Global Equity Market Crashes
Content
Global Equity Crashes
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 ² agonized little speculators,... sold-out traders,... inquisitive individuals and tourists seeking ... a closer view of the national catastrophe it 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
Crash
Each equity market crash has a widespread impact - on the economy, on the sentiment of investors, on the entire outlook surrounding the economy. So it becomes imperative that we understand what happens in some of these crashes, and how can we avoid massive damage or look to benefit from these crashes. This is also important in 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 underlying theme to these bubbles. We will also look at examples and anecdotes around these crashes.
1929 - US
Pre Crash Boom After world war I, the US market witnessed at extraordinary period of prosperity - which came to be known as µThe Roaring 20s¶. The Stock markets jumped nearly 6 fold in 8 years, prior to the 1929 crash. Manufacturing was on the rise - as denoted by the Federal Reserve Index of Industrial 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 made available which eventually made its way to stock markets. The amount of broker loans - which hovered around USD 1 billion in early 1920s, jumped to 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.
1929 - US
The Build up to the Crash Speculative activity in the markets was on the rise - so was margin trading. There was a serious 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 the market to dry up excess liquidity. The Fed thought about increasing rates early in 1929, but deferred action at that time. One reason that people thought prices were very high for stocks was presumed to be a scarcity of common stocks in the country. This resulted in formation of new entities known as trusts, which would raise investor money to invest in securities of other companies. In the beginning of 1927, there were 160 investment trusts. Another 140 opened that year, 186 in 1928 and 265 in 1929. In 1929, they were permitted to get listed on the stock exchanges.
1929 - US
The Build up to the Crash These trusts were leveraged - that is they used borrowed money to build up positions. There were more layers of leveraging, where trusts held shares of other trusts. This could result in a gain of 700-800% when the underlying securities just gained by 50% or so! This resulted in a 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 of underlying securities. Goldman Sachs launched 2 trusts, which became popular investment destinations in 1929. While sometime in September 1929, the markets started becoming volatile and choppy, there voices 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 ² the Dow stood at 381.17, up 27% from the previous year. Over the next few weeks, however, prices began to move downward. The lower they fell, the faster they picked up 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 September 1929 - much higher than the usual average.
1929 - US
The Actual Crash Stocks had become extremely volatile in the run up to the crash. After witnessing a sharp fall and a brief recovery in September and October beginning, the actual crack started around October last week. The Dow Jones crashed 12% and 11% on 2 consecutive days - October 28 & 29. The volume on stocks traded on October 29, 1929 was a record that was not broken for nearly 40 years, in 1968 Markets ended October about 40% lower than their September top. There was a bounce in 1930, which led people into thinking that the worst is over. The US President Herbert Hoover actually 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 were unemployed; the figure more than tripled by 1933, the worst year of the Depression. The national unemployment rate peaked at 25% in 1933. The stock market tumbled after the initial bout of recovery
1929 - US
The Aftermath - The Great Depression Once the initial recovery ended, the share prices tumbled, with the eventual low coming in 1933, about 90% below the 1929 high of the market. This high was not breached for another 21 years after 1933. Some 25% of all banks in the US failed during 1929 - 32. There was a massive run on the banks - while the government did not extend support to the failing banks. Some 4,000 banks and other lenders 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. Commodity prices continued to suffer, creating problems for the farmers. Steel production was at 35% of the capacity by mid-1931. It further fell to 12% by 1932.
1929 - US
The Aftermath - 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. Only post world war II did improvement come. Individual stocks were completely battered. Most large stocks fell nearly 90%. The fate of the investment trusts was even worse, with most of the trust stocks falling from prices higher than 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 Harvard Economic Society, continued to come out with reports that the worst is over. They came out with their opinion on more than 10 occasions between 1930 and 1931, and were clearly found 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 mattered before the crash.
