Money to Prepare for a Crash?

During times of market uncertainty, it is crucial to adopt a strategic investment approach. Consider the following:

  • Diversify: Spread your investments across various categories like stocks, bonds, and commodities to reduce risk.
  • Seek Safety: Consider moving a portion of your portfolio to cash or cash equivalents before a market crash, allowing you to buy back your investments at lower prices and benefit from future appreciation.
  • Secure Guarantees: Keep a portion of your savings in guaranteed investments such as bank CDs (certificates of deposit), Treasury securities, or fixed/indexed annuities to safeguard against market fluctuations.
  • Hedge Your Positions: If you anticipate a downturn, you can profit from it by selling stocks short, buying put options on stocks, or financial indices. These strategies can benefit from declining prices.
  • Pay Down Debts: Liquidate holdings to pay off high-interest debts, such as credit card balances, consumer loans, or a significant portion of your mortgage. Minimising monthly obligations can provide stability during a bear market.
  • Capitalise on Tax Opportunities: Use tax-loss harvesting to sell losing positions and offset gains in taxable accounts. This strategy allows you to write off losses against gains and potentially reduce your taxable income.

What Investors Can Do to Prepare: How Investors Should Deal With Stock Market Volatility

Adopting a proactive mindset and implementing strategies to manage your investments effectively is essential during stock market volatility. Consider the following tips:

Know What You Own — And Why

Understanding stock market volatility is crucial for assessing investment risk. Knowing how volatility works gives you valuable insights into the current market conditions, helps you evaluate risk and allows you to tailor your portfolio to match your growth goals and risk tolerance.

By understanding what you own and how volatility happens, you can make informed decisions and navigate the stock market more effectively.

Pay Off High-Interest Debt

When dealing with stock market volatility, you generally have two options: invest more or pay off debt. Paying off high-interest debt will likely give better returns than almost any investment. Doing so also gives you financial flexibility during an economic downturn.

Be Ready to Buy the Dip: Have a Fully Funded Emergency Fund

Buying the dip is a strategy where you purchase stocks at discounted prices. You then profit by selling your shares when the stock market recovers. It involves believing that a price decline is a short-term event and viewing the dip as a chance to buy stocks at a bargain.

Don’t Spend Excessive Amounts of Money

During market volatility, it’s crucial to understand that risk is inherent. Overspending in a volatile market can result in substantial losses.

Making impulsive, short-term investment decisions when the market is volatile is unreliable. It’s essential to resist acting out of fear and instead stick to a well-thought-out, long-term investment plan during periods of volatility.

Trust in Diversification: Make Sure Your Investments Are Diversified

The main objective of diversification is to mitigate risk by spreading your investments across various asset classes, industries, or geographic regions. Doing so minimises the overall risk of your portfolio during a stock market crash.

Get a Second Opinion

Although risky, market volatility can be lucrative if you make the right moves. Getting a second opinion from experts or experienced brokerages can aid you in leveraging their knowledge and expertise. They can help you identify opportunities in volatile markets.

Focus on the Long Term

Staying committed to a long-term strategy during market turbulence allows you to capitalise on discounted stock prices and accumulate more shares. You may notice higher long-term returns when volatility subsides and prices recover.

Take Advantage Where You Can

Heightened stock market volatility opens up profitable long-term and short-term opportunities. In other words, you can benefit from volatility.

For example, a buy-and-hold approach, where you buy and hold onto stocks for an extended period, will enable you to capitalise on long-term growth. This strategy revolves around the notion that despite market fluctuations, it ultimately generates favourable returns.

Pro Tip

Remember, stock market crashes are part of the natural cycle of financial markets. While they can be unsettling, you must maintain a long-term perspective, stay informed, and have a well-diversified investment strategy in place.

Frequently Asked Questions (FAQs)

  • How did the stock market crash result in the Great Depression?

The 1929 stock market crash caused panic among investors. Without investors, the financial systems of that era become vulnerable, forcing businesses to collapse, raising unemployment levels, and removing billions of dollars of wealth from the economy.

  • What caused the 2008 stock market crash?

The stock market crash of 2008 occurred due to defaults on mortgage-backed securities. Several factors contributed to the crash, including predatory mortgage lending, unregulated markets, high consumer debt levels, and the sharp decline in home prices.

  • Why is the Federal Reserve raising interest rates right now?

The Federal Reserve is taking measures to address inflation by increasing interest rates to the highest level in 16 years. Interest rate increases have significantly impacted borrowing costs throughout the global economy, resulting in a slowdown in sectors like housing.

  • How do the Federal Reserve’s rate hikes affect the stock market?

When the FOMC (Federal Open Market Committee) announces a rate hike, it can trigger a decline in business earnings and a drop in stock prices. Rate hikes typically result in a significant downturn in the stock market.

  • What was the biggest stock market crash ever?

The Dow Jones Industrial Average (DJIA) faced a historic one-day decline of 22.6% on October 19, 1987. This event is known today as Black Monday, the most significant single-day stock market drop in history. 

  • Are we in a recession?

As of May 2023, the United States hasn’t officially entered a recession according to the traditional definition. Yes, there have been some periods of economic slowdown back in 2022. However, the overall resilience of the economy has prevented it from sliding into a recession.

 

Disclaimer: The information provided in this article is for general informational purposes only and does not constitute financial advice. It is not intended to be a recommendation to buy or sell any financial instrument or engage in any investment activity.

While we strive to provide accurate and up-to-date information, we do not guarantee its completeness or accuracy. We rely on various sources for the information presented, and we cannot guarantee the reliability or accuracy of these sources.

The information provided here does not necessarily reflect the products or services offered by our company. Any mention of financial products or services is for informational purposes only and should not be considered an endorsement.

All investments involve risk, including the potential for loss of principal.

This information should not be considered as financial advice. You should always seek professional financial advice from a qualified advisor before making any investment decisions.

 

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