Global Equity Market Crashes

8/3/2019 Global Equity Market Crashes

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Global Equity Crashes


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Introduction

"It came with a speed and ferocity that left men dazed. The bottom, simply

fell out of the marketThe streets were crammed with a mixed crowd agonized little speculators,... sold-out traders,... inquisitive individuals andtourists seeking ... a closer view of the national catastrophe Where wasit going to end?"

Account of the stock market crash in the New York Times.


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Contents

Global Equity Market Crashes

-1929 - US Markets Crash

-1987 - US Market Crash

-1992 - Indian Market Crash

-2000 - Indian & US Market Crash

-2008 - The Global Credit Crisis

The Common Theme

Learnings


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Crash

Each equity market crash has a widespread impact - on the economy, on thesentiment of investors, on the entire outlook surrounding the economy. So it becomesimperative that we understand what happens in some of these crashes, and how canwe avoid massive damage or look to benefit from these crashes. This is also importantin order to manage our expectations from equity markets

Each crash will be analyzed in 4 phases

Pre-crash period.

The Build-up to the crash.

The Crash.

Aftermath

We will look at various markets globally - to understand if there is a common underlyingtheme to these bubbles. We will also look at examples and anecdotes around these crashes.


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1929 - US

Pre Crash Boom

After world warI, the US market witnessed atextraordinary period of prosperity - which came tobe known as The Roaring 20s. The Stock markets

jumped nearly 6 fold in 8 years, prior to the 1929crash.

Manufacturing was on the rise - as denoted by theFederal Reserve Index ofIndustrial Production -which rose from 67 in 1921 to 110 in 1928.

The Federal Reserve cut interest rates in 1927 - which resulted in more money being madeavailable which eventually made its way to stock markets.

The amount of broker loans - which hovered around USD 1 billion in early 1920s, jumpedto USD 6 billion in 1928 (This was a gauge of speculative activity in the markets). Soon

many corporations started lending surplus money to be invested into the stock markets.


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1929 - US

The Build up to the Crash

Speculative activity in the markets was on the rise - so was margin trading. There was aserious belief that good times are going to last long.

The US elected a new President, Herbert Hoover in 1928. The outgoing President Coolidge

made a claim that conditions are great and stocks are cheap!

Moreover, the ammunition to cut excess supply of funds from the markets was drying up.The US Fed only held USD 228 million in government bonds, which could be sold to themarket to dry up excess liquidity. The Fed thought about increasing rates early in 1929, butdeferred action at that time.

One reason that people thought prices were very high for stocks was presumed to be ascarcity of common stocks in the country. This resulted in formation ofnew entities knownas trusts, which would raise investor money to invest in securities of other companies. In thebeginning of 1927, there were 160 investment trusts. Another 140 opened that year, 186 in1928 and 265 in 1929. In 1929, they were permitted to get listed on the stock exchanges.


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1929 - US

The Build up to the Crash

These trusts were leveraged - that is they used borrowed money to build up positions. Therewere more layers of leveraging, where trusts held shares of other trusts. This could result ina gain of 700-800% when the underlying securities just gained by 50% or so! This resulted ina surge to sponsor trusts who would sponsor trusts who would in turn sponsor more trusts.

These trusts issued shares which traded at a price that had little relation to the value ofunderlying securities. Goldman Sachs launched 2 trusts, which became popular investmentdestinations in 1929.

While sometime in September 1929, the markets started becoming volatile and choppy, therevoices of concern were few. Moreover, any such opinions were denounced. Steel production

was down, several banks had failed, and fewer homes were being built, but few paid

attention the Dow stood at 381.17, up 27% from the previous year. Over the next fewweeks, however, prices began to move downward. The lower they fell, the faster they pickedup speed. And leverage now started working in the other direction!

The average P/E (price to earnings) ratio of S&P Composite stocks was 32.6 in September1929 - much higher than the usual average.


