Since everyone is talking about stock market crashes this week, let’s add some context here…

Since the invention of the Dow Jones Industrial Average at the turn of the last century, there have been eleven instances in which stocks declined by more than 35% from peak to trough, or what you would term a market crash. We’ll talk about how the Dow Jones Industrial Average behaved during these crashes as it is our oldest index; there was no such thing as the S&P 500 until 1957 and the Nasdaq didn’t come along until later.

The most benign of these eleven crashes took place between January of 2000 and October of 2002. It lasted for 999 days and lopped off 37.8% of the Dow’s price, ending that fall at around 7286. The damage in the tech-heavy Nasdaq was obviously much worse but, unless you had abandoned all of your blue chips to chase dot com stocks exclusively, it wasn’t the end of the world. It should be noted that the tech crash was augmented by the uncovering of massive frauds at both Enron and WorldCom and punctuated with the September 11th attacks.

The worst of these eleven crashes took place from April of 1930 and ended July of 1932, investors had lost 86% of their money in just 813 days. This was the big one, far grislier than the 48% killer of the fall of 1929, although that ’29 crash took place in an astonishing two months. Within a few years, stocks would crash twice more. The Dow once again dropped 47% from March 1937 through March 1938 and then another 40% between September 1939 through 1942. This was followed by the Second World War and it took until the late 1940′s before stock prices had fully recovered.

The very first crash in Dow Jones history happened within a year or so of the advent of the index. In June of 1901, the Dow began to fall and it didn’t stop until November of 1903, handing investors (there weren’t many of them in those days) a brutal loss of 46% inside of 875 days. To give you some perspective of what life in America was like during this first crash of the modern era, consider the following facts:

* Life expectancy in the U.S. was 47
* Only 14% of homes had a bathtub
* Maximum speed limit in most cities was 10mph
* Average wage was 22 cents and hour – avg salary/year was about $300
* More than 95% of all births took place at home
* Only 6% of the population had graduated from High School
* The #1 cause of death was Pneumonia and Influenza
* The American flag had 45 stars

We’ve certainly come a long way since then, both in terms of society and the maturation of the modern markets. This is not to say that we don’t remain every bit as susceptible to panics and crashes as we always have. Fear and greed are the two variables that never change throughout human history and certainly since the beginning of the stock market.

Some of these eleven historic crashes had proximate causes – concrete developments we could point to that began the event. Most of them began mysteriously, with no warning or historically important reason. The cause of the 1929 crash is still shrouded in fog, all we know is that markets had been running up in a speculative fever for a decade and then one day – out of the blue –  people didn’t feel like playing anymore.

If you are reading this, it is likely that you will witness another Dow Jones crash of greater than 35% at some time during your life. It could begin tomorrow or you may not see one for decades. There is no schedule and it is unlikely that anyone will be able to pinpoint the spark in advance.

But it is important to remember the following before despairing over the pain that will someday come:

1. Crashes create opportunity and kings will be made during the next one.

2. Crashes clear the system of antiquated industries and business models, paving the way for new fortunes to be made and entirely new ways of doing business and improving our lives. Real estate gets cheap enough for young, innovative companies to take root and begin to change the world all over again. The latest 53% Dow crash, from October 2007 through March 2009, has arguably done exactly that.

3. There’s never been a stock market crash that the Dow hasn’t recovered from, and there’s never been a crash that’s gone on for longer than 1000 days before bottoming.

4. Crashes are extremely rare, while we’ve averaged one crash per decade since the Dow Jones came into existence, four of them have taken place in the span of one ten year period.

5. The Dow bottomed out at 30.88 after its very first crash. It revisited that level precisely upon bottoming out during the crash of 1906-1907 and then came close once again during the horrors of the early 1930′s. The amount of subsequent wealth creation that came as a result of weathering these periods cannot be overstated. Since the dawn of the index through last year, the Dow has returned an annual average of 9.4%  - half from capital appreciation and half from dividends. Those who’ve attempted to dance in and out, constantly expecting a crash, have likely captured very little of that, if any at all.