1987 - US
Dow Jones 1983-1988
Pre Crash Boom The stock market rallied strongly in the years leading up to the crash. The Dow Jones Industrial Average rallied from about 1000 in 1983 to 2700 in 1987, before cracking. 1987 opened with bond yields near their lowest levels in nine years. Corporates issued more than $200 billion in notes during all of 1986 -- two times the level of debt issued in 1985.
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There had been an influx of new investors, such as pension funds, into the stock market during the 1980s, and the increased demand helped support prices Also - newer trading strategies around portfolio insurance and program trading had come up. Portfolio insurance meant selling stocks below a particular level, and program trading was essentially entering into a trade based on certain levels getting breached. These were unchartered territories - and the impact was wide.
1987 - US
Dow Jones 1983-1988
The Build up to the crash Many interesting factors came to the fore in the build up to the crash. The trade deficit of US soared, resulting in the US dollar plummeting. Interest rates soared, as Long-term bond yields that had started 1987 at 7.6% climbed to approximately 10%.
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Oil prices - which had fallen in previous years, jumped up from nearly USD 16 per barrel to 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 against multiple 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.
1987 - US
Speculative companies with unclear business plans start springing up. Business descriptions were vague, such as this "Synergy Space-Bovubetribucs forges a new frontier in the introduction of organic entities into the ecosystem of the lunar-scape in order to promote greater synergy. This triumphant new 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 this for AT&E Corp, a company developing a wristwatch-based paging system. Analyst Evelyn Geller of Blair & Co. says of AT&E, "The thing could trade anywhere -- up to 30 times earnings. 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 being realized." Although Geller spoke specifically of AT&E, her comments could be taken as a general 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. Both Iran and US fire missiles on each others tankers and oil platforms respectively.
1987 - US
The Actual Crash Stocks started sliding a few days before the crash. Before the Black Monday, the markets fell nearly 10% in the previous week. On October 19, 1987, markets tumbled completely, falling a whopping 508 points or 22% in a single day. This is till date the largest single day fall for the DJI. Global markets also tumbled. The global rout also began on the same day, and had already caused substantial declines in markets before the US market opened. The FTSE 100 Index lost 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 getting delayed - and prices lagging. The uncertainty fueled even more selling - and resulted in the index losing 22% on October 19th 1987.
1987 - US
The aftermath Markets actually rebounded soon, and the crisis was not a long lasting one - especially since the underlying economy was not a cause for concern. The fall was accentuated due to program 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 had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling about 60% 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 inject reserves to buoy liquidity in financial markets. Circuit limits were introduced in the indices. Given the lack of structural issues in the economy, the economy as well as the markets bounced back soon - the US markets created a new high in 1989 - in 2 years from the Black Monday. Economic growth over the next 2 years was about 3.9%, even faster than the 2 years preceding the crisis.
1992 - India
Pre Crash Boom
Sensex 1991-92
Indian economy had just been liberalized, after passing through some tough phase - under the leadership of the then finance minister Mr. Manmohan Singh. FDI in various sectors had been opened up, tariffs were removed and the protectionist environment made way to healthy competition. This resulted in a belief that India is poised to grow significantly in the future - a belief which was not misplaced entirely, but came a bit too early. Also, while the India story had some takers, it was largely a scam that led to the huge rally in the stock market
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Harshad Mehta, a name about to become familiar all over India for his involvement in a multi-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 and shore up the prices of these stocks. The stock market rallied nearly 300% in 1.5 years.
1992 - India
The Buildup to the crash
Sensex 1991-92
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As the rally continued unabated, Harshad Mehta kept swindling more and more money. Stocks went hyperbolic, especially stocks in the infrastructure sector. A stock like ACC went up from Rs 200 to Rs 10,000 (not adjusted for subsequent bonuses - hence not comparable to the current price) The BSE Sensex moved from about 1000 in Jan 1991 to create a high of 4500 in March 1992. The astounding 4 fold 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 to March 1992. Then however, came the crash
1992 - India
The Crash
Sensex 1992 - 93
In April 1992, it came to the notice of the government of Indian that there was a shortfall in the government securities held by SBI. Investigations then uncovered the entire scam, where bank funds were misappropriated - sometimes with the knowledge of corrupt bank officials and sometimes without the knowledge of unsuspecting bankers. Brokers acted as conduits in inter-bank transactions, thereby holding the securities and making the payments.