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1929 - US

TheActual Crash

Stocks had become extremely volatile in the run upto the crash. After witnessing a sharp fall and a briefrecovery in September and October beginning, theactual crack started around October last week. TheDow Jones crashed 12% and 11% on 2 consecutivedays - October 28 & 29. The volume on stocks

traded on October 29, 1929 was a record that wasnot broken fornearly 40 years, in 1968

Markets ended October about 40% lower than their September top. There was a bounce in1930, which led people into thinking that the worst is over. The US President Herbert Hooveractually proclaimed in March 1930 - "All the evidences indicate that the worst effects of the

crash upon unemployment will have passed during the next 60 days"

On the other hand, the worst was yet to come - By the spring of 1930, 4 million wereunemployed; the figure more than tripled by 1933, the worst year of the Depression. Thenational unemployment rate peaked at 25% in 1933. The stock market tumbled after theinitial bout of recovery


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1929 - US

TheAftermath - The Great Depression

Once the initial recovery ended, the share pricestumbled, with the eventual low coming in 1933,about 90% below the 1929 high of the market.This high was not breached for another 21 yearsafter 1933.

Some 25% of all banks in the US failed during1929 - 32. There was a massive run on the banks- while the government did not extend support tothe failing banks. Some 4,000 banks and otherlenders ultimately failed.

The singular feature of the great crash of 1929 was that the worst continued to worsen.People jumped in to buy as the stock prices declined, only to lose more money. Commodityprices continued to suffer, creating problems for the farmers. Steel production was at 35% ofthe capacity by mid-1931. It further fell to 12% by 1932.


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1929 - US

TheAftermath - The Great Depression

Global trade continued to collapse. This would eventually result in a collapse in the GBP,and more trade barriers being introduced - which eventually exacerbated the situation. Onlypost world warII did improvement come.

Individual stocks were completely battered. Most large stocks fell nearly 90%. The fate of theinvestment trusts was even worse, with most of the trust stocks falling from prices higherthan USD 100 before the crash to sub USD 1 by 1932.

The impact was also felt on economists and economic societies. One such entity, the HarvardEconomic Society, continued to come out with reports that the worst is over. They came outwith their opinion on more than 10 occasions between 1930 and 1931, and were clearlyfound wanting. It was considered an esteemed organization, but was eventually dissolved

after the crisis. Many economist also lost their place in the people whose opinion matteredbefore the crash.


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1987 - US

Dow Jones 1983-1988

Pre Crash Boom

The stock market rallied strongly in the years leadingup to the crash. The Dow Jones IndustrialAveragerallied from about 1000 in 1983 to 2700 in 1987,before cracking.

1987 opened with bond yields near their lowest levelsinnine years. Corporates issued more than $200billion innotes during all of 1986 -- two times the levelof debt issued in 1985.

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There had been an influx ofnew investors, such as pension funds, into the stock marketduring the 1980s, and the increased demand helped support prices

Also - newer trading strategies around portfolio insurance and program trading had comeup. Portfolio insurance meant selling stocks below a particular level, and program tradingwas essentially entering into a trade based on certain levels getting breached. These wereunchartered territories - and the impact was wide.


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1987 - US

Dow Jones 1983-1988

The Build up to the crash

Many interesting factors came to the fore in the buildup to the crash.

The trade deficit of US soared, resulting in the USdollar plummeting. Interest rates soared, as Long-termbond yields that had started 1987 at 7.6% climbed toapproximately 10%.

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Oil prices - which had fallen in previous years, jumped up from nearly USD 16 per barrelto about USD 22 per barrel during the course of the year, stoking inflationary fears, and

thereby pushing bond yields even higher.

There was a lot of activity on the investigation front - as the SEC initiated charges againstmultiple companies in insider trading. There were almost a dozen cases which came up

during 1987 - giving an idea of rampant malpractices in the securities markets.


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1987 - US

Speculative companies with unclear business plans start springing up. Businessdescriptions were vague, such as this -

"Synergy Space-Bovubetribucs forges a new frontier in the introduction of organic entitiesinto the ecosystem of the lunar-scape in order to promote greater synergy. This triumphantnew paradigm will be enacted through a leveraged advantaged momentum initiator."(reference - www.investpedia.com)

There were others for which analysts came out with vague recommendations - such as thisforAT&E Corp, a company developing a wristwatch-based paging system. Analyst EvelynGeller of Blair & Co. says ofAT&E, "The thing could trade anywhere -- up to 30 timesearnings. So you're talking about $1,000 a shareYou can't put a price on this -- you can't.

