We are all aware of the financial crisis that is hitting financial markets around the globe. The US stock market crashed almost exactly two months ago. The question we are looking at today is whether the stock market crash is over? What is going to happen next? Will markets go up or down? That is the question on everyone’s mind. Now you know I never give predictions on this channel, but this is another opportunity to talk about business history. So we are going to look at market crashes that will hopefully give you some perspective on what is happening in the market right now. WATCH NOW!
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VIDEO SUMMARY
Let us start by looking at the current stock market information for the Dow. The Dow Jones Industrial Average is a pool of 30 large companies on US stock exchanges. People use the Dow as one metric of the performance of some of the best US stocks. Since COVID-19 started, the Dow initially dropped 37% by March 23, 2020. It then bounced back, and has remained fairly flat and sits at a drop of 19% as of Friday.
This is following the typical pattern we see in market crashes. There is usually a sudden drop in the market, followed by a period of high volatility as the market stabilizes. Then there is usually a point you can identify where the market recovery begins. The question in this situation, is whether the period of volatility is over, and whether the market is on its way to recovery. If this period of volatility is still going, is there going to be another drop in the stock market?
Let us look more closely at what is going on with the COVID-19 crisis. Most of the US is still under some level of quarantine. The unemployment rate continues to increase, although it has been slowing. The Bureau of Labor Statistics released new unemployment numbers a week ago, putting unemployment at 14.7%, the worst unemployment since the Great Depression. However, there was a tweet by someone named Betsey Stevenson. Betsey Stevenson is the Chief Economist of the US Department of Labor. She tweeted that there was a mistake in the unemployment numbers. It turns out that when they were doing the unemployment survey, that people who lost their jobs due to COVID-19 were classified incorrectly as “temporarily” unemployed and not included in the unemployment numbers. So the unemployment rate is really nearly 20%.
Now we are starting to see bankruptcies in the news. We have seen bankruptcy announcements from JC Penney, Neiman Marcus, and J Crew. There are rumors of several more major companies on the brink of bankruptcy. I am not going to say the names online, because I do not want to add to the chaos, but you can find the news stories yourself. The situation is really bad.
To put this situation in context, I find it helpful to look at how capital markets function at a high level. The way stock markets work, is you have a pool of capital where wealthy people invest their money. This money flows to businesses which are legal entities engaged in some business plan. These businesses create jobs. These jobs are interactions between workers and customers that generate productivity. The productivity turns into profit for the businesses. Profit turns into dividends for the stockholders. In a healthy market, money flows down and back up this value chain.
Let us compare this pandemic to the Great Recession in 2008. During the Great Recession, financial markets collapsed. People were buying and selling mortgage-backed securities that really did not have any value, because people were purchasing second and third homes they really could not afford. When all this was revealed, billions of dollars in the financial markets suddenly evaporated. This shut down the value chain and we entered the Great Recession, until the financial markets could straighten out this mess.
The COVID-19 pandemic is almost the exact opposite problem. Everyone right now is stuck in their homes, either by quarantine or they are just too scared to leave. So we have no workers and no customers. We still have all these rich people who want to invest money, but no one at the bottom end of the value chain is generating productivity. Businesses are going to go bankrupt, which means stock holders will lose all their money. This is a very bad situation.
But the real question is not whether this is a bad situation. The real question is: is the stock market correctly valued? Is the stock market already taking into account the true impact of the bankruptcies that are coming? If the stock market price already takes into account all this bad information, prices may be on the way to recover. If the stock market prices does not take the true situation into account, stock prices may continue to drop.