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Here the broker could provide with a fake broker receipt which worked as a contract that the securities 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 the tune of Rs 3500 crore, and the unearthing resulted in the Sensex falling nearly 55% from its highs in the coming year.
1992 - India
The Aftermath Harshad Mehta was arrested. His arrest also revealed massive scale of corrupt practices in the 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 various names and accounts, and no-one knew the extent of shareholding indirectly in his name till the time of his death. Markets crashed - resulting in a huge loss of value in terms of market capitalization, far higher than the scam value itself - as securities whose prices had been bumped up fell, and there was a fear of higher regulation and slowdown in the liberalization and reform process. Foreign Investors 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 of the 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.
2000-01 - The Dot Com Crash
Pre Crash Boom
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The Dot Com Bubble was created during the years 1995-2000, as the technology sector grew led by innovation. The spread of internet created a new paradigm in businesses, and company after company launched online business models. The IPO of Netscape marked the beginning of a new era. These business models, while good in idea, carried a lot of execution as well as business risk. However, led by unbridled optimism , internet stocks and technology stocks rallied massively in these years.
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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 other new technology businesses. It was assumed that any dot-com company which was able to garner huge market share will succeed. While in principle the idea was correct, but this was 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 a massive bubble being created in these companies. The employees and promoters of these companies made a lot of money when they went public - and this money was again pumped into the sector.
2000-01 - The Dot Com Crash
The Build Up to the Crash
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Between 1999 to 2000, the US Fed increased rates 6 times. The economy was losing speed. This was bound to have an impact on the share prices of internet companies, which were based on very optimistic economic growth premises. It was assumed de-facto that a model successful in one country 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 second quarter 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 of the 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.
2000-01 - The Dot Com Crash
Nasdaq 2000-2004
The Actual Crash The crash began in March 2000. The NASDAQ (Technology heavy Index) peaked at the value of above 5000, only to subsequently get hammered by nearly 80% in the years to come. The initial six days resulted in a loss of nearly 10%. Soon the companies which had seen huge rallies in their stock prices started unwinding, and resulted in many of them losing 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 a large 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 from March 2000 to October 2002.
2000-01 - The Dot Com Crash
The Aftermath - some examples of the bubble e.Digital Corporation (EDIG): Long term unprofitable OTCBB traded company founded in 1988 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 closing price of $2.91 on December 31, 1999 to intraday high of $24.50 on January 24, 2000. It quickly 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 dialup Internet access, acquired Time Warner, the world's largest media company. Within two years, boardroom disagreements drove out both of the CEOs who made the deal, and in October 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 site which 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 $1 when it declared bankruptcy in February 2001. Source - www.wikipedia.com
2000-01 - The Dot Com Crash
The Aftermath - 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 but lack of any revenues or profits. The number of IPOs in 2001 was 76, and none of them doubled. Many dot com companies liquidated, or were bought over by competitors. Some survived the crash to emerge stronger - such as Yahoo and Google. Also evident was the fact that while there 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 without earnings were not valued at huge valuations simply due to a client base.
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 due to a scam, which involved the technology company stocks. Ketan Parekh, a broker - came into prominence, largely due to his dealings in stocks of 10 companies. These companies included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips, Pritish Nandy Communications, HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics. He carefully selected companies in the technology, telecom and media space - which was buzzing globally in the Dot-Com boom. Ketan used to start cornering stocks which lacked liquidity in the market. Then the stock used to be put into play through various accounts. Once the price jumped, Ketan scouted for institutional investors to sell his stock. At its peak, these stocks used to be the most traded counters in India. Many mutual funds picked up these stocks, in order to boost returns. However, Ketan used borrowed money to buy a large chunk of these stocks. It was also alleged that money was used from 2-3 banks, including the Global Trust Bank.