Most of your favorite crash-fetishists have track records that you wouldn’t wish on your worst enemy. It is one thing to be aware of the potential for terrible things to happen, it is quite another to give up on life and opportunity altogether.

Category: Investing, Markets, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

16 Responses to “Everything You Need to Know About Stock Market Crashes”

  1. b_thunder says:

    “Downtown” writes:
    “2. Crashes clear the system of antiquated industries and business models, paving the way for new fortunes to be made and entirely new ways of doing business and improving our lives. Real estate gets cheap enough for young, innovative companies to take root and begin to change the world all over again. The latest 53% Dow crash, from October 2007 through March 2009, has arguably done exactly that.”

    Really? JPM, C, BAC, WFC, GS are still around, and more TBTF than ever (not to mention weekly revelations of yet another illegal activity such as LIBOR and FX manipulation.) The Federal Gov’t is still 95% of the residential mortgage market. The Fed and the Feds are hell-bent on making RE prices unaffordable for average folks yet again.

    Crashes used to clear the system, except the “clearing” done during 2001/03 and 2007/09 is not even nearly complete.

    • BennyProfane says:

      Yes, I wish this statement would be edited:

      “Real estate gets cheap enough for young, innovative companies to take root and begin to change the world all over again. The latest 53% Dow crash, from October 2007 through March 2009, has arguably done exactly that.”

      Maybe in Detroit, but, RE has a long way to drop elsewhere before kids with college debt and little cash can afford to conquer the world.

    • willid3 says:

      well as long as we have the deregulation ‘fever’ we will keep having TBTF banks, and there will continue to be scams that are run by banks (LIBOR among others). and the government has been the vast majority of the residential mortgage market since before ww2 and the after the great depression. and while there was a growing private sector version, it was done using smoke and mirrors and was one of the biggest scams wall street has dreamed up since the great depression days.
      and nobody really wanted to clear the system in a way that would not have punished every one, that would have been nationalizing the TBTF and selling them off in pieces. no what seems to always be meant by those who advocate clear the system, lets punish every one, including those who created the mess. we can’t let those who had nothing to do with it off for some reason.

    • VennData says:

      “…Really? JPM, C, BAC, WFC, GS are still around…”

      Really? Merrill Lynch, CountryWide, Bear Sterns, Indy Mac and hundreds of smaller banks

      http://en.wikipedia.org/wiki/List_of_banks_acquired_or_bankrupted_during_the_Great_Recession

  2. constantnormal says:

    While an honest(?) scale to measure them by (in this case, the DJIA), at least one with any duration to speak of, is a fairly recent thing, market crashes are not. Prof Minsky’s inherent instability of markets comes into play whenever markets slip their leashes and are allowed to run wild, which eventually takes them out into the crowded traffic of the streets, and crashes invariably ensue, with banking and frauds of some sort or other seeming to be common features.

    For an unmeasured glimpse into the history of these things, check out Wikipedia: http://en.wikipedia.org/wiki/List_of_economic_crises

    And many fine tomes have been penned over the years detailing the degrees of disaster that these things bring to us, burning lessons into the minds of those around at the time. Alas, the learning is not inherited, so subsequent generations get to re-learn them firsthand, as Experience is the best teacher of all, with learning that far exceeds that produced by the finest schools.

    Our leashes have not yet been restored, and we have only had a bruising encounter from our most recent romp in the streets. We’ll be back here, at some point in the not-terribly-distant future.

    Meanwhile, all you can do is the best you can do, in a rational, unemotional, and prudent manner. If you operate thusly, mstakes will still happen, but you won’t be run over by a truck.

  3. BennyProfane says:

    “The worst of these eleven crashes took place from April of 1930 and ended July of 1932, investors had lost 86% of their money in just 813 days. This was the big one, far grislier than the 48% killer of the fall of 1929, although that ’29 crash took place in an astonishing two months.”

