Financial markets have always gone through periods of volatility. One need only look as far back as the Great Depression of the 1930s or the Global Financial Crisis of 2008 to see how quickly a market can turn and how long it can take for recovery, and it’s essential that investors should always maintain a long-term outlook when making decisions about their investments to weather any short-term fluctuations in the market.

When looking back over time and analysing financial market performance after a ‘market crash’, it’s clear that these markets have always been cyclical in nature. Taking a long-term outlook and understanding how they recover over time is key. When looking back at major market falls or crashes, some were caused by mismanagement or bad decision-making, and some more by a combination of global events such as the recent Covid-19 pandemic and the war in Ukraine.

For example, the main reason for the Wall Street Crash of 1929 was the huge stock speculation that had preceded it. Millions of people invested their money in stocks and shares which then subsequently led to a considerable drop in share prices. The market crash that followed led to the Great Depression during the 1930’s across the US, and significantly affected global economies, and it took over twenty years for markets to recover completely¹.

Overvaluation of stocks

Several factors, including overinflated stock prices, massive debt levels and weak consumer confidence, caused the Great Depression. This led to an extended period where financial markets worldwide contracted significantly, with some countries experiencing more than a 50% drop in international trade during the years of the Great Depression².

The Black Monday crash occurred on October 19,1987 and is widely believed to have been caused by a combination of factors such as instability in the global economy, overvaluation of stocks, large-scale selling orders and program trading.

Market sentiment reversal

Program trading involved using computer algorithms to rapidly execute large numbers of trades simultaneously, resulting in an increased speed and volume of transactions with little regard for fundamentals or overall market conditions. This created an environment where stock prices could quickly become overinflated and suddenly collapse with almost no warning.

In addition to these technical causes, psychological factors also played a role in the crash; investors had become overly confident in their ability to predict future stock movements and were unprepared for the sudden reversal of market sentiment.

Asset bubble bursts

As a result, many investors panicked and sold their shares en masse, leading to the downward stock price spiral that characterised this crash.

The same could be said of the Global Financial Crisis of 2008, which reportedly was caused by a combination of factors, including lax regulation and oversight, government policies that encouraged homeownership for people who could not afford it, and the bursting of an asset bubble in the United States housing market.

Complex financial instruments

Financial institutions had invested heavily in mortgages and other risky investments, leading to losses as home prices declined. Additionally, large banks took on too much risk through complex financial instruments known as derivatives, which magnified their losses when these instruments went sour.

This lack of transparency made it difficult to understand the full extent of interconnected risks among institutions and markets. Ultimately the result was a systemic failure that led to significant economic disruption worldwide.

Exacerbating market instability

More recently, the COVID-19 pandemic significantly impacted the global financial markets. Markets experienced an initial shock and subsequent volatility as investors reacted to the increased uncertainty about the economic outlook.

Stocks, bonds, and other securities have been impacted by this turbulence, resulting in losses for some investors. In addition, the pandemic has caused disruptions to industries around the globe, further exacerbating market instability.

Potential economic impacts

As a result of these events, central banks and governments implemented economic stimulus measures to protect jobs and businesses from collapse. These actions provided liquidity in markets and encouraged riskier investments, such as stocks, to be made more attractive.

As confidence has returned over time, so has investor sentiment, helping drive up stock prices in certain sectors. In the longer term, it is likely that the global financial markets will remain volatile due to the uncertainty surrounding future public health developments and their potential economic impacts.

Short-term fluctuations

Each cyclical event has affected markets differently and for varying lengths of time. Still, each has reminded us that financial volatility can occur without warning, underscoring the importance of professional portfolio management.

However, despite these events devastating effects, financial markets have consistently recovered from them in time. It remains to be seen what will happen with current market conditions. However, investors should keep short-term fluctuations from diverting them from taking a long-term view of their investments.

Multiple asset classes

While it is essential to react and adjust to survive in the short term, investors must still be focused on the long run when making decisions that will affect their portfolios. Investors can better prepare and protect their portfolios from major market downturns by understanding historical trends.

This includes diversifying investments across multiple asset classes, adjusting risk levels according to individual goals, maintaining adequate cash reserves for emergencies or opportunities, and taking a long-term view of the markets to ensure steady gains over time. Investing with these strategies enhances an investor's chances of weathering any potential storms on the horizon.

Sources
¹ 11th November 2022 | Stock market crash of 1929 | Britannica.com
² The Great Depression | Lumen Learning

Please note: This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

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