2000-01 - Indian Market Crash
The Crash Ketan had used the same stocks as security with various banks to borrow more, and buy more. 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. The ferocity 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 to the fore, stocks fell, many of them close to zero from levels like Rs 2000-3000.
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2000-01 - Indian Market Crash
Sensex 1999 - 2001
The Aftermath Stock markets too tumbled - largely led by the IT stocks. Most big IT stocks have till date not been able to reach the highs they made in March 2000. Structurally however, the economy rebounded quickly, since the crash was largely global in nature, and excesses were largely contained in a few sectors.
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Many retail investors lost a large chunk of their money in this crash, in a bid to gain from the 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 at abnormal movements of stock prices. However , large chunk of the money remains untraced and not many people went through rigorous punishments.
2008 - The Credit Crisis
Pre Crash Boom
Major Markets - 2001-2008
Interest rates had been low globally for quite some time since 9/11. This resulted in strong growth, led by free capital , breaking of trade barriers and the emergence of new economies. Emerging market did exceedingly well, so did the developed markets, led by the belief that easy capital was always available. Global markets rallied from 2002 onwards, most of them 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 capital needed avenues for investment. The innovation in the financial world created new products, such as Mortgage Backed Securities and Collateralized Debt Obligations. These instruments would enhance the return for any investor, and hence there was more demand for such arrangement. Money was in abundance - and was looking for areas to get deployed.
2008 - The Credit Crisis
The Buildup to the Crash
Major Markets - 2001-2008
Enter securitization - The real estate sector was doing exceedingly well. More and more people borrowed money to buy houses. Now the mortgage provider - in order to reduce its risk - sold a pool of these mortgages to investment banks. Investment banks then clubbed these mortgages together, and sold them into tranches to various investors. Each investor got a varied return based on the 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 expand the mortgage base. Thus loans were given out to people who were not qualified 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.
2008 - The Credit Crisis
The Crash
Major Markets - 2008-2010
Eventually though - the economics had to catch up. Once the house prices stopped going up, and the housing bubble burst, the mortgage backed securities lost a large part of their value. Anyone creating, holding or insuring these securities was in trouble. Once the financial system sensed trouble, lending froze. This led to a complete credit freeze in the financial system - where no one could 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 the troubles everywhere. US tumbled, Europe faced crisis, and led by a panic selling of institutional investors, emerging markets also plummeted. Countries like India, which were really not impacted directly by the crisis also faced the heat. Equity markets tumbled 6070% in most countries.
2008 - The Credit Crisis
The Aftermath Markets faced the worst freeze since 1929. Unlike 1929 though, the governments jumped in to 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 were given. 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 1930¶s kind of depression, the rebound was sharp. As we speak, most markets have recovered massively from their bottoms, with some within 15-20% of their previous highs (India being one of those). Economic condition in emerging markets has improved - as their own fundamentals came to the fore. US remains in economic 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 real panic started after the first round of bounce had happened. We need to wait and watch if anything like that materializes.
The common theme
Bubble - irrational exuberance Most of the crisis we have discussed so far, are clear case of bubbles being created due to the irrational exuberance of market participants. People rush to buy in stocks, in anticipation of the ever rising prices. Story to sell Usually there is a story to sell! Something that sounds like the next big thing. It was investment trusts with leverage in 1929, program trading in 1987, India¶s liberalization in 1992, 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 will never say that outlook is bad, while CEOs are people like us, who assess 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 repeating itself at an alarming frequency. The more we think we are different, the more we end up being the same.
The Learning
Bubbles and Crashes are realities However much we may like to think that this time is different, we need to remember that investors and traders participating in the markets have similar behaviours. So while the times may 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 reality and 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 the benefit 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 today¶s context - power sector is one such story. Ignore commentary by politicians No politician will ever say that the picture is grim. So no point listening to them. Half of the time 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 you are Warren Buffet. Else, remember, no one went broke booking profits.