As I mentioned before, we are currently at a 19% drop in the market. With all the economic damage we are facing, does it make sense that the Dow would only drop 19%? To address this question, we are going to look at all the stock market drops of the Dow in recent history.
| % drop when market recovery started | |
| Sept 11 Attacks (2001) | 15% |
| Dot com Bubble (2000) | 16% |
| Russian Currency Crisis (1998) | 18% |
| COVID-19 (2020) | 19% |
| Great Recession (2008) | 29% |
| Black Monday (1987) | 30% |
| Great Depression (1929) | 88% |
As I said before, all these crashes had a dramatic crash, then a short period of high volatility while the market stabilizes. This table marks the percentage drop from the point when the market starts its recovery. I am attempting to compare our current market level, with what would be a comparable market level in history, if we were on the road to recovery.
Let us walk through these. The Sept 11 attacks had a 15% drop in the Dow. The Dot com Bubble had a 16% drop in the Dow. Keep in mind that technology companies most affected during this crash were not part of the pool of stocks in the Dow, and the NASDAQ and S&P500 had much greater drops. The Russian currency crisis in 1998 had an 18% drop. This is when Russia devalued its currency and defaulted on its debt. Then we have where we currently sit today with COVID-19 at a 19% drop in the Dow. Then we get into much larger drops from the Great Recession in 2008 at 29%, which is 10% more than where we are at today. Black Monday in 1987 the Dow dropped 30%. Black Monday was primarily due to poor trading practices in the 80s. And finally we have the Great Depression in 1929, where the Dow lost 88% of its value over a three year period. So in the historical context of these crashes, the current level of stock decreases is fairly reasonable. The crashes in 2008 and 1987 were 10% greater. And the Great Depression was much greater.
Let’s talk about the Great Depression. There was an immediate drop in the stock market of 43%, but then the market continued to decline over the next three years. Over those three years, people lost 88% of the value of their investments. Almost all of their retirement savings was gone.
Another thing to look at is whether the current COVID-19 crash is similar in character to the other crashes. You would think the rates of decrease would be closer to similar types of events. We know what caused each event. Sept 11 was a military attack. The Dot com Bubble was related to a specific industry. The Russian Currency Crisis dealt with a foreign countries currency. You can look at each one of these examples and ask whether COVID-19 is more similar to these smaller level crashes, or more similar to the Great Recession and the Great Depression.
So let us go back to unemployment. The current US unemployment rate is somewhere around 20%, the highest since the Great Depression. Unemployment during the Great Depression was 25%. Now our current stock market valuation of the Dow is a 19% decrease, where the Great Depression valuation of the Dow resulted in a 88% decrease. So I will ask you again. Does the current valuation of the Dow at a 19% loss make sense, given the current economic situation? Are we headed for more decreases in the stock market? Let me know what you think, in the comment section down below.
The second question is how long do these stock market crashes last? How long is it going to be before recovery starts again? In other words, when is the right time to buy back into the market. I have also pulled data from all the same stock market crashes on the number of days from the time the crash started until recovery started again. You can see that this crisis has already gone on a long time. We are already sitting at 86 days which is already the fifth longest recovery, and it does not seem like the recovery from COVID-19 is starting soon. The Great Recession took 301 days before markets started to recover, and the Great Depression, as I mentioned earlier, took three years before recovery started again.
| Days until market recovery started | |
| Sept 11 Attacks (2001) | 21 |
| Black Monday (1987) | 52 |
| Dot com Bubble (2000) | 60 |
| Russian Currency Crisis (1998) | 76 |
| COVID-19 (2020) | 86 |
| Great Recession (2008) | 301 |
| Great Depression (1929) | 1002 |
Let us make a summary of this discussion. What we are doing is evaluating the current stock market valuation in the context of business history. And we are asking the question, does the current stock market valuation make any sense? Does it make sense that we are sitting at only a 19% drop in the Dow? Now just because something happened a certain way in history does not mean it is going to happen the same way in the future, so you have to be very careful here. But people still have to make real time decisions today. People today are deciding what to do with their stock portfolios. And you want to get the most information possible so you can make the best decision. Because the real question you are asking, is do you think the market is going to go up? Or do you think the market is going to go down?
Leave a comment down below letting me know what you think!
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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.