One year ago today, the S&P 500 reached its lowest point in the coronavirus-induced market crash. The benchmark index bottomed out at 2,237 on March 23, 2020, following some of the largest down days in market history.
On March 16, the S&P 500 dropped 12%, the same day the stock market’s “fear gauge,” -the Cboe VIX volatility index- closed at a record high. Insider spoke with two analysts to unpack a rollercoaster year for financial markets.
“There was almost a sense of numbness to the continued volatility, but because of the uniqueness of the crisis, there was also a real sense of ‘how low can we go?'” said Ross Mayfield, a Baird investment strategy analyst. “It was also coupled with the panic in the real world – grocery shelves were ransacked, the streets were empty, and there was a real fear amongst most people I talked to.”
Megan Horneman, director of portfolio strategy of Verdence Capital Advisors, said her team tried to focus on the buying opportunity presented instead of worrying about the collapse of the financial markets at the height of the crash last year.
“We added equity exposure and credit exposure throughout March 2020 because we knew the government would be pumping trillions of dollars into the economy to get us through the self-inflicted recession,” she told Insider.
By early June, the S&P 500 was back within a few percentage points of all-time highs.
“The surprise was in the strength of the rebound,” Mayfield said. “Almost everyone figured it had to crash again or retest the lows, and it just never did (even as the pandemic worsened into the summer).”
While the S&P 500 saw a healthy rebound, investors also began to pour their cash into more speculative assets. Horneman said one of the most surprising parts of the market rebound was witnessing how “massive liquidity can fuel speculation.” She cited the GameStop rally and bitcoin’s nearly 800% run-up as two examples of cash-fueled investors stepping out further on the risk curve in 2020.
Horneman has now seen a shift in market sentiment. While the initial rebound was driven by low rates and stimulus, now stocks have been guided by optimism around the rollout of the vaccine and reopening of the economy. This can be seen by the rotation from stay-at-home tech stocks into stocks that hinge on a reopening, like travel and entertainment names.
The S&P 500 has now gained 76% since its lowest point one year ago. The analysts expect the next leg of the rally to continue to be supported by stimulus and accommodative policy from the Fed, but they also see economic growth driving the market higher.
“In the end the most supportive factor will be the reopening of the global economy. We have the cure, the vaccine,” said Horneman.” Once we can reopen the global economy we will be left with massive stimulus, healthy corporate and consumer balance sheets and substantial pent up demand. This should lead to a multi-year acceleration in economic growth.”
Warren Buffett’s preferred market gauge has surged to an all-time high, signaling global stocks are extremely overpriced and could crash in the coming months.
The global version of the “Buffett indicator” has breached 123%, surpassing its previous record of 121% during the dot-com bubble. The milestone was first highlighted by the Welt market analyst Holger Zschaepitz on Twitter.
The metric takes the combined market capitalizations of publicly traded stocks worldwide, and divides it by global gross domestic product. A reading of 100% or more suggests the global stock market is overvalued relative to the world economy.
Buffett, the billionaire investor who runs Berkshire Hathaway, trumpeted the indicator in a Fortune magazine article in 2001. He described it as “probably the best single measure of where valuations stand at any given moment.”
When the yardstick hit a record high before the dot-com bubble burst, that should have been a “very strong warning signal,” Buffett added.
However, Buffett’s favorite indicator has several shortcomings. For example, it compares current stock valuations to past GDP figures. Not all countries provide regular, reliable GDP data either.
The gauge’s elevated level also reflects the fact that pandemic-linked lockdowns, business closures, and travel restrictions have depressed economic growth. Meanwhile, government interventions have artificially pumped up stock prices.
For example, the Buffett indicator continues to flirt with record highs in the US, partly because federal officials have pumped trillions of dollars into the economy over the past year.
Here’s the global version of the Buffett indicator:
The stock market is constantly moving, prices of individual equities rising and falling throughout the trading day. Whenever the majority of them – or a representative group of them, called a stock market index – takes an especially large dive, a panicked cry often arises:
“The stock market has crashed!”Stock market crashes are certainly scary: Hundreds of investments decline their value, investors lose thousands of dollars – on paper, anyway.
But what causes them? And what are the after-effects?
Here is a closer look at what a stock market crash really is and what you need to know before one impacts your portfolio.
What happens when a stock market crashes?