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 ² agonized little speculators,... sold-out traders,... inquisitive individuals and tourists seeking ... a closer view of the national catastrophe it going to end?" Account of the stock market crash in the New York Times.
Where was
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
Crash
Each equity market crash has a widespread impact - on the economy, on the sentiment of investors, on the entire outlook surrounding the economy. So it becomes imperative that we understand what happens in some of these crashes, and how can we avoid massive damage or look to benefit from these crashes. This is also important in 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 underlying theme to these bubbles. We will also look at examples and anecdotes around these crashes.
1929 - US
Pre Crash Boom After world war I, the US market witnessed at extraordinary period of prosperity - which came to be known as µThe Roaring 20s¶. The Stock markets jumped nearly 6 fold in 8 years, prior to the 1929 crash. Manufacturing was on the rise - as denoted by the Federal Reserve Index of Industrial 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 made available which eventually made its way to stock markets. The amount of broker loans - which hovered around USD 1 billion in early 1920s, jumped to 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.
1929 - US
The Build up to the Crash Speculative activity in the markets was on the rise - so was margin trading. There was a serious 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 the market to dry up excess liquidity. The Fed thought about increasing rates early in 1929, but deferred action at that time. One reason that people thought prices were very high for stocks was presumed to be a scarcity of common stocks in the country. This resulted in formation of new entities known as trusts, which would raise investor money to invest in securities of other companies. In the beginning of 1927, there were 160 investment trusts. Another 140 opened that year, 186 in 1928 and 265 in 1929. In 1929, they were permitted to get listed on the stock exchanges.
1929 - US
The Build up to the Crash These trusts were leveraged - that is they used borrowed money to build up positions. There were more layers of leveraging, where trusts held shares of other trusts. This could result in a gain of 700-800% when the underlying securities just gained by 50% or so! This resulted in a 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 of underlying securities. Goldman Sachs launched 2 trusts, which became popular investment destinations in 1929. While sometime in September 1929, the markets started becoming volatile and choppy, there voices 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 ² the Dow stood at 381.17, up 27% from the previous year. Over the next few weeks, however, prices began to move downward. The lower they fell, the faster they picked up 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 September 1929 - much higher than the usual average.
1929 - US
The Actual Crash Stocks had become extremely volatile in the run up to the crash. After witnessing a sharp fall and a brief recovery in September and October beginning, the actual crack started around October last week. The Dow Jones crashed 12% and 11% on 2 consecutive days - October 28 & 29. The volume on stocks traded on October 29, 1929 was a record that was not broken for nearly 40 years, in 1968 Markets ended October about 40% lower than their September top. There was a bounce in 1930, which led people into thinking that the worst is over. The US President Herbert Hoover actually 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 were unemployed; the figure more than tripled by 1933, the worst year of the Depression. The national unemployment rate peaked at 25% in 1933. The stock market tumbled after the initial bout of recovery
1929 - US
The Aftermath - The Great Depression Once the initial recovery ended, the share prices tumbled, with the eventual low coming in 1933, about 90% below the 1929 high of the market. This high was not breached for another 21 years after 1933. Some 25% of all banks in the US failed during 1929 - 32. There was a massive run on the banks - while the government did not extend support to the failing banks. Some 4,000 banks and other lenders 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. Commodity prices continued to suffer, creating problems for the farmers. Steel production was at 35% of the capacity by mid-1931. It further fell to 12% by 1932.
1929 - US
The Aftermath - 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. Only post world war II did improvement come. Individual stocks were completely battered. Most large stocks fell nearly 90%. The fate of the investment trusts was even worse, with most of the trust stocks falling from prices higher than 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 Harvard Economic Society, continued to come out with reports that the worst is over. They came out with their opinion on more than 10 occasions between 1930 and 1931, and were clearly found 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 mattered before the crash.
