By Jean Strock, AFA 1 May 2020
As markets grapple with a government mandated shut down of economic activity in response to Covid 19 it is interesting to look back at previous market crashes to put this one into perspective.
1929 Wall Street Crash and the Great Depression
The most infamous crash was in 1929 on Wall Street followed by the Great Depression – which did not fully resolve until World War II.
The Wall St Crash followed a period of wild speculation as the world recovered from World War I and the outbreak of Spanish Flu. The Roaring Twenties saw a period of strong economic growth, electrification, the motor car and the advent of instalment credit for the purchase of consumer goods. Shares were often bought using broker loans. It turned into a classic bubble. In the last three months of 1929 the Dow Jones Index fell by 48% and by the low point of July 1932 had declined by 89%.
Worse than the initial crash was the Great Depression which followed, exacerbated by the responses of central banks as well as the severe drought which turned agricultural land in the US into the proverbial dustbowl. The Great Depression was marked by a massive fall in industrial output and deflation of 30%. Global GDP fell by 15% compared to a fall of only 1.9 % during the period of the Global Financial Crisis of 2008-091.
The central banking system was set up to be the lender of last resort yet following the Wall St crash the Federal Reserve failed to fulfil this function. It allowed a spiral of deflation and banking failures to continue, increasing interest rates instead of cutting and failing to provide liquidity to stressed banks. The collapse of many large US banks added to the panic and cash hoarding that occurred. Central bank failures were highlighted in Milton Friedman and Anna Schwartz’ famous 1963 book A Monetary History of the United States 1867 – 1960.
Ben Bernanke who governed the US Federal Reserve across the period of the GFC was a great student of the 1930’s Depression and was well placed to respond aggressively in 2008/09.
The 1970s Oil Shock
The oil shocks of 1973-74 accompanied by rampant inflation destroyed investment returns in real terms. In October 1973 the OPEC countries proclaimed an oil embargo which caused the price of oil to rise 400% by March 1974. The oil price during the Covid crisis has moved in the opposite direction, collapsing completely with falling demand and plentiful supply overloading storage facilities.
1987 Share Market Crash
The 1987 Black Monday stock market crash (arriving on the Tuesday in New Zealand) marked an abrupt fall in markets with the Dow Jones falling by 22.6% in a single day. Over October the New Zealand market declined by 30% and by the following February was down an eye watering 55%. This crash was exacerbated by stock market systems which were completely overwhelmed causing trading suspensions and closures. In most countries the economic impact was short lived and central banks provided liquidity to support financial institutions. For New Zealand, in the midst of a great liberalisation of the economy the effects were deeper and lasted longer than the rest of the world. I will explore this in a later article.
The 2008 Global Financial Crisis
The Global Financial Crisis of 2007- 2009 again originated in financial markets, was self-inflicted and took years to unwind. Financial ‘engineering’ saw the introduction of ‘collateralised debt obligations’ and ‘credit default swaps’ while in the housing market low interest loans were provided to those with no hope of paying market interest rates. The loan originators did not care, they had already bundled up the mortgages and sold them to Wall Street who on-sold them in tranches to pension funds and other investors as Triple A rated securities.
When the bankruptcy of Lehman Brothers was announced on 14 September 2008, mayhem was unleashed in financial markets. As mentioned, Ben Bernanke was the man of the hour to head off a repeat of a possible Great Depression. Treasury Secretary Henry Paulson unleased TARP (the Troubled Asset Relief Programme) and the Bernanke led Fed spent US 1.2 trillion buying financial assets and making emergency loans to shore up the financial system.
So what of the Covid 19 crisis? It is unusual in that it has not originated in the financial system or due to economic stresses, albeit markets were looking expensive. Governments have imposed varying degrees of economic shut down on businesses, in New Zealand’s case backed up by a National State of Emergency. There are very few businesses that would have included a pandemic in their SWOT analysis.
Many commentators are picking a 4th quarter rally, pointing at China’s rapid recovery. In New Zealand markets have rallied strongly since March 23 despite large companies like Air New Zealand and Auckland Airport effectively entering a period of ‘hibernation’. We are yet to see the impact on company earnings.
The hope is for a V shaped recovery and Goldman Sachs has described event driven sell offs as being shorter and sharper than more usual structural or cyclical bear markets. If there are further outbreaks of the virus the recovery could be W shaped. However, the truth is we do not know. There is a lot of real hurt and disruption still to work its way through the economy. Much will depend on governments and central banks unleashing fiscal and monetary stimulus to keep businesses solvent and the economy afloat.
Ben Bernanke has stated “with help from the Federal Reserve and from the Treasury, I’m not really expecting a major financial crisis” https://www.marketplace.org/2020/03/23/former-fed-chair-bernanke-covid19-downturn/. Let’s hope he is right.
At Saturn Advice we believe staying the course and not attempting to time the markets is likely to give investors the best outcome. If you want to discuss your individual circumstances or what we are doing to mitigate the impact of the Covid sell off on investment portfolios please get in touch.
- The Ascent of Money, Niall Ferguson, Penguin Group 2008
- Fool’s Gold, Gillian Tett, Little Brown 2009
The views expressed in this article are the views of the author. The information provided is of a general nature and is not intended to be personalised financial advice. You may seek appropriate personalised financial advice from a qualified Authorised Financial Adviser to suit your individual circumstances.