You don't know where it is going to go. You are buying a dream, a dream that is beingrealized."Although Geller spoke specifically ofAT&E, her comments could be taken as ageneral indicator of the type of analysis that has caused these price eruptions. AT&E, for its

part, no longer trades. (reference - www.wikipedia.com )

The last straw was some geopolitical tension between US and Iran in October 1987. BothIran and US fire missiles on each others tankers and oil platforms respectively.


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1987 - US

TheActual Crash

Stocks started sliding a few days before the crash.

Before the Black Monday, the markets fell nearly10% in the previous week. On October 19, 1987,

markets tumbled completely, falling a whopping508 points or 22% in a single day. This is till datethe largest single day fall for the DJI.

Global markets also tumbled. The global rout also began on the same day, and had alreadycaused substantial declines in markets before the US market opened. The FTSE 100 Indexlost 10.8% on that Monday and a further 12.2% the following day. In the month of October,

all major world markets declined substantially.

Further, program trading and portfolio insurance resulted in a wave of selling orders,which the exchanges were not equipped to handle. This resulted in orders actually gettingdelayed - and prices lagging. The uncertainty fueled even more selling - and resulted in theindex losing 22% on October 19th 1987.


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1987 - US

The aftermath

Markets actually rebounded soon, and the crisis was not a long lasting one - especiallysince the underlying economy was not a cause for concern. The fall was accentuated due toprogram trading and margin calls, but that was bound to be a temporary

October 1987 though was bad - by the end of October, stock markets in Hong Kong hadfallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling about60% from its 1987 peak, and taking several years to recover.

The US Fed intervened, and issued a statement on Tuesday morning (October 20, 1987),indicating that it would support market liquidity. For the next several weeks, the Federal

Reserve continued to i

nject reserves to buoy liquidity i

nfinancial markets. Circuit limitswere introduced in the indices.

Given the lack of structural issues in the economy, the economy as well as the marketsbounced back soon - the US markets created a new high in 1989 - in 2 years from theBlack Monday. Economic growth over the next 2 years was about 3.9%, even faster than the2 years preceding the crisis.


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1992 - India

Pre Crash BoomSensex 1991-92

Indian economy had just been liberalized, after passingthrough some tough phase - under the leadership of thethen finance minister Mr. Manmohan Singh. FDI invarious sectors had been opened up, tariffs were removed

and the protectionist environment made way to healthycompetition.

This resulted in a belief that India is poised to growsignificantly in the future - a belief which was notmisplaced entirely, but came a bit too early. Also, whilethe India story had some takers, it was largely a scamthat led to the huge rally in the stock market

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Harshad Mehta, a name about to become familiar all overIndia for his involvement in amulti-thousand crore scam, was the main player behind the huge rally.

Harshad was selling the India story, at the same time using bank funds illegally to buy andshore up the prices of these stocks. The stock market rallied nearly 300% in 1.5 years.


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1992 - India

The Buildup to the crashSensex 1991-92

As the rally continued unabated, Harshad Mehta keptswindling more and more money. Stocks went hyperbolic,especially stocks in the infrastructure sector. A stock likeACC went up from Rs 200 to Rs 10,000 (not adjusted for

subsequent bonuses - hence not comparable to thecurrent price)

The BSE Sensex moved from about 1000 in Jan 1991 tocreate a high of 4500 in March 1992. The astounding 4fold move was justified solely by selling the India

liberalization story.

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The last 3 months were the most amazing, with the Sensex doubling from Jan 1992 toMarch 1992. Then however, came the crash


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1992 - India

The CrashSensex 1992 - 93

InApril 1992, it came to the notice of the governmentofIndian that there was a shortfall in the governmentsecurities held by SBI. Investigations then uncoveredthe entire scam, where bank funds were

misappropriated - sometimes with the knowledge of

corrupt bank officials and sometimes without theknowledge of unsuspecting bankers.

Brokers acted as conduits in inter-bank transactions,thereby holding the securities and making thepayments.