1987 - US
Dow Jones 1983-1988
Pre Crash Boom The stock market rallied strongly in the years leading up to the crash. The Dow Jones Industrial Average rallied from about 1000 in 1983 to 2700 in 1987, before cracking. 1987 opened with bond yields near their lowest levels in nine years. Corporates issued more than $200 billion in notes during all of 1986 -- two times the level of debt issued in 1985.
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There had been an influx of new investors, such as pension funds, into the stock market during the 1980s, and the increased demand helped support prices Also - newer trading strategies around portfolio insurance and program trading had come up. Portfolio insurance meant selling stocks below a particular level, and program trading was essentially entering into a trade based on certain levels getting breached. These were unchartered territories - and the impact was wide.
1987 - US
Dow Jones 1983-1988
The Build up to the crash Many interesting factors came to the fore in the build up to the crash. The trade deficit of US soared, resulting in the US dollar plummeting. Interest rates soared, as Long-term bond yields that had started 1987 at 7.6% climbed to approximately 10%.
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Oil prices - which had fallen in previous years, jumped up from nearly USD 16 per barrel to 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 against multiple 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.
1987 - US
Speculative companies with unclear business plans start springing up. Business descriptions were vague, such as this "Synergy Space-Bovubetribucs forges a new frontier in the introduction of organic entities into the ecosystem of the lunar-scape in order to promote greater synergy. This triumphant new 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 this for AT&E Corp, a company developing a wristwatch-based paging system. Analyst Evelyn Geller of Blair & Co. says of AT&E, "The thing could trade anywhere -- up to 30 times earnings. 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 being realized." Although Geller spoke specifically of AT&E, her comments could be taken as a general 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. Both Iran and US fire missiles on each others tankers and oil platforms respectively.
1987 - US
The Actual Crash Stocks started sliding a few days before the crash. Before the Black Monday, the markets fell nearly 10% in the previous week. On October 19, 1987, markets tumbled completely, falling a whopping 508 points or 22% in a single day. This is till date the largest single day fall for the DJI. Global markets also tumbled. The global rout also began on the same day, and had already caused substantial declines in markets before the US market opened. The FTSE 100 Index lost 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 getting delayed - and prices lagging. The uncertainty fueled even more selling - and resulted in the index losing 22% on October 19th 1987.
1987 - US
The aftermath Markets actually rebounded soon, and the crisis was not a long lasting one - especially since the underlying economy was not a cause for concern. The fall was accentuated due to program 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 had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling about 60% 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 inject reserves to buoy liquidity in financial markets. Circuit limits were introduced in the indices. Given the lack of structural issues in the economy, the economy as well as the markets bounced back soon - the US markets created a new high in 1989 - in 2 years from the Black Monday. Economic growth over the next 2 years was about 3.9%, even faster than the 2 years preceding the crisis.
1992 - India
Pre Crash Boom
Sensex 1991-92
Indian economy had just been liberalized, after passing through some tough phase - under the leadership of the then finance minister Mr. Manmohan Singh. FDI in various sectors had been opened up, tariffs were removed and the protectionist environment made way to healthy competition. This resulted in a belief that India is poised to grow significantly in the future - a belief which was not misplaced entirely, but came a bit too early. Also, while the India story had some takers, it was largely a scam that led to the huge rally in the stock market
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Harshad Mehta, a name about to become familiar all over India for his involvement in a multi-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 and shore up the prices of these stocks. The stock market rallied nearly 300% in 1.5 years.
1992 - India
The Buildup to the crash
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As the rally continued unabated, Harshad Mehta kept swindling more and more money. Stocks went hyperbolic, especially stocks in the infrastructure sector. A stock like ACC went up from Rs 200 to Rs 10,000 (not adjusted for subsequent bonuses - hence not comparable to the current price) The BSE Sensex moved from about 1000 in Jan 1991 to create a high of 4500 in March 1992. The astounding 4 fold 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 to March 1992. Then however, came the crash
1992 - India
The Crash
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In April 1992, it came to the notice of the government of Indian that there was a shortfall in the government securities held by SBI. Investigations then uncovered the entire scam, where bank funds were misappropriated - sometimes with the knowledge of corrupt bank officials and sometimes without the knowledge of unsuspecting bankers. Brokers acted as conduits in inter-bank transactions, thereby holding the securities and making the payments.
