FORECASTS & TRENDS E-LETTER
by Spencer Wright
August 20, 2024

IN THIS ISSUE:

1. The Anatomy of a Market Crash

2. A Brief History of Crashes

3. Market Crashes vs. Market Corrections and a History of Corrections

4. Final Thoughts

Most people recognize the necessity of investing for long-term financial security. Whether you are a passive index investor, an active trader or use professional third parties to manage your assets, one thing is true. Given enough time in the markets you will experience at least one major crash.

These extreme market events have had many different names over the centuries, yes centuries. From manias to panics, from crisis to crash, these high volatility dislocations share some commonality.

The Anatomy of a Market Crash

While the circumstances and root causes of crashes are particular to each event, they do share certain factors. Here are some common characteristics found in most crashes:

• Sudden and Abrupt Decline: Market crashes are marked by a rapid and unexpected drop in stock prices, often exceeding 20% in a short period.
• Panic Selling: Investors rush to sell their assets, exacerbating the decline and creating a self-reinforcing feedback loop.
• Excessive Optimism: Market crashes often follow periods of excessive optimism, speculation and economic bubbles.
• Lack of Regulation: Inadequate regulation or oversight can contribute to market instability and increase the likelihood of a crash.
• News Events: Significant news events, such as wars, natural disasters, or economic crises, can trigger a market crash.
• System Glitches: Technical issues or trading platform failures can also trigger a rapid sell-off and market crash.
• Margin Debt: High levels of margin debt and leverage can amplify market volatility and increase the severity of a crash.
• Price-Earnings Ratios: Elevated price-earnings ratios can indicate a market bubble, making a crash more likely.
• Crowd Psychology: Market crashes often involve a collective psychological shift, where investors’ expectations and sentiment suddenly change, leading to a rapid sell-off.
• Long-Term Economic Factors: Underlying economic issues, such as economic decline, debt or imbalances, can contribute to a market crash.

A Brief History of Crashes

Let’s look at the first market crash and the most recent.

As you may know, the first market crash was the Dutch Tulip Mania in 1637.

Believe it or not, there was a period in the 17^th century, over 150 years before the founding of the United States, when the Dutch tulip was the most sought-after commodity in the world. At its peak a single tulip bulb could buy a house in Amsterdam. As you can see in the graphic above, prices rose steadily over the first three years as demand for tulip bulbs grew. In year four, the public entered the fray hoping to strike it rich quickly. This sparked a big increase in demand and an unsustainable rise in price. What followed was a shift from investing to mania, ultimately leading to a total bust when hundreds of thousands of speculators were wiped out and severe damage was done to the Dutch economy.

The Tulip Mania crash exhibited many of the characteristics mentioned above. In particular, we can see excessive investor optimism, lack of regulation, crowd psychology and panic selling.

There have been many other crashes since. Notably was the credit crisis of 1772-1773, which began in London and spread across Europe and the Americas. Some consider this to be the first modern global financial crisis. Other U.S.-centered panics occurred in 1819, 1837, 1857, 1873, 1893, 1901, 1907 and, of course, the start of the Great Depression in 1929.

Now let’s look at the most recent crash, the Covid crash of 2020.

This massive 30% decline took less than a month and was not the result of systemic failure, economic duress or rampant speculation. It was a true “black swan event” – a one-off that came out of nowhere. The move was the most rapid 30% decline in the history of markets, taking only 33 trading days to realize. This decline was sparked by pure panic selling and fear of the unknown. What might have been equally as powerful was its ‘V’ shaped recovery.

You might be wondering why the 2020 Covid event is the most recent crash and not the global market decline in 2022. The 2022 drop was not a crash, but rather a market correction in response to the Federal Reserve’s tightening policy to cool inflation – a planned negative market stimulus. This leads us to a discussion of the differences between crashes and corrections.

Market Crashes vs. Market Corrections and a History of Corrections

As I mentioned earlier, a market crash generally happens when one or more factors in the bulleted points above occur. A correction is the result of more healthy market factors, such as a rapid rise over a short period of time that results in a pullback while profits are booked. We can also see a correction as the result of central bank action, like the bear market of 2022.

A bear market is not a crash. Crashes are sudden and destructive, usually for years. Corrections are shorter, usually shallower and are necessary for a healthy and well-functioning market. Some of the most dramatic up moves come during bear markets. Consider this list of market crashes and corrections for the S&P 500.

In this case the corrections are in blue, and the crashes are in red. The cut off between the two is less than or greater than a 20% drop in the markets. As you can see, there have only been 10 ‘crashes’ over the last 70 years.

Now consider what is not pictured, that being the corrections of 10% or less. There are many, many of these. Consider this chart.

The above data is somewhat out of date, but it provides a good example of the frequency of typical market declines.

Many of these corrective periods take place in bull markets. Think of it like this: the market’s occasional pauses are the energy required to keep moving higher. Frankly, investors should be encouraged that there have only been 36 significant market disruptions from 1950 to the present. While there can be volatility and pullbacks for many reasons, the market always regains its footing.

Final Thoughts

As you can see, there is a big difference between market crashes and market corrections. Market corrections are common and are nothing to fear. In fact, they go unnoticed by most investors. Market crashes, panics, manias, etc., are another matter. They inflict significant financial damage that usually takes a long time to heal. But the market does heal. It has every time.

Thanks for reading,

Forecasts & Trends is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.