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Here the broker could provide with a fake broker receipt which worked as a contract that thesecurities will be delivered at a later date. These fake receipts came to light in the

investigations, and subsequently the entire scam came to light. The total scam was to thetune of Rs 3500 crore, and the unearthing resulted in the Sensex falling nearly 55% from itshighs in the coming year.


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1992 - India

TheAftermath

Harshad Mehta was arrested. His arrest also revealed massive scale of corrupt practices inthe banking industry, which world hand in hand with Harshad while the scam happened.

The entire money has never been found. Harshad Mehta allegedly bought shares in variousnames and accounts, and no-one knew the extent of shareholding indirectly in his name tillthe time of his death.

Markets crashed - resulting in a huge loss of value in terms of market capitalization, farhigher than the scam value itself - as securities whose prices had been bumped up fell, andthere was a fear of higher regulation and slowdown in the liberalization and reform process.ForeignInvestors became wary, and took a while to come back to India

The good that came out of this was stronger regulation - and setting up of the NSE. Many ofthe systems which were a result of the movement of a regulated economy into an unregulated

one - were overhauled - and security checks around many of these processes came up.


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2000-01 - The Dot Com Crash

Pre Crash Boom

The Dot Com Bubble was created during the years1995-2000, as the technology sector grew led byinnovation. The spread of internet created a newparadigm in businesses, and company after companylaunched online business models. The IPO of Netscapemarked the beginning of a new era.

These business models, while good in idea, carried a lotof execution as well as business risk. However, led byunbridled optimism , internet stocks and technologystocks rallied massively in these years.

Nasdaq 1996-2000

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The lower interest rates in 1997-98 led to a huge supply on money, and venture capitalists

- driven by strong returns in a few internet stocks, invested heavily in othernewtechnology businesses. It was assumed that any dot-com company which was able togarner huge market share will succeed. While in principle the idea was correct, but thiswas more like a necessary but insufficient condition for the business to succeed. However,given the novelty of the ideas and the difficulty in valuing these stocks resulted in amassive bubble being created in these companies. The employees and promoters of thesecompanies made a lot of money when they went public - and this money was againpumped into the sector.


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The Build Up to the Crash

Between 1999 to 2000, the US Fed increased rates 6times. The economy was losing speed. This was boundto have an impact on the share prices of internetcompanies, which were based on very optimisticeconomic growth premises.

It was assumed de-facto that a model successful in onecountry will be successful in the rest of the world.

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The tech sector became so dominant, that from the second quarter of 1999 to the secondquarter of 2000, all the gains in S&P 500 index were contributed by the Tech Index.

Finally, many firms had spent large amounts on technology upgradations in the wake ofthe Y2K problem. These firms stopped or curbed their technology spend as soon as the

problem passed away without too much of an issue.

In the year 1999, there were 457 IPOs, most of which were internet and technology related.Of those 457 IPOs, 117 doubled in price on the first day of trading.


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Nasdaq 2000-2004

TheActual Crash

The crash began in March 2000. The NASDAQ(Technology heavy Index) peaked at the value ofabove 5000, only to subsequently get hammered bynearly 80% in the years to come. The initial six days

resulted in a loss ofnearly 10%. Soon the companieswhich had seen huge rallies in their stock pricesstarted unwinding, and resulted in many of themlosing more than 90-95% of their values.

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As companies kept reporting losses quarter after quarter, the patience of investor ran out.This resulted in a massive wave of correction, as the stock prices tumbled. There was alarge scale loss of wealth created by the bubble, as some of the examples on the next slide

will show

The dot-com crash wiped out $5 trillion in market value of technology companies fromMarch 2000 to October 2002.


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TheAftermath - some examples of the bubble

e.Digital Corporation (EDIG): Long term unprofitable OTCBB traded company founded in1988 previously named Norris Communications. Changed its name to e.Digital in January

1999 when stock was at $0.06 level. The stock rose rapidly in 1999 and went from closingprice of $2.91 on December 31, 1999 to intraday high of $24.50 on January 24, 2000. Itquickly retraced and has traded between $0.08 and $0.20 in 2008 and 2009.