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Here the broker could provide with a fake broker receipt which worked as a contract that the securities 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 the tune of Rs 3500 crore, and the unearthing resulted in the Sensex falling nearly 55% from its highs in the coming year.
1992 - India
The Aftermath Harshad Mehta was arrested. His arrest also revealed massive scale of corrupt practices in the 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 various names and accounts, and no-one knew the extent of shareholding indirectly in his name till the time of his death. Markets crashed - resulting in a huge loss of value in terms of market capitalization, far higher than the scam value itself - as securities whose prices had been bumped up fell, and there was a fear of higher regulation and slowdown in the liberalization and reform process. Foreign Investors 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 of the 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.
2000-01 - The Dot Com Crash
Pre Crash Boom
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The Dot Com Bubble was created during the years 1995-2000, as the technology sector grew led by innovation. The spread of internet created a new paradigm in businesses, and company after company launched online business models. The IPO of Netscape marked the beginning of a new era. These business models, while good in idea, carried a lot of execution as well as business risk. However, led by unbridled optimism , internet stocks and technology stocks rallied massively in these years.
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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 other new technology businesses. It was assumed that any dot-com company which was able to garner huge market share will succeed. While in principle the idea was correct, but this was 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 a massive bubble being created in these companies. The employees and promoters of these companies made a lot of money when they went public - and this money was again pumped into the sector.
2000-01 - The Dot Com Crash
The Build Up to the Crash
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Between 1999 to 2000, the US Fed increased rates 6 times. The economy was losing speed. This was bound to have an impact on the share prices of internet companies, which were based on very optimistic economic growth premises. It was assumed de-facto that a model successful in one country 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 second quarter 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 of the 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.
2000-01 - The Dot Com Crash
Nasdaq 2000-2004
The Actual Crash The crash began in March 2000. The NASDAQ (Technology heavy Index) peaked at the value of above 5000, only to subsequently get hammered by nearly 80% in the years to come. The initial six days resulted in a loss of nearly 10%. Soon the companies which had seen huge rallies in their stock prices started unwinding, and resulted in many of them losing 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 a large 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 from March 2000 to October 2002.
2000-01 - The Dot Com Crash
The Aftermath - some examples of the bubble e.Digital Corporation (EDIG): Long term unprofitable OTCBB traded company founded in 1988 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 closing price of $2.91 on December 31, 1999 to intraday high of $24.50 on January 24, 2000. It quickly 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 dialup Internet access, acquired Time Warner, the world's largest media company. Within two years, boardroom disagreements drove out both of the CEOs who made the deal, and in October 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 site which 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 $1 when it declared bankruptcy in February 2001. Source - www.wikipedia.com
2000-01 - The Dot Com Crash
The Aftermath - 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 but lack of any revenues or profits. The number of IPOs in 2001 was 76, and none of them doubled. Many dot com companies liquidated, or were bought over by competitors. Some survived the crash to emerge stronger - such as Yahoo and Google. Also evident was the fact that while there 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 without earnings were not valued at huge valuations simply due to a client base.
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 due to a scam, which involved the technology company stocks. Ketan Parekh, a broker - came into prominence, largely due to his dealings in stocks of 10 companies. These companies included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips, Pritish Nandy Communications, HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics. He carefully selected companies in the technology, telecom and media space - which was buzzing globally in the Dot-Com boom. Ketan used to start cornering stocks which lacked liquidity in the market. Then the stock used to be put into play through various accounts. Once the price jumped, Ketan scouted for institutional investors to sell his stock. At its peak, these stocks used to be the most traded counters in India. Many mutual funds picked up these stocks, in order to boost returns. However, Ketan used borrowed money to buy a large chunk of these stocks. It was also alleged that money was used from 2-3 banks, including the Global Trust Bank.
