Stock market goes through bubble and crash as a part of business cycle. All US stock market crashes are backed by bubble.
Now we will examine how us stock market went through all the crash and bubble and how market was also recovered in the last 100 years.
Here we will also discuss the reasons behind major stock market bubbles and crashes.
stock market crash 1929:
1929 stock market crash is one of the major stock market crashes in US history, as this stock market tumbled led to the great depression to the USA from 1929.
Before stock market crash, Dow had a long bull market started from 1921.After almost a decade bull run, stock market faced historical 1929 October crash. This crash is famously known as “Black Thursday”.
Dow index hits 381 points in in 1929. Lots of people made money based on speculation during this period without considering the fundamental of the underlying stock.
Great depression stock market also induced investors to invest heavily using leveraged capital.
As stock market started to fall down, lots of investor had to close their position because of margin call from their broker.
Dow index took 25 years to come back 1929 level from 1929 stock market crash.Reasons for stock market crash in 1929:
1.High P/E Ratio:
During 1929 us stock market crash, stock average P/E ratio was 60. This ratio is too high even considering today’s world.
2. High leveraged buying:
Investor could buy stock with high margin. The margin for the stock was only 10 percent of the total value.
As investors started to speculate the stock for high gain with high leveraged buying, a very small market correction forced investor to liquidate their position with huge loss.
3.Tight monetary policy:
Fed monetary policy was also responsible for the 1929 stock market crash. High interest rate of margin buying made it difficult for investors to pay back broker money.
Parabolic movement in stock market indicates exuberance buying without proper investment knowledge.
High stock trading volume also confirms this idea. As stock hit all time high in 1929, stock began to move down.
This correction leads to stock market crash as no other buyers were available to buy stock during that period
Stock market crash 1987– Black Monday
1987 stock market crash is another major stock market crash in USA history. Infamous “Black Monday” is related with the stock market crash of 1987.
Bull market started in 1982 and end up with 1987 market crash. Dow fall down 22 percent in a single day. That is largest drop in Dow’s history.
In 1982’s bull market was fueled by merger, leveraged buyout and take over. Stock market become almost doubled from 1986 t0 1987.
Dow Jones index hits 2000 points during this time.Reasons for 1987 stock market crash:
1.Use of program trading:
Many analysts believe that use of computer algorithm to buy and sell stock by large financial institution is the reason for this crash.
Some experts believe that coordination problem between underlying stock and derivative is the reason for the stock market crash.
3.lack of liquidity:
Some people believe that lack of liquidity was another problem in the market that induced market crash.
P/E ratio was high for the major market indexes during the crash.
As we know if stock started to move on parabolic style that means there is a lot of exuberance buyer in the market. And a market correction was due in the future.
May be above mentioned reasons make the crash imminent, but from chart movement and business cycle view a correction was expected in the market.
The Dot-com Bubble or tech bubble
US stock market is characterized by dot-com bubble during this period. Tech bubble started at 1991 and was almost 10 years long.
This bull market was not only one of the longest bubble in the history, but also induced a major crashes of the US stock market.
This bubble was propelled by Technology Company. That’s why this bubble is called dot-com bubble. Technology company founder became extremely wealthy and NASDAQ composite index exceed 5000 points from 350.
Some people started to believe this bubble as a starting point of new economy where traditional business cycle and recession is a past thing.
Some of the well-known company’s in tech bubble are amazon, CISCO. Us stock market lost $ 8 trillion asset during this crash.Reasons for the Dot-com Bubble
Stock overvaluation is one of the main reason for dot com bubble. Lot of companies were not profitable but they had the valuation over billion doller.
lax accounting system in corporate culture induced fraud accounting balance sheet and companies hid their debt to the investor.
During this period, day trading become highly popular. Any one can start trading without any obligation. As most of the day trader were inexperienced, they lost most of the money.
Dot com bubble started at the beginning of 1990 and busted at 2000. During this period NASDAQ composite moves from 350 to above 5000 points.
In other words, Nasdaq composite raised 1400 percent during this period.
Market started to move parabolic pattern at the beginning of 1999 and moved till the crash at 2000. Dot com bubble busted on march 2000 and Nasdaq composite loose more than 3000 points in just one year.
Stock market crash in 2008
Stock market crash in 2008 also known as housing bubble or subprime mortgage bubble. This crash was similar like great depression in1929.
Subprime mortgage was lending to the home loan to the borrower who had lower credit rating than average homeowner credit rating and borrower ability to pay loan back was lower than average home owner.
This type of mortgage had high risk of default. However, government eased mortgage loan policy so more people became home owner in USA.
Because of this policy, homeowner percentage was increased to 69 percent in 2007 that was all time high for USA. Disadvantage with this policy was that as less qualified people got the mortgage they were unable to pay monthly mortgage installment and many people became default because of that.
