The ‘Corona Crash’: A Historical Perspective

23rd Mar '20 by Alex Naamani

53 comments 9605 reads

History repeats itself. Specific details change as we step through time, but certain patterns recur again and again. This is particularly true in the stock market. Bear markets have followed bull markets since the 17th century, when Dutch investors were burned by the ‘Tulip Mania’ bubble of 1637. At the same time, bear markets come in all shapes and sizes. Sometimes crashes coincide with economic downturns. Sometimes they don’t. Some bear markets bottom out quickly, but sometimes it takes years to reach rock bottom.

With this in mind it is important to try and understand what type of bear market this ‘Corona Crash’ is. Like all bear markets, the ‘Corona Crash’ will present investors with opportunities to buy stocks at bargain prices. But where there is opportunity, there is also risk. Shareholders may get hurt if they invest before stocks reach their low point. In order to gain a deeper understanding of this bear market, I want to take a closer look at various stock market crashes that have occured in recent history, and explore what investors might expect during the drawdown of 2020.

1973: A Steeper Fall Than 1929

The crash of 1973-75 hit British stock markets hard. The financial journalist, Christopher Fields recalled that ‘it was a steeper fall than there had been in this country in the Great Crash of 1929-31’. It wiped out Jim Slater, author of The Zulu Principle. Before the markets collapsed, Slater had been a high-flying tycoon. After the crash, he retired to write childrens’ books. In his memoirs, Slater recalled that:

“1974 was to be the year of the hurricane with a vengeance. On 1 January 1974 the Financial Times 30-Share Index stood at 344. By the end of the year, the index dropped to 163." - Jim Slater

The FT 30 (precursor to the FTSE 100) lost around 70% of its value between 1973 and 1975. The index stood at 478 in January 1973. When it bottomed out in January 1975, it closed at 146.

Why did the markets collapse? Britain faced severe political and economic problems. It was often condemned as the ‘sick man of Europe’. The Arab-Israeli war of 1973 was the short-term factor which triggered the crash. The conflict caused oil prices to rocket. Inflation went through the roof, reaching 25% in 1975. At the same time, trade unions were becoming more militant. Strikes damaged…

Unlock with Email

Unlock with Google

Already have an account?
Login here

ridavies

24th Mar '20

Thanks for that, Alex. Always great to read the views and analysis of my betters. However, there is no reference to an imppending downturn in the world economy BEFORE coronavirus. ; over-valuing of the US stock market etc. Also, as always, there will be recovery in some sectors faster than others. Are they different this time. Finally, there are always differences in the conditions at any given time. Currently, we have the ability in many sectors to operate at a distance. Home working has shown how they can be exploited, and how much we can live with them. Couple that with the need to respond to global warming, and we should all be asking do we need to travel anywhere near so much as in the past - for business, for leisure. This may well not just be on an economic but also an ethical basis. We can do it; and out of necessity, we have proved it, so do we need all these conferences when we can have conference calls etc It is a challenge to the technology which I have confidence in achievement if there is sufficient demand support; and to us as people who dont like change at the best of times, and this may just present the conditions in which we are prepared to have a go in sufficient numbers.

Interesting point you, Intuitive6191, make about travel abroad at reasonable coat. I have a time share in the French Alps, and have taken the calculated risk of booking flights with EZY, assuming they are still operating by then. I have booked using a credit card so that should be safe, if the credit card Amex company is still around.

My real point is that the total cost for 4 flights (2 internal UK and 2 international), with Easy Boarding, and luggage was about £250. I would guess that in real terms that is around 50% of what I would have paid 20 years ago. The key questions are will these low prices appear again; who will have the money to afford them and the associated holidays; and will we start in the light of global warning to think about what we can do in extremis. Nothing like 'in extremis' to make one think, assess the possibility of beneficial change and to use inate human creativity to achieve it. Lets hope so.

I dont think that the holiday business with recover anytime soon - and im talking many months rather than a few.....but given the unwillingness of people to change, I may be totally wrong.

Economic_Literate

You need to brush up on Modern Monetary Theory (MMT). You are wrong on several points.

.http://bilbo.economicoutlook.n...

Taleb has mad good living just stating the bleedin' obvious.

'Taleb points out that it is impossible to predict future events.'

Wow.

GavSmith01

Small point but FTSE 100 was at 7500 levels before the crisis.

