A look at the Stock Market Crashes. Past, Present and Future?
Which Stock Market Crash?Do you remember the crisis in the banks, personal fortunes being decimated following a great surge in value, many people facing bankruptcy, a looming financial disaster which is affecting the world?The year is 1929, and the Dow has just plunged from nearly 400 down to 145, losing 23% within two days, or The year is 2008, and the Dow has plunged over 1000 points already.
How do you define a stock market crash? Is it a set amount of loss in a short period of time? I don’t believe that there is an official definition, but it is accepted that a stock market crash involves double digit percentage losses in a short time. Often associated with a bear market, the main difference is the speed of the decline.
The trading systems broke down in 1929, with the telephone and ticker tape machines overwhelmed by the sheer volume of people trying to sell and get out of the market. Although this arguably precipitated the ultimate consequences, whether the trading systems coped or not would not prevent the bankruptcies and personal tragedies. It just delays the outcome of finding a final value for the market on which all concerned agree. For instance, if the Dow fell in the current situation by another 2000 points, wouldn’t that be regarded as a stock market crash by all observers, whether or not the systems survived?
Safeguards have been put in place to try to stop the market destroying itself, whether by computerized trading as in 1987, or by general panic selling; but the safeguards would still allow this decline in one day. They close the market for one hour if the Dow drops 10%, and for two hours if it drops 20% before 2pm – 2000 points is less than 20%. The market is not closed unless the Dow drops 30% in one day, unless there is some dramatic event to cause it to close. This would still allow a drop such as in 1929.
One of the strong influences in the run up to a stock market crash is overvaluation, the widespread idea that things can only increase in value, and the availability of credit to allow more investment than can be reasonably afforded. Which year did you think of when I said that, 1929 or 2008?In 1929, the utility stocks were suddenly perceived to be overvalued, on a fundamental basis, and they started the decline into the crash.
In 2008, the mortgage market is suddenly perceived to be overvalued, on a fundamental basis, which has started a decline in the investment banks that hold them, and has already led to one company vanishing.The 1929 crash resulted in appalling poverty across the world. Unemployment in Britain more than doubled, from 1 million to 2.5 million in 1930. In the US, the depression resulted in 12 million unemployed, with 12,000 becoming redundant every day, and the economy only really picked up with the Second World War and its demands for production.
This time, the precursor to the present situation is the dot-com bubble, which burst in 2000-2001, and the response of the government, in the form of the Federal Reserve, was to cut the discount rate from 7.50% to 2.75%. There is a school of thought that this has stored trouble for the economy by fuelling the house price rises, which are now adjusting back to a more true value.Another factor in the present US economy is corporate fraud and creative accounting. Fraud was evidenced by the Enron and WorldCom affairs, but for every company that is found out, there are many more undiscovered issues in the current businesses. Wall Street supported mergers of major companies, such as AOL & Time Warner, which served mainly to inflate the companies’ bottom line, to ensure suitable bonuses for the management, and resulted in job losses. Creative accounting invented a new gimmick, for which the term “securitization” has been adopted. This bundled less good mortgages, called sub-prime, into packages called “collateralized debt obligations” which were sold to investors as a secure rather than risky investment – the theory being that the averaging out of many debts somehow created a better grade of risk.The government has acted to protect the corporate interests, which may suggest some corporate influence in Washington. This is hardly surprising, given the inordinate cost of running for election in the US, which requires millions of dollars each month just to stand a chance. Unfortunately, this prevents the customary and essential natural selection process, which would weed out the less responsible companies and strengthen the economy.If you want to find out how to profit from the corporate influence, and learn more about the stock market, you can take a free course, available at www.insightsupport.com.