Another point is as more people were qualified for mortgage, the number of home buyer had increased. As supply of home buyer increased, the price for house went up.
More people stepped into this game when they saw good opportunity to make money as housing price went up. Subprime loan increased from 332 billion to 1.3 trillion from 2003 t0 2007.
Dow reached its peak at 2007. After that index started to show its weakness and was holding in a range from 14000 points to 11000 points more than one year.
DOW broke its support level at June 2008, DJIA was completely collapsed and lost more than 3000 point by October 2008.
After some consolidation stock made its final move and reached the bottom above 6500 points at March 2009. The stock market crash of 2008s’ major events:
1.Lehman brother collapse:
Lehman brothers was one big investment bank of Wall Street. 2008 financial crash hit this bank because of their overexposure to subprime landing.
Lehman brothers bankruptcy filing was the largest bankruptcy of the US history. Dow fall down 499 points because of that events.
2.Bear Stearn’s fall down:
Bear Stearn was the first financial entity that was collapsed because of subprime crisis. Bear Stearn stock price fall hardly and bank was facing liquidity crisis to run the operation.
Latter it merged with JP Morgan Chase with 90 percent less value.
3.Fannie Mae and Freddie Mac Fall:
Fannie Mae and Freddie Mac are two government sponsored entity faced big problem because of housing market bust.
These two entities had more 5 trillion dollar Mortgaged backed Securities (MBS) and debt outstanding with 1.5 trillion dollar debt. Government took over these two entities because of possible collapse of these 2 entities.
Bull market 2oo9:
2009 bull market has begun as Fed injected money to recover the stock market, stabilize the financial system, and pump the economy’s growth. Fed also introduced zero interest rate for rapid recovery of the financial system.
As an early stage bull market from 2009 to 2014, stock market made an impressive growth. S&P return during this period was 165 percent or annualized return is 17.69 percent and DOW jones return was 142.097% or 15.877% annualized return.
Stock Market crash August 2015
After S&P make new high in May 2015, index was making sideways move and this sideways was almost 6 month long.
Market veterans were expecting a market correction because all the major indexes were tried to make new high but failed several time.
S&P 500 broke down the sideways at august 20 2015 from 2076 and reached its bottom to 1876 at august 24. S&P 500 index lost 9 percent value in 5 days only.
On the other hand Dow lost more than 1000 points in august 24 2015, the 8th largest loss of DOW index in the history of Dow.Possible reason for market crash 2015
1.Stock is overvalued:
According to Nobel Prize-winning economist Robert Shiller’s adjusted price-to-earnings (CAPE) ratio, S&P 500 historic average is 17. The ratio was 27 at FEB 2015, 58% higher than historic average.
According to Shiller S&P 500 and Dow should come back to 1300 and 11000 respectively for corresponding the historic average. That is 30 percent decline to stock market.
When stock market heat the 20 percent decline, this is considered as official bear market in US stock market.( Risk of big stock drops grows: Robert Shiller).
Right now CAPE ratio is 25 percent that is still 47 percent higher than than historic average.
2.Market Correction was due:
Market was not making any 10 percent correction last 36 month. This is one of 5th longest time in SP500 history stock market without correction, according to Gail Dudack, chief investment strategist at Dudack Research Group.
Stock market data indicates this kind of long due correction kick off the possible bear market. However, the other streaks that were longer than current steak end up with average 31 percent selloff.
3.End of Fed QE and Possible Interest rate Hike:
Current bull market was started by Fed’s incentive to stabilize the stock market and financial system. The Fed implemented this strategy through
4.Quantitative Easing (QE) and Zero Interest Rate Policy (ZIRP):
Fed QE was divided into three sessions and QE ended in October 2014. This QE and Zero Interest Rate Policy boosted stock market and initiate new bull market in 2009.
As QE ended in 2014 and possible interest rate hike in 2015, stock market went to the sideways first six month of the 2015.
In August stock market showed weakness to move higher and ultimately broke long time support in august 20 2015. Stock made 10 percent correction august 24 2015.
Second possible stock market correction January 2016:
After august 2015 stock market crash, indexes made a short rally. Dow moved from 15370 point to 17977 points. SP 500, NASDAQ followed the Dow. Dow was holding above 17000 point from October to beginning of January.
At the beginning of January broke 3 month support line of 17000 points and quickly came down to 15450. Dow was down more than 2500 points or 14 percent from its November 2015 peak point during this time.
This market correction seems different than the previous august correction.The stock market crash of August,2015, market moved up quickly and was holding closely 18000 points almost 3 month.
But after January market correction, market make a very small rally and went up to 16500 points. After that Dow started to pull back now holding below 16000 points.
Another points is that most of major stocks including apple, amazon, LinkedIn went down even more than Dow index.
This was alarming, because major stock prices fallen down than the major indexes indicates investors’ confidence for investing or holding investment are low. This happens before of the starts of the bear market.