On January 11, 2000, America Online, a favorite of dot-com investors and pioneer of dial-up Internet access, acquired Time Warner, the world's largest media company. Within twoyears, boardroom disagreements drove out both of the CEOs who made the deal, and inOctober 2003 AOL Time Warner dropped "AOL" from its name.

Boo.com, an online fashion store, spent $188 million in just six months. It used a sitewhich was built using Java and Flash based technology, which was slow on the dial up

internet connections used then. It went bankrupt in May 2000.

eToys: share price went from the $80 reached during its IPO in May 1999 to less than $1when it declared bankruptcy in February 2001.

Source - www.wikipedia.com


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TheAftermath - changes in the way business is run

There were regulations put in place in the treatment of stock options

Private Equity investors became more wary of companies which had just business ideas butlack of any revenues or profits.

The number ofIPOs in 2001 was 76, and none of them doubled.

Many dot com companies liquidated, or were bought over by competitors. Some survived thecrash to emerge stronger - such as Yahoo and Google. Also evident was the fact that whilethere was mass scale destruction of wealth, a large number of companies actually survived.This showed that the problem was less with the companies than with the way they were

valued. Valuations became sanguine once again, and for a long while companies withoutearnings were not valued at huge valuations simply due to a client base.


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2000-01 - Indian Market Crash

The Build Up to the Crash

India also had its own share of problems around 2000. The problem however was dueto a scam, which involved the technology company stocks.

Ketan Parekh, a broker - came into prominence, largely due to his dealings in stocks of 10companies. These companies included Amitabh Bachchan Corporation Limited (ABCL),

MuktaArts, Tips, Pritish Nandy Communications, HFCL, Global Telesystems (Global), ZeeTelefilms, Crest Communications, and PentaMedia Graphics. He carefully selectedcompanies in the technology, telecom and media space - which was buzzing globally in theDot-Com boom.

Ketan used to start cornering stocks which lacked liquidity in the market. Then the stockused to be put into play through various accounts. Once the price jumped, Ketan scoutedfor institutional investors to sell his stock. At its peak, these stocks used to be the mosttraded counters inIndia. Many mutual funds picked up these stocks, in order to boostreturns.

However, Ketan used borrowed money to buy a large chunk of these stocks. It was alsoalleged that money was used from 2-3 banks, including the Global Trust Bank.


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The Crash

Ketan had used the same stocks as security with various banks to borrow more, and buymore. Once the market started to correct, the institutions started dumping these stocks.This was when he needed more margin, and when the entire play came out in the open. Theferocity of the fall resulted in the scam being unearthed. Most of the stocks did not have

great business plans, and the prices had been rigged. Once business fundamentals came tothe fore, stocks fell, many of them close to zero from levels like Rs 2000-3000.

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Sensex 1999 - 2001

TheAftermath

Stock markets too tumbled - largely led by the ITstocks. Most big IT stocks have till date not beenable to reach the highs they made in March2000.

Structurally however, the economy reboundedquickly, since the crash was largely global innature, and excesses were largely contained in afew sectors.

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Many retail investors lost a large chunk of their money in this crash, in a bid to gain fromthe stock price jumps. Unfortunately, the end was fast - and devastating for many of these

stocks.

There were certain reforms in the system. SEBI became more proactive in looking atabnormal movements of stock prices. However , large chunk of the money remains untracedand not many people went through rigorous punishments.


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2008 - The Credit Crisis

Pre Crash BoomMajor Markets - 2001-2008

Interest rates had been low globally for quitesome time since 9/11. This resulted instrong growth, led by free capital , breakingof trade barriers and the emergence ofnew

economies.Emerging market did exceedingly well, so didthe developed markets, led by the belief thateasy capital was always available. Globalmarkets rallied from 2002 onwards, most ofthem making new highs in the process.

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The lower interest rates and lowering of trade and capital flow barriers meant that excess

capitalneeded ave

nues for i

nvestme

nt. The i

nnovatio

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the financial world created

newproducts, such as Mortgage Backed Securities and Collateralized Debt Obligations. These

instruments would enhance the return for any investor, and hence there was more demandfor such arrangement. Money was in abundance - and was looking for areas to getdeployed.