There are many definitions of what a stock market crash is. Some categorize a crash strictly as a stock market or a stock market index (a representative sampling of stocks) losing more than 10% of its value in a single day. Others provide a more general view, simply stating that a crash is a significant or dramatic loss in the stock market’s value, and the prices of shares overall, usually within a short period of time.
Any way you look at it, a stock market crash happens when confidence and/or value placed in publicly traded assets goes down, causing investors to sell their positions, and move away from active investing, and towards keeping their money in cash, or the equivalent.
The impact of a crash can vary as well. Sometimes, it’s limited. For example, on Oct. 19, 1987, after five years in a strong bull market, the Dow Jones Industrial Average (DJIA) and S&P 500 both dropped over 20%, following markets throughout Asia and across Europe. The crash was short and markets quickly recovered.Within a few days, the DJIA regained more than 43% of the points it lost and within nearly two years the market had recovered almost 100%.
At other times, the effects are widespread, and longer-lasting. The most notorious example is the Crash of 1929. Stock prices dropped first on Oct. 24th, briefly rallied – and then went into free fall on Oct. 28-29. Ultimately, the market lost 85% of its value. Though not the sole cause, this crash was one of the contributing factors of the Great Depression, the worst economic period in American history, lasting nearly 10 years.
What causes a stock market crash?
Historically, stock market crashes often occur after a long period of economic and/or market growth. Confidence in the economy, steady stock gains, and low unemployment are all drivers of bull markets, as these sustained rallies are known. As more and more stocks are purchased, prices go up – both of individual equities and of the stock indexes themselves.
But in the world of securities, prices can’t keep rising indefinitely, and bull markets can only last for so long before something happens to turn the tide. Sometimes it’s a general shift in sentiment, as in 1929, but usually some precipitating event occurs.
Numerous things can cause a stock market to crash, including:
Panic: This is one of the most common contributing factors to a crash. Stockholders who fear the value of their investments are in danger of dropping will sell their shares to protect their money; as prices begin to drop, the fear spreads, more sales ensue, and this can lead to a crash. Anything from a major player in the market having financial troubles to fears about the impact specific legislation may have can cause scores of investors to panic and sell off stock.
Natural or man-made disasters: These can include all sorts of catastrophes, from floods to wars to pandemics. Case in point: the coronavirus-induced crash of March 2020. As realization of the spread of COVID-19 began to take hold, the economic outlook for the US and countries worldwide began to look grim. While countries announced travel limitations, mandatory business shutdowns, and quarantines, consumers stocked up on essential supplies causing shortages, companies began protecting profit margins through layoffs and furloughs, and investors started selling off stocks.
Economic crises: A problem in industry or one section of the economy often has a ripple effect. One example is the subprime mortgage crisis, which unfolded over 2007-2008. Earlier in the decade, deregulation in the banking industry had led to an increase in mortgages to high-risk borrowers since the beginning of the decade. When these borrowers began defaulting on payments, home prices dropped, and the housing market collapsed. Even worse, many of the now-worthless mortgages had been packaged and sold off to institutional investors – who in turn lost billions on them. Big firms began to fold, and the stock market reacted sharply. From Sept. 19 to Oct. 10, the Dow Jones Industrial Index declined 3,600 points.
Speculation: When you have people and companies investing in a sector in the hopes that an asset or security will grow or based on future performance expectations, you have speculation that often creates a bubble. If the performance disappoints, and hype doesn’t live up to the reality, the bubble bursts and a mass sell-off occurs.
The 20 biggest drops in the New York Stock Exchange, ranked by percentage drop in the Dow
Dow Jones Industrial Average
drop in points
October 19, 1987
March 16, 2020
October 28, 1929
October 29, 1929
March 12, 2020
November 6, 1929
December 18, 1899
August 12, 1932
March 14, 1907
October 26, 1987
October 15, 2008
July 21, 1933
March 9, 2020
October 18, 1937
December 1, 2008
October 9, 2008
February 1, 1917
October 27, 1997
October 5, 1932
September 17, 2001
Source: Dow Jones S & P Indices
An example of a stock market crash
Sometimes, crashes are due to several factors. One example is the Dotcom Bubble-induced Crash of 2002.
It started with speculation. A boom of investing in internet companies prevailed through much of the late 1990s. E-commerce was the new frontier for investors and money flooded the rapidly evolving technology sector and inflated valuations beyond profits these companies could ever realistically provide.
Venture capitalists swooped in early to provide funding to dotcoms that were on the rise towards going public, quickly cashing out after their overpriced debuts. Excitement over internet tech and the future of business mixed with companies that had yet to turn a profit pumped up an economic bubble.
