Value investor with a deep passion for understanding and a desire to improve results over time.
Lesser-Known Stock Market Crashes
Two years are etched into the brains of nearly every investor: 1929 and 2008. It's for a good reason: these stock market crashes are among the worst in history, and like a kid who is burned by a hot stove for the first time, that's not the sort of lesson you tend to forget.
However, not all crashes are created equally, and we're going to take a look at three stock market crashes that differ in meaningful ways from the bigger ones but which also share similar characteristics, especially the idea of contagion across unexpected markets.
This spotted dive through history visits Japan, Russia, and the United States, but as we'll see, all three were both influenced and were caused by events in other parts of the world, and all three have their own unique lessons to teach us.
1. A Lost Decade: The Japanese Asset Bubble (1992)
If you lived through the Global Financial Crisis of 2008, you are probably well aware of real estate bubbles. While the Great Recession is the granddaddy of asset bubbles, the Japanese Asset Bubble of 1992 provides great insight into how markets work.
First, the prices of real estate kept going up and up, and to describe this trajectory as anything short of a mega-bubble would be disingenuous. At one point, the Imperial Palace of Tokyo was estimated to be worth more than the entire US state of California, and individual buildings in Japan were worth more than entire cities in the US.
Meanwhile, stocks were also going to the moon since the intoxicating appreciation in real estate was contagious. Speculation jumped into the driver's seat, and the Nikeei 225, a widely referenced index of Japanese stocks, quintupled in just about eight years.
Now, bubbles usually burst, but not all of them stop with a precipitous crash, nor do they all crash at the same rate. Japan's crash was unusually slow in a way: the 225 crashed about 40% in a year, then continued a very slow, steady decline from 1992 until about 2010. "Lost Decade" is very generous, indeed.
2. 1973: The Triple Whammy Crisis
In 1973, a perfect storm of events flooded global markets. First, the "Nifty Fifty," a group of stocks adored by Wall Street, built up a lot of steam starting with the late '60s. These stocks were the darlings of the day, similar to FAANG stocks in the 2000s or dot-com stocks in the late '90s, with valuations seemingly unimportant.
The feeling that you couldn't buy at too high a price, since the stocks always went up, pervaded. Inevitably, this classic stock market bubble was fueled by P/E ratios in the 70s (and higher), and the crash back to earth meant enormous losses: Polaroid, a seemingly invulnerable company, lost 91% of its value at the bottom).
Lots of Americans who lived through the '70s remember the OPEC Oil Embargo, a geopolitical even with enormous consequences for the world's economy that are still resonating today. Long gas lines pervaded the US as even-numbered license plates bought gas on one day, while odd numbers were allowed to buy the next day. This oil shortage caused price spikes, disrupting price stability everywhere, and the contagion led to a nasty contraction in the real economy.
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Finally, Richard Nixon had a double-barreled shotgun blast to add to the mix. Between 1971 and 1973, due to mounting pressure, Nixon took the United States off of the gold standard, which had been enforced by the Bretton Woods system since 1944.
This "Nixon shock" resonated around the world, but the resignation due to Watergate was another nail in the coffin of the stock market. "Tricky Dick" added insult to injury by resigning over the Watergate scandal, shattering the image of the office of the President forever and causing a great deal of market pessimism.
3. Russian Ruble Crisis (1998)
History often has a funny way of repeating through cycles; hopefully, Russia's 21st-century ruble crisis doesn't prove to be as devastating to markets as 1998's version 1.0.
In the late '90s, investors and economists alike were optimistic about the future of the former USSR, and optimism for a new market-based economy led capital into the country. Meanwhile, war in Chechnya caused Russia to run a fiscal deficit, meaning they plowed further and further into debt by spending more than they brought in.
Under optimal circumstances, this wouldn't necessarily amount to much, but since Russia relied so much on oil, a sharp decline in prices due in part to the Asian Financial Crisis (see the pattern of contagion again?) put serious pressure on Russia's ability to service its debts. Eventually, the interest payments on the debt they owed surpassed Russia's GDP, creating a rapid downward spiral of desperation.
When a government doesn't pay back its debts, that's called a sovereign default. Sovereign defaults are very, very bad for trust in a nation's currency. What reason would anyone have to think the ruble would have strong purchasing power, given that the nation just broke its agreement to pay its debts?
As faith in the currency fell, so fell Russian markets. The ruble fell some 2/3 in a month at its worst, and investors largely steered clear of investing in their markets for a decade. Russia's economy recovered relatively quickly, however, due to a recovery in the price of oil (go figure).
Study the Cycles
As you can see, these crises were precipitated by a wide range of events. Speculation in asset prices (Japan), too much debt (Russia), and a combination of malaise and a lack of trust in the dollar (US) were immediate triggers, but outside events going on between other nations were already laying minefields in each case.
In all three cases, the contagion spread to the rest of the world as investors searched for safe havens for capital, driving other prices up and rocking the markets. It is often said that history does not repeat, but it does rhyme, and while the next crash won't look exactly like the three above, there's a very good chance that it shares similar characteristics.
By examining the past, we're not necessarily doomed to repeat the mistakes of our ancestors, and while we might not be able to anticipate every crash, there's plenty we can do to be ready just in case it happens. You might enjoy a specific article I wrote with this in mind, 3 Ways to Use Cash to Protect Your Portfolio From a Crash. Thanks for reading all the way to the end!
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2022 Andrew Smith