People love it when we talk about a stock market crash because it is one so fascinating and so horrifying of an event at the same time.
Even if you’re new to the stock market, chances are that you’ve gone through an actual stock market crash in 2020 caused by the Coronavirus pandemic.
While those who are connected with the financial markets for a long time, have seen even bigger and even worse crashes that took years to recover.
Many traders and investors are so interested in predicting a stock market crash because if you go right, you can make a fortune in a matter of weeks.
But it’s not that easy to predict anything about the market, let alone a crash. And ideally, you shouldn’t even try because more people lose money trying to predict a crash than in an actual crash.
However, studying and analyzing previous major crashes gives you much more than just the hints and ability to prepare and predict the next one.
Today, we’re going to overview the Dow Jones Industrial Average over the past 100 years and analyze all the major crashes that have taken place and how they impacted the economy and our lives. Let’s begin!
The Great Depression (Stock Market Crash 1929)
You might have heard about it many times. The stock market crash of 1929 was the biggest and the scariest crash ever in the stock market’s history.
The Dow Jones crashed nearly 90%, obviously taking the whole economy with it, bringing about what’s now referred to as the great depression.
But what caused and fueled such a humongous crash? Well, like any other crash, one of the major factors was market euphoria.
Reduced interest rates by the fed and boom in the economy, referred to as the roaring 20s, took the stock markets to uncomfortable heights fueled by the increased purchasing power of individuals.
The roaring 20s also led people and financial institutions to take too much debt and leverage to invest in the stock market.
After climbing nearly 500% in one decade from 1920 to 1929, the bubble finally burst when one fine Monday, the market corrected nearly 15%.
High-leveraged financial institutions and individuals couldn’t meet their debt obligations, and many started going bankrupt.
This event led to a loss of trust in America’s financial system, and investors started pulling out. The depression that followed was one of the worst and lasted a good three years, from 1929 to 1932.
What you can learn from this is to be careful the next time market climbs 500% in one decade. On a serious note, be extra cautious when everyone is greedy because euphoria more often than not leads to catastrophic results.
Black Monday 1987
This black Monday was quite similar to the last black Monday in 1929. The stock market plunged more than 20% in a single day. But this time around, the technology was present to add to the crash.
That morning on a fine Monday in October 1987, people woke up with the news that The US has fired missiles into Iran, which obviously made people panic and think that we’re in a war again.
When the opening bell rang that day on wall street, panic selling started taking place, which caused even more panic, and consequently, even more selling.
But it wouldn’t have been so severe had we not had the new computer trading technology that allowed brokers to place bigger and faster orders.
The panic selling didn’t stop that day because of lessening confidence in buyers and ease of placing orders, leading to a 23% loss of market value in one day.
Though the crash didn’t get worse and the markets started recovering from the very next week, it took 2 years for the markets to reach a new high.
There was, fortunately, no recession that followed Black Monday, but it taught many investors that panic selling is a bad idea.
The Dot-com Bubble Burst (2000-02)
Another catastrophic result of market euphoria was the dot-com crash, which caused the tech-heavy Nasdaq to fall over 80% in the span of 2 years.
In the late 90s, the internet was the biggest thing in the universe. It was the revolution and the emergence of a new tech-based economy, and obviously, nobody wanted to miss out.
First, entrepreneurs went crazy over this thing called the internet buying domains and creating companies to do all sorts of things online.
Watching the growth of these companies, investors started going all-in on the opportunity pouring a lot of money into them, taking the share prices to unprecedented levels.
New companies emerged out of nowhere and achieved million-dollar valuations just by adding dot-com to their names. Pets.com, Globe.com, Toys.com all became multi-million dollar companies.
But in all these glitters, one thing was missing, profits. None of these companies with billion-dollar valuations and huge sales numbers were profitable. All they were selling to investors was a promise. A promise to make some profit, sometime in the future.
The bubble grew bigger and bigger, with more companies going for blockbuster IPOs and gaining more and more in valuations.
With Federal Reserve tightening monetary policy and insiders cashing out, selling pressure was already on the rise when Japan entered a recession and Nasdaq plunged heavily in March 2000, and the bubble burst.
The market crashed, the economy entered a recession, and within months, the companies that reached $100 million valuations become worthless.
The result was a depression that lasted a couple of years and the markets took more than half a decade to recover the losses. What you can learn from the dot-com crash is that not all glitters are gold, and you shouldn’t invest in a company without strong fundamentals.
The Housing Market Crash (2008-09)
In the late 2000s, the investors were looking for new and safe sources of return. So it was the time mortgage-backed securities were introduced.
Mortgage-backed securities were hot among investors because they were apparently safe, real estate prices were soaring high, and the economy was in good shape, at least up until that point.
But as everything has its downsides, Mortgage-backed securities were no different. You see, bankers use to get a commission on every loan they lend.
So, hungry for commissions, many lenders started lending money to unqualified home buyers, people who would not be able to meet their mortgage obligations. These were called “subprime loans.”
These subprime mortgages were pooled with other mortgages and already bribed rating agencies used to give them AAA ratings, which investors happily bought.
What added to the fire was Credit Default Swaps (CDS). Issued by insurers, CDS are derivatives that payout if the mortgage borrower defaults.
Soon, the whole financial system was dependent on housing prices. The whole system was to collapse if the housing prices were to fall, which they did.
The triggering point of this crash was the fall of America’s one of the largest investment banks, Lehman Brothers. After their bankruptcy, the housing prices started free falling, which collapsed the whole system.
This led to the second most devastating economic depression since 1929. The Dow Jones plunged over 50% in the next 1.5 years.
Many companies and financial institutions were forced to shut down, and more than 2 million American jobs were lost in 2008 alone. What you should learn from this crash is that greed should never trump common sense and decency.
Covid-19 Crash (2020)
This is the one that almost all of us witnessed firsthand. The last year’s Covid-19 crash was also one of the major ones that brought a slowdown in the economy, but things were very different this time.
The stock market crashed for a reason that was not man-made, hopefully. And the fear in the minds of people was valid. A pandemic was going on that was destroying countless businesses and jobs.
People were already fearful and even counted in the upcoming recession in the price, causing the Dow Jones to fall 35% in less than 4 weeks.
But like Black Monday of 1987, technology here played an important role here too, but in a positive way. As fast the crash was, as swift was the recovery, thanks to apps like Robinhood that enabled even the most unlikely to invest in the stock market.
It just took 9 months for the market to recover all the losses and go even higher. So high, in fact, that the Dow Jones has nearly doubled from the low made in March 2020 at the time of writing.
The covid-19 crash was the shortest a market crash of more than 30% has ever lasted. We don’t know, however, if this is the new normal or we’ve just been spoiled, and some will pay a price in the next crash.