In 2000, the Federal Reserve increased interest rates (partly to stem the overheated investment activity) and poor financial performance from dotcoms began to surface, bursting the bubble and throwing the NASDAQ index into a bear market. By October 2002, the tech-heavy Nasdaq Composite index had fallen more than 75% from its March 2000 height of 5,048.62.
A recession began, which was exacerbated by the Sept. 11, 2001 terrorist attacks in New York City that shut down the New York Stock Exchange and other markets for several days. In between the economic uncertainty and the shadow of war, stocks crashed when trading resumed on Sept. 17. The government had to step in with economic stimulus policies before the economy as a whole began to recover from two major blows so close together.
Can a stock market crash be prevented?
There really is no way to prevent the stock market from crashing. However, governments have added safeguards to prevent severe drops and upsets in market stability.
Once such tactic is the circuit breaker, instituted after the 1987 crash. If the S&P 500 Index experiences a drop of 7% or more over the previous day, trading in all US stock markets are halted. Depending on the severity of the drop, trading could be suspended for either a 15-minute period or the rest of the day. The purpose of this measure is to give analysts and investors time to gather enough accurate information before making trade decisions.
Large amounts of stocks might also be purchased by private investors to try and stabilize a market. In fact, that used to be quite effective a century ago, shortening the Panics of 1873 and 1906. The government itself can step in, lowering interest rates to encourage investors to borrow and buy.
But even with these mitigating factors, crashes still happen.
What should you do if the stock market crashes?
First thing: Don’t panic and sell out. Yes, it’s hard to hold on and watch your portfolio balance shrink. But unloading when prices are falling is rarely a winning move. Markets tend to shift back over time and you could end up losing money in the long term if you sell when shares are low.
Remember that crashes can be short-lived, and prices may quickly rebound.
This is especially important for older folk or retirees who are looking to live on their investment income or capital gains. They may not have enough time to recoup their losses before needing to use that money for day-to-day expenses. Becoming more anticipatory with market shifts becomes more important the closer you are to this point.
One advance strategy is to ensure that you have a strong mix of defensive stocks in your portfolio. These are securities that are much less influenced by disruptions in the market and tend to be in industries considered to be essential, such as utilities and food. If the market crashes, they may feel some financial pain. However, it will be much less than with cyclical stocks, which are in industries greatly dependent on a flourishing economy to grow.
If you see economic conditions start to shift toward leaner times, and stocks seem to be entering a prolonged sluggish phase – a bear market – you may want to pull your investment dollars out of the market and place them in a safer financial product that can still earn money. Shifting to CDs or bonds when volatility in the market is getting perilous can be a good move to safeguard your money until things stabilize.
The financial takeaway
The natural cycle of markets is to rise and fall. While crashes in the stock market can result in crippling losses, economies inevitably bounce back. This makes a strong case for taking a long-view approach to investing. That means creating a strong portfolio that will hold up to dives in market values and provide a healthy mix of securities that will grow when times are good and see you through when times are lean.
Though the thought of a market crash may be scary, recovery will eventually come. You just have to invest carefully to minimize your risks and keep a close eye on economic conditions.
Three little words strike more fear into investors’ hearts than anything else: stock market crash.
It’s not just that they mean losses (another word that scares investors). It’s also that no one knows for sure when a stock market crash is going to happen – though the signs were often there in retrospect – or even exactly what it is. There’s no one official definition.
Generally, though a stock market crash is seen as a single trading day in which a stock exchange/market drops by at least 10%. But it can also be “anytime there’s suddenly a lot of volatility that makes you wonder whether the world is coming to an end tomorrow,” says Terry Marsh, a finance professor emeritus at Haas School of Business at the University of California Berkeley.
Here’s the scoop on eight of the most notable stock market crashes in recent financial history, their causes, and their fallout. Unless otherwise noted, they occurred on US exchanges, though the effect often spread to other countries.
1. The Panic of 1907
What happened: A group of investors borrowed money from banks to finance an effort to corner shares of United Copper Company. UCC went bust under the weight of speculation, and then other firms followed: Stocks lost 15% to 20% of their value. Public confidence in banks fell and depositors rushed to withdraw their money, causing ruinous runs.
The damage: Some banks and stock brokerages failed, and many top executives at surviving financial institutions either resigned or were fired. Businesses couldn’t get bank loans, causing them to fail.
