History is peppered with crises and crashes. Capital Hill charts financial crashes – from the bursting of the tulip bulb bubble in 1637 to the present day. How did markets recover and what can investors learn from history?
The triggers might be different, but the result is always the same – market crashes are followed by recoveries. While the oft-quoted investment maxim that ‘past performance is no guarantee of future returns’ remains as true today as it has ever been, a brief look at history can serve as a reminder for investors to hold their nerve, take a long-term view and ride out short-term volatility.
Capital Hill recounts a short history of market crashes and recoveries – and what today’s investors can learn from the past:
Tulip bulbs are widely regarded as the subject of the first financial bubble. Introduced to Holland in 1593, tulips became widely sought-after, particularly after the plant contracted a virus that gave its petals a multicoloured hue. In what became known as tulip mania, or ‘tulpenmanie’ in Dutch, people spent their life savings to get their hands on the exotic bulbs.
“This reached such frenzy that at its peak in the winter of 1636 individual bulbs were being traded at a price equivalent to seven years’ earnings for a skilled worker,” said Steve Forbes, managing director of Alan Steel Asset Management. “Three months after the peak the price of bulbs had fallen by more than 99%.”
The crash, in February 1637, had its roots in Haarlem, north Holland. The city was suffering an outbreak of the bubonic plague – one explanation for a routine bulb auction not attracting many buyers.
Crucially, the crisis had no critical influence on the prosperity of the Dutch Republic, which was the world’s leading economic and financial power in the 17th century. From about 1600 to 1720 the Dutch had the highest per capita income in the world. More importantly, people started learning about the dangers of herd mentality in the financial world.
The ‘roaring 20s’ was a decade of economic growth and prosperity, driven by recovery from wartime devastation and deferred spending. Overconfidence in the stock market created an unsustainable asset bubble.
By mid-1929, the cracks were beginning to show. There were signs of a slowdown in the economy, with declining production, rising unemployment, low wages and mounting debt.
The stock market reacted strongly to this weaker economic reality. ‘Black Tuesday’ on 29 October 1929 saw the Dow Jones Industrial Average, an index of 30 prominent US companies, shed 12%, taking it down almost 25% from its 3 September peak. It destroyed confidence in Wall Street and triggered the Great Depression – a severe economic depression that lasted for most of the 30s.
© Hulton Archive/Getty Images
President Roosevelt’s ‘New Deal’ programme, enacted between 1933 and 1939 to bring about the ‘three Rs’ of relief, recovery and reform, set a precedent for a federal government to play a key role in the economic and social affairs of a nation.
The Dow bottomed out in July 1932 with an 89% loss – making it the worst bear market in modern history. It took almost 25 years, until November 1954, for it to recoup all its losses. Investors learned the importance of not overpaying for stocks and of having a well-diversified portfolio.
© Hearst Newspapers/Getty Images
In the autumn of 1987, stock markets were amidst a five-year bull-run. The global economy had recovered from the recession and stagnation of the 70s. Credit was expanding, house prices were rising and investors were in a bullish mood. That soon changed.
On 19 October 1987, stock markets in Asia, Europe and the US went into freefall, dropping more than 20%, in what became known as ‘Black Monday’. In the US, the Dow Jones fell 23% – almost double the previous one-day record set during the Wall Street crash.
Worries over a turn in fortunes for the global economy and rising inflation played a part in unnerving investors, as did political tensions between the US and Iran. But it was the introduction of computerised trading that really accelerated the crash.
“The idea of using computer systems to deal with large-scale trades was very new at the time,” said Michelle Pearce-Burke, co-founder of online investment service Wealthify. “Some systems would automatically sell stocks when a specific loss target was reached. Prices were pushed down and a domino effect started.”
This highlighted the downward spiral effect of mass selling into a bear market. The downturn did not last long. With the help of central banks who cut interest rates, financial markets in the US and Europe recovered fully. In fact, five years later, markets were rising by up to 15% a year.
The commercialisation of the internet in the 90s led to a mentality of ‘if you build it, they will come’. Waves of investor capital fuelled start-ups, despite them being loss-making. The phrase ‘irrational exuberance’ was coined to describe the environment.
“At the height of the dotcom bubble, the major driver of market sentiment was FOMO – fear of missing out,” said Jerry Thomas, head of global equities at Sarasin & Partners.
“Stock market winners were determined by the likes of ‘Queen of the Net’ Marie Meeker, and Henry Blodget, head of the Merrill Lynch global internet research team. The IPO market was vibrant, and investors were piling into new listings – even if these companies often lacked stable cash flows, demonstrable track records or coherent business plans.”
Significant fraudulent activity also characterised the period as companies looked to justify their lofty valuations by artificially inflating revenues and notional profits.
© Peter Morgan/REUTERS
The bubble burst in March 2000 when the tech-dominated Nasdaq index peaked at more than 5,000 having experienced a five-fold increase in the preceding five years. It lost more than 20% in April and 80% from peak to trough in October 2002. It took 15 years, until March 2015, for the Nasdaq to regain its dotcom peak. It has since rallied around 85% to 9,300.
Tech companies are benefiting from the current environment of remote working and a longer-term digitisation trend, so remain hugely attractive to investors today, but they have learned the importance of solid earnings visibility over a multi-year timeframe.
© Chip East/REUTERS
In September 2008, Wall Street banking giant Lehman Brothers filed for bankruptcy having been hit by exposure to sub-prime mortgages. Its collapse spread mass panic and turned a credit crunch into a full-blown global financial crisis.
Countries around the world slumped into recession. In 2009, the UK economy shrank by 4.2% and unemployment rose to 7.6%. Governments were quick to intervene to ignite economic growth. Central banks cut interest rates to historic lows to stimulate consumption and investment. The crisis underlined the importance of financial regulation and supervision, and tougher regulations were introduced to safeguard against future excesses.
Markets were quick to recover. The UK stock market lost around 42% but trimmed losses to just 8% by the end of 2009. “This shows the resilience of markets as a whole and that with a well-structured portfolio even the trickiest market environments can be navigated,” said Joe Healey, an investment research analyst at the Share Centre.
Continuing to put capital to work in markets when they are low pays off over the long term. An investor who allocated £1,000 per year, drip-fed monthly, into a simple S&P 500 tracker in the five years leading up to and following the crisis would have lost 34% at the depths of it but made 62% if they stuck to their strategy, Share Centre figures show.
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Jennifer is an award-winning British financial journalist. She left The Sunday Times, where she was deputy Money editor, to set up her own company, mediahill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper. She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.
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