Meldrew

25th Mar '20

I sold all my shares soon after the downturn started. It means that I did not lose much of my investment pot. My problem is what I do now. I fully agree with Alex and Nassim that optionality seems to be the way forward. It also makes sense to drip feed.

My gut feeling is that the effects of Covid-19 are not going to go away any time soon so it may be too early to start reinvesting, despite the recovery this week. I feel it could turn out to be a 'dead cat bounce'.

The WHO believes that the USA is on track to be the next epicentre of Covid-19. If so, the the consequences could be more damaging to the world economy than we have seen so far. That is without the fact that Covid-19 is still expanding throughout the UK and most of the world. The situation in China looks promising but it could take some time before supply chains are rebuilt and their economy really gets going again. They need the rest of the world to shake off Covid-19 first.

I have been tempted to buy gold. I'm sorry I didn't over a year ago when I first considered it. I might still do so. I have considered buying back shares in gold mining companies like POG and SHG, although they have been volatile.

I might stay on the sidelines and wait a while longer before I start drip feeding.

Star8

Alex

An excellent article: clear, informative and actionable.

One point I would suggest to help get a handle on the current situation is to look at the causes of the crashes you mention.

1987 apparently had no clear cause as far as I know. The market dropped and there were no buyers. Portfolio insurance was blamed (a then touted means to insure or protect the portfolio which whilst good in theory, failed the real-world test : in practice there was no one on the other side of the trade when the theory assumed there always would be.) Therefore a quick recovery was, in hindsight, not surprising. There was no fundamental fault in the system.

2001 and the dot.com crash was a sudden market realisation that the Emperor had no clothes : dot coms like any economic entity in the stockmarket world, had to make a profit or have a realistic prospect of a profit. This was a massive cultural or perception shift and the market did a 180 degree turn from unreasonable optimism to unreasonable pessimism.

2008 also had a fundamental cause. The Great Financial Crash was initially caused by an unprecedented simultaneous fall in all US House prices impacting on a previous mispricing of credit. The zealous selling of financial derivatives (MBS, CDOs ABS CLOs etc) was based on the underlying assumption that spreading risk across enough securities (in effect pyramiding it) meant risk was erased or could be disregarded. Obscene rewards for financial sales with none for no sales blinded the participants to their products' faults.

This crisis it could be argued, had a lot in common with the 1973 crash which combined a weakening economy, social strife and massive real estate speculation on borrowed money. This crash as you point out had the largest drop. You do not mention how long this market took to bottom out but I remember in 1975-6 looking at notable companies that were priced at 10%. of their previous highs.

Our current crash is somewhat different in nature and magnitude. It is not the Economy or financial misperception that is causing the current crisis but an evident existential threat to all of us. Effectively no one alive today can remember or has experienced such a situation;the last being Spanish Flu plague in 1918-19. SARS, Ebola, Zika and H1N1 were localised and dealt with far away from us -scarcely a mark on our horizons and with far fewer casualties.

In this unknown territory, with no effective cure (as yet) and a deteriorating situation, human nature and markets will fear the worst and panic. The markets can deal with bad news: they cannot price in the unknown. Further the economic effects will most likely compound as part shortages eg. in cars, mobile phones , human shortages in staffing and government restrictions take effect on our finely tuned international economic mechanisms.

The economic measures as instituted by the government as concerns the Stockmarket markets are economic and palliative: interest rate reduction, liquidity supply. They are neither cures nor a remedy.

Given the above it is likely that the market bottom is quite far off. Even given a proven vaccine (months away apparently) it will take additional months to repair the dislocation and for profits to perceptibly recover. Perhaps we should anticipate worse news rather than give in to the human nature of hope and anticipation of better times even when unsubstantiated by reality ?

As a final important point one should not neglect the significant role of Hedge Funds in current market movements . Until recently they have had a number of unimpressive years due mainly to generally weak or slow market movements .

It is now Showtime for them. Expect every market move to be exaggerated as hedge funds compound the trend especially since now that many normal market participants e.g. Pension Funds will be frightened to step into trying to resassert fundamental value. (Standard Long only Private Client Discretionary Funds and Pension Funds are generally risk averse).

But of course I could be wrong and often am, according to my nearest and dearest...

insy09

I had the same approach and the same view. China's approach was eradicating it while USA, UK and Europe have a different approach trying to manage the spread. It will likely occur again in China IMO with wider effects to global economy.

jgunnsm2

27th Mar '20

They still have social distancing so doubt it’s over.

john horner

Very Interesting article

Rusty2

Still testing in China, hence new cases most days, yes one day there was none but today there was 55 new cases, they also have over 1,000 in serious/critical condition, so it's not completely over just much reduced, if information is accurate.