    And some wonder why so many hate this market, and hide in safety, fearing a second shotgun blast. They read the history of markets, too.

    • VennData says:

      People hate the market…

      1) Because they are not in it

      2) They are not in it because of politics

      …BOTH of which support JB’s point. These are opportunities, and if you can’t see past the silly political agenda your opld man stuck you with, what makes you think you should get the benefits of American’s prosperity? If you’re illogical, anti-science, and filled with hate, why would you deserve anything in this life?

  4. LeftCoastIndependent says:

    I’m not an expert on economic history, but it is my understanding that we have never been through a period of aggressive QE like what we are doing now. QE is the reaction to the “liquidity crisis” of 2008 and we will just have to wait and see how the end game looks when it is all said and done. Don’t forget, the FED will want to sell all those trillions of assets on their books which will distort the bond market that much more. Not to mention the Japan, China, Euro, and EM debt situation on steroids which is highly likely to go bust. Where our economic future ends up is any bodies guess at this point.

  5. ch says:

    People talking about stock market crashes are fighting the last war:

    http://www.bloomberg.com/news/2014-02-18/u-s-cross-border-outflow-of-capital-hits-highest-since-2009.html

    There is a crash in demand alright – it’s a crash in demand for USD sovereign debt. what happens to the price of risk when the unit in which it is priced suffers from a drop in fundamentals?

    Same thing as happened the last time we saw this in February 2009…risk asset prices skyrocket.

    In Venezuela, it’s known as a “currency crisis.” In the US, financial commentators label it a “bull market.”

    Potato, Potahto. Just don’t miss it.

    • willid3 says:

      so there is a crash on demand for treasuries. just like there is an even bigger crash in demand for most if not all other assets?

    • VennData says:

      Bush cut the value of the dollar in half. Under Obama, it’s actually risen.

      Remember when they used to count the quarters of consecutive positive GDP growth? Now we count years.

      Employment ready to surpass Bush’s peak with lower deficits, and with all the boomers retiring. productivity, exports, energy efficiency and independence are here. And you GOPers want to shut down government.

  6. bear_in_mind says:

    It’s all about timing and asset allocation. If you were 70+ years old and over-exposed to equities in 2008-09, you probably got killed with the declines, forced IRA selling at exactly the wrong time and, of course, panic. What I learned from it was diversify and save MUCH more than you think you’ll need so you won’t have to depend on every last dime in your portfolio. And then, of course, have a plan for when the next inevitable downturn comes and how you’ll prepare when you see your assets shrink. Have a plan, work the plan.

  7. VennData says:

    How do you recover from a crash?

    Feed the right wing nuts with tabloid nonsense and keep them petrified while logical asset allocaters move money into equities, investments, and clean up the debt-fueled greed, wars, trillion dollar deficits, and Medicare-Part-D socialism their GOP leaders fostered upon us.

  8. Mattw says:

    I have a few questions:

    1. What’s the difference between a small crash and a big one?
    2. What was different about the 1929 crash resulting in the Great Depression?
    3. What’s different about the 2008 crash that has put us on a path blazed by Japan?
    4. What’s the connection between a large financial crash and war?

    Here are some short answers (corresponding):

    1. Time of stability. Bigger just needs more time of stability.
    2. Time of stability. Time ran out.
    3. Time of stability. Time ran out, but we suppressed it anyway. The economy is now broken.
    4. Different forms of a crash.

    Think of a society under a dictatorship. More stability until time runs out, then revolution. So too with the economy. Stability is the equivalent of pushing down on the lid of a boiling pot of water. It works until it doesn’t work. When it breaks it stays broken until a large crash is allowed to happen. Only a revolution – great depression – will now fix the problems.

    Problems spread throughout society at about the same rate. A big financial crash indicates time is up, and it is also up in totally unrelated areas. 9/11/2001 was a warning of trouble. 2008 announced its arrival. Now there is trouble in the military and with thinking about national security.

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