What resulted: “We learned that when more than one financial institution is in trouble,someone must inject liquidity” into the system, says Carola Frydman, a finance professor at Kellogg School of Management at Northwestern University. At the time, private financier J.P. Morgan put together a rescue package that finally restored order on the exchanges. Realizing how economically significant the stock market had become, however, the US government created the Federal Reserve System to formulate monetary policy and provide emergency funds in crises.
2. Black Monday and Tuesday, Oct. 28-29, 1929
What happened: For nearly a decade, the stock market had kept rising in a speculative spiral. Overproduction in factories and a Roaring 20s giddiness led consumers to take on too much debt and believe financial instruments would climb perpetually higher. Finally, catching on to the overheated situation, seasoned investors began cashing out. Stock prices dropped first on the 24th, briefly rallied – and then went into free fall on Oct. 28-29. The Dow Jones Industrial Average dropped 25% in those days. Ultimately, the market lost 85% of its value.
The damage: The Crash of 1929 didn’t cause the ensuing Great Depression, but it served as a wake-up call to massive underlying economic problems and exacerbated them. A panicked rush to withdraw money caused overextended banks to fail, depriving depositors of their savings. Deprived of lenders, businesses began to collapse, leading to scarcities of goods. As many as 25% of Americans ended up jobless, spurring foreclosures, migration, and demoralizing poverty. Gross domestic production (GDP) dropped 30%. The economic woe spread overseas, hitting Europe particularly hard.
What resulted: A slew of reforms and new legislation. They included the Glass Steagall Act of 1933, which separated retail banking from investment banking – and led to the creation of the Federal Deposit Insurance Corporation (FDIC) to insure bank depositor funds. The National Industrial Recovery Act was passed to promote stable growth and fair competition, and the Securities and Exchange Commission (SEC) was established to oversee the stock market and protect investors from fraudulent practices.
3. Black Monday, October 19, 1987
What happened: Sinking oil prices and US-Iran tensions had turned the market pessimistic. But what led to the wipeout was the relatively new prevalence of computerized trading programs that allowed brokers to place bigger and faster orders. Unfortunately, they also made it difficult to stop trades soon enough once prices started to plummet. Ultimately, The Dow and S&P 500 each dropped more than 20% and Nasdaq lost 11%. International stock exchanges also tumbled.
The damage: Fortunately, the crash didn’t cause a recession or hardship. Trader Blair Hull helped set things right by putting in a large order for options at the Chicago Board Options Exchange on Black Monday. The main casualty of the crash was consumer confidence. It was essentially a computer-IT “plumbing problem” that “scared people,” says Marsh.
What resulted: The financial community realized how stock exchanges around the world were interconnected. The SEC implemented circuit breakers, also known as trading curbs, to halt trading for the day once a stock exchange declines by a given amount. To ensure liquidity, then-Federal Reserve Chairman Alan Greenspan ensured credit was available and made it clear that “the Fed has your back,” says Marc Chandler, a chief market strategist at Bannockburn Global Forex.
4. Japanese Asset Bubble Burst, 1992
What happened: Japan’s real estate and stock markets had flown to unprecedented heights in the 1980s. At first backed by fundamental economic growth, the spiral had become speculative by the decade’s end. In 1992, the bubble of inflated real estate and stock prices finally burst.
The damage: The Nikkei index fell by nearly half, setting in motion a minor, slow-moving Japanese recession. There were never mass business closures – though “high-end restaurants didn’t do as much business,” says Marsh – but not much growth either. US investors weren’t hurt badly because they typically had only small amounts of Japanese stocks in their portfolios. Japanese investors, however, never fully regained their confidence in the stock market.
What resulted: The Japanese government placed subtle controls on its financial system. “Still, it took decades for the Japanese [stock] market to recover,” says Tyler Muir, an associate professor of finance at UCLA Anderson School of Management. The economy too: In fact, the 1990s are dubbed “The Lost Decade” in Japan.
5. Asia Financial Crash of 1997 (aka Tom Yum Kung Crisis)
What happened: Under pressure because the country borrowed too many US dollars, Thailand saw its baht currency collapse on July 2, 1997, declining 20% in value, and spurring debt and defaults that sent a ripple effect throughout several Asian financial systems.
The damage: Currency in other Asian countries, including Malaysia and Indonesia, tumbled as well. “In South Korea, women were giving the government their gold rings to melt down” and make into ingots for international sale to help a suddenly bankrupt nation pay off its debt, says Chandler.