2000-01 - Indian Market Crash
The Crash Ketan had used the same stocks as security with various banks to borrow more, and buy more. 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. The ferocity 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 to the fore, stocks fell, many of them close to zero from levels like Rs 2000-3000.
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The Aftermath Stock markets too tumbled - largely led by the IT stocks. Most big IT stocks have till date not been able to reach the highs they made in March 2000. Structurally however, the economy rebounded quickly, since the crash was largely global in nature, and excesses were largely contained in a few sectors.
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Many retail investors lost a large chunk of their money in this crash, in a bid to gain from the 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 at abnormal movements of stock prices. However , large chunk of the money remains untraced and not many people went through rigorous punishments.
2008 - The Credit Crisis
Pre Crash Boom
Major Markets - 2001-2008
Interest rates had been low globally for quite some time since 9/11. This resulted in strong growth, led by free capital , breaking of trade barriers and the emergence of new economies. Emerging market did exceedingly well, so did the developed markets, led by the belief that easy capital was always available. Global markets rallied from 2002 onwards, most of them 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 capital needed avenues for investment. The innovation in the financial world created new products, such as Mortgage Backed Securities and Collateralized Debt Obligations. These instruments would enhance the return for any investor, and hence there was more demand for such arrangement. Money was in abundance - and was looking for areas to get deployed.
2008 - The Credit Crisis
The Buildup to the Crash
Major Markets - 2001-2008
Enter securitization - The real estate sector was doing exceedingly well. More and more people borrowed money to buy houses. Now the mortgage provider - in order to reduce its risk - sold a pool of these mortgages to investment banks. Investment banks then clubbed these mortgages together, and sold them into tranches to various investors. Each investor got a varied return based on the 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 expand the mortgage base. Thus loans were given out to people who were not qualified 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.
2008 - The Credit Crisis
The Crash
Major Markets - 2008-2010
Eventually though - the economics had to catch up. Once the house prices stopped going up, and the housing bubble burst, the mortgage backed securities lost a large part of their value. Anyone creating, holding or insuring these securities was in trouble. Once the financial system sensed trouble, lending froze. This led to a complete credit freeze in the financial system - where no one could 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 the troubles everywhere. US tumbled, Europe faced crisis, and led by a panic selling of institutional investors, emerging markets also plummeted. Countries like India, which were really not impacted directly by the crisis also faced the heat. Equity markets tumbled 6070% in most countries.
2008 - The Credit Crisis
The Aftermath Markets faced the worst freeze since 1929. Unlike 1929 though, the governments jumped in to 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 were given. 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 1930¶s kind of depression, the rebound was sharp. As we speak, most markets have recovered massively from their bottoms, with some within 15-20% of their previous highs (India being one of those). Economic condition in emerging markets has improved - as their own fundamentals came to the fore. US remains in economic 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 real panic started after the first round of bounce had happened. We need to wait and watch if anything like that materializes.
The common theme
Bubble - irrational exuberance Most of the crisis we have discussed so far, are clear case of bubbles being created due to the irrational exuberance of market participants. People rush to buy in stocks, in anticipation of the ever rising prices. Story to sell Usually there is a story to sell! Something that sounds like the next big thing. It was investment trusts with leverage in 1929, program trading in 1987, India¶s liberalization in 1992, 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 will never say that outlook is bad, while CEOs are people like us, who assess 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 repeating itself at an alarming frequency. The more we think we are different, the more we end up being the same.
The Learning
Bubbles and Crashes are realities However much we may like to think that this time is different, we need to remember that investors and traders participating in the markets have similar behaviours. So while the times may 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 reality and 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 the benefit 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 today¶s context - power sector is one such story. Ignore commentary by politicians No politician will ever say that the picture is grim. So no point listening to them. Half of the time 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 you are Warren Buffet. Else, remember, no one went broke booking profits.