David Collinge

Super article. I'd also add diversification as a strategy and the view that every closed door could become an open door. One unknown is the high potential for tax rates to increase similar to what happened after world war 2.

I was complacent too but I relied on the herd immunity strategists for my information.

John Calvert

I have invested through all the crashes including 1973/4. However I am more worried about this one as it is worldwide and will devastate worldwide production for a considerable time.

In the early 2000,s I was a deciple of Fred Stafford who followed the teachings of W D Gann.

The time to worry is if the FTSE closes below 3900 as according to Gann the next stop is 1950 even if it takes some time.

He was spot on in 1974.

CharMar

Very fine article, and a timely 'step-back and survey'. As noted by others below the responses are an interesting read. Much talk of paradigm shift.. I would be v interested to understand better why yet more debt, in quantums never before seen, may not stand a good chance of fulfilling the classic definition of inflation: too much money chasing too few goods. If the global 'output gap' has grown or become dislocated through a prolonged C-V shut down and with further severe GDP and market declines, CBs/ Govt are on the hook to have to continue printing money; whatever the economic scoffers might say to that in their complacency about low interest rates, there is only one ultimate lever to control inflation. Interest rates. Present strains on the financial system are quite bad enough. And it's worth remembering the bond markets are many times the size of equity markets. That's where the action is. Any significant outbreak implies huge strains, once more, on the global financial system in the fixed income markets. It has huge consequences for costs of capital, and would in my view be a paradigm shift. Someone tell me it a phantom, a nightmare...Coro-inflation? The Next Wave? I damn well hope not.

xcity

I would be v interested to understand better why yet more debt, in quantums never before seen, may not stand a good chance of fulfilling the classic definition of inflation: too much money chasing too few goods.

This is a possibility, though not in the near future. And it is something the government can control. - a lot will depend on what decisions it takes as well on what happens in the worldwide economy. And it can do QE without increasing debt if it chooses.

The intention of previous QE, apart from refloating banks, was to increase demand and inflation. To do that it also needed to be sufficient to overcome the reduced multipliers from increasing banking reserves. Unfortunately too much smashed into asset price rises rather than real world prices; it seems they still have a lot to learn on how to manage this QE lark. But, in theory, the government ought to be able to pull it back again. This cycle the timing was completely disorganised. China, USA, UK, ... Abe, EU, Trump. Might have got the EU and Abe out of position and China had a few little goes. Impact would have been much better if they had been more in sync, though the upswing and bull market would have been shorter; but would certainly have been up by more.

My guess is that they will see the positive side of a little excess inflation and will take a while to pul it back if inflation does swing further up. Inflation reduces the value of debt and no-one dislikes that except bondholders. Banks prefer inflation and higher interest rates and so do most people who hold cash. So buying shares could be worthwhile, if you could only be sure which will prove to be assets rather than a pack of confetti.

Ned Kelly

28th Mar '20

There are a couple of other factors to be considered here:

1. The "Corona crash" has coincided with an oil price war which I don't think is going to be over quickly. This may be a plus in terms of cheaper fuel but has undoubtedly contributed to the sudden drop in the indices.

2. The outcome in the US of the virus which may/probably will be, much more serious in terms of deaths and debt than in Asia . Also Asia may well come out of the crisis ahead of the US and contribute to a shift in economic power to the east. This could significantly hamper a return to growth in the UK and Europe

Zipmanpeter

29th Mar '20

I agree the current crises will significantly accelerate the shift in economic power to the East and specifically China (as the dominant Asian power). Old 'stocks' of European capital will be further run down and populist demands for more healthcare will lead to bigger state burdens.

However, the bigger move may be a return to a more mercantilst approach to trade globally, with some production reshored but greater system losses from less trade and innovation.

30th Mar '20

Thoughtful stuff xcity, and on the whole I see your points. However: a) CBs doing QE is one thing, but Govts taking on commitments through fiscal systems on this scale is another, surely? They actually have to produce cash to pay people. b) I do take your point about the Goldilocks scenario on inflation... but we'll see if Govts can not only give ( because they must), but take back on a time scale that doesn't leave them with hugely increased funding needs. Maybe your QE comes in again there. As the FT reports, big strains are showing up in fixed income ETFs at a time when liquidity needs are once more being driven by market declines. Not just equity market declines either. Historically 'risk