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The Buildup to the CrashMajor Markets - 2001-2008

Enter securitization - The real estate sectorwas doing exceedingly well. More and morepeople borrowed money to buy houses. Nowthe mortgage provider - in order to reduce its

risk - sold a pool of these mortgages toinvestment banks. Investment banks thenclubbed these mortgages together, and soldthem into tranches to various investors.Each investor got a varied return based onthe amount of risk he entailed.

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Since these products seemed like a win-win situation for everyone - it was in the benefit of

everyone to expa

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nout to people who were

notqualified enough to get those loans. These loans were clubbed together, and then sold off

again in tranches, with the assumption that the default probability would remain constant.


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The CrashMajor Markets - 2008-2010

Eventually though - the economics had tocatch up. Once the house prices stoppedgoing up, and the housing bubble burst, themortgage backed securities lost a large part

of their value. Anyone creating, holding orinsuring these securities was in trouble.Once the financial system sensed trouble,lending froze. This led to a complete creditfreeze in the financial system - where no onecould be trusted to last the crisis.

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Bank after bank faced trouble, with a few larger ones actually filing for bankruptcy.

Globalization had taken its gains to all parts of the world, now it was its turn to take thetroubles everywhere. US tumbled, Europe faced crisis, and led by a panic selling ofinstitutional investors, emerging markets also plummeted. Countries like India, which werereally not impacted directly by the crisis also faced the heat. Equity markets tumbled 60-70% in most countries.


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TheAftermath

Markets faced the worst freeze since 1929. Unlike 1929 though, the governments jumped into rescue the companies. Massive amounts of money was thrown on the problems. Interest

rates were cut globally, in some cases all the way to zero percent. Massive tax break weregiven. In spite of these assurance, unemployment has continued to increase, consumer

spending has taken a hit and capacity utilization has been languishing.

However, since the crash was pricing in a 1930s kind of depression, the rebound was sharp.As we speak, most markets have recovered massively from their bottoms, with some within15-20% of their previous highs (India being one of those). Economic condition in emergingmarkets has improved - as their own fundamentals came to the fore.

US remain

s in

econ

omic trouble. But if equity markets are to be believed, the worst is over.Remember however, in any bear market - there can be massive bear market rallies which

make people believe that the worst is over. US in 1930s is a classic example - where the realpanic started after the first round of bounce had happened. We need to wait and watch ifanything like that materializes.


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The common theme

Bubble - irrational exuberance

Most of the crisis we have discussed so far, are clear case of bubbles being created due to theirrational exuberance of market participants. People rush to buy in stocks, in anticipation ofthe ever rising prices.

Story to sell

Usually there is a story to sell! Something that sounds like the next big thing. It wasinvestment trusts with leverage in 1929, program trading in 1987, Indias liberalization in1992, internet in 2000 and real estate prices & mortgage backed securities in 2008. Moreover,most people innately believe that the story is going to unfold and make everyone rich.

Unnecessary faith in statements by people in high positions

Investors pay high attention to what heads of states or CEOs of companies are saying. In

reality, heads of states willnever say that outlook is bad, while CEOs are people like us, whoassess situations with about as much precision as we can do.

This time is different

Most investors tend to believe that this time is different - however, history keeps repeatingitself at an alarming frequency. The more we think we are different, the more we end up beingthe same.


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The Learning

Bubbles and Crashes are realities

However much we may like to think that this time is different, we need to remember thatinvestors and traders participating in the markets have similar behaviours. So while the timesmay change, markets repeat bubbles and crashes very frequently. Speculations will continue,and usually the end of speculation is similar in most cases. So we need to accept his realityand try and manage our risk around this.

How to spot a bubble

Now this is usually difficult to do. Hindsight always helps, but in the field we do not have thebenefit of hindsight. The easier thing is to spot the story which is selling, and try to avoid it -however much attractive it looks like. In todays context - power sector is one such story.

Ignore commentary by politicians

No politician

will ever say that the picture is grim. Sono poi

nt liste

ning to them. Half of thetime they are lying and the remaining half they do not know what they are saying!

Keep taking profits when you can

Keep taking some money off the table. Buy and hold works - over very long periods or if youare Warren Buffet. Else, remember, no one went broke booking profits.


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Global Equity Market Crashes

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