What resulted: “East Asia got the lesson to self-insure” after the International Monetary Fund imposed tough measures in exchange for financial relief, says Marsh. And the crash raised awareness of the interconnectedness of regional financial markets and economies.
6. Dot-Com Bubble Burst, 2000-02
What happened: In the 1990s, with the internet revolutionizing professional and personal life, stocks in companies with “.com” after their names surged. Twelve large-cap stocks rose more than 1,000%; one, chipmaker Qualcomm, saw its stock increase more than 2,500%. Investors gobbled up shares of tech IPOs but seemed unaware that not every company tied to the World Wide Web could sustain its growth – or even had a viable. “A new economy was being born and it was hard to place a value on it,” Chandler says. But finally, people did – aided by some tighter money policies imposed by the Federal Reserve. They started to sell. By October 2002, the tech-heavy Nasdaq had fallen more than 75% from its March 2000 crescendo of 5,048.62.
The damage: Pets.com, Toys.com, and WebVan.com went out of business, along with numerous other internet companies large and small. Even larger, blue-chip tech companies suffered.
What resulted: Along with revealing that many tech startups had no clothes, “the overall downturn also exposed things that otherwise would have stayed hidden” in other firms, like accounting irregularities, says Muir. The Sarbanes-Oxley Act of 2002 was established to protect investors from corporate fraud. And “a lot of broker-dealers probably did more due diligence before they put more money into any internet funds,” says Marsh.
7. Subprime Mortgage Crisis, 2007-08
What happened: At the turn of the 21st century, real estate was hot. Hungry for commissions, lenders practically gave money to under qualified homebuyers. Investors bought up mortgage-backed securities and other new investments based on these “subprime” loans. Eventually, though, the inevitable happened: Burdened by debt, borrowers began to default, property prices fell, the investments based on them dived in value. Wall Street noticed, and in 2008 the stock market started to decline. By early September, it was down almost 20%. On Sept. 15, the Dow Jones Industrial Average dropped nearly 500 points.
The damage: Financial giants that had invested heavily in real estate securities, including venerable firms Bear Stearns and Lehman Brothers, failed. Businesses couldn’t get loans because banks “didn’t know who to trust,” says Muir. Unemployment approached 10%. The misery spread overseas, where the Nikkei dropped almost 10% on Oct. 8, 2008. The US entered the Great Recession, which officially lasted until 2009, though economic recovery remained sluggish for years.
What resulted: Through the Troubled Asset Relief Program, or TARP, the federal government rescued hobbled financial institutions; it also assumed control of other agencies, like troubled mortgage-market-makers Fannie Mae and Freddie Mac. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 regulated swaps and other exotic investments for the first time and led to the creation of the Consumer Financial Protection Bureau.
8. COVID-19 crash, March 16, 2020
What happened: By the beginning of 2020, COVID-19 had spread widely in China and then to Europe – notably Italy – and to the US, where restaurants and nonessential stores closed to stem the tide of infection.
As investors realized the extent to which the coronavirus could spread and negatively affect the economy, the stock market began to quiver. On March 16, with mandatory lockdowns being announced,the Dow Jones Industrial Average lost nearly 13% and the S&P 500 dropped 12%.
The damage: Struggling businesses furloughed or laid-off workers and some shuttered forever. Restaurants were limited to deliveries only and then partial-capacity table service. Travel restrictions kneecapped the airline and hotel industry. The human loss of the COVID pandemic has been devastating, with more than 300,000 deaths in the US and 1.5 million worldwide. As of September, more than 31 million people were either unemployed or lived with an unemployed family member, according to the Center on Budget and Policy Priorities.
What resulted: The Cares Act of 2020 allowed extended unemployment payments, and government stimulus funds helped Americans stay afloat. The stock market bounced back as e-commerce companies like Amazon, makers of personal protection equipment, and pharmaceutical companies surged in value. Many businesses whose employees worked remotely during the COVID crisis said they would continue a similar arrangement once the pandemic passes, but “it remains to be seen whether it’s a permanent shift,” says Muir.
The Financial Takeaway
Many of the above examples demonstrate how disasters that strike stock exchanges can leave positive legacies in their wake – even though they cause plenty of immediate pain.
Some stock market crashes maul economies for years. Others merely shake up investor confidence, making people more cautious in their choices. They can cause human tragedies and result in game-changing government reforms.
While the triggering events for stock crashes vary – involving everything from copper-mania to condo prices – the ultimate outcome has always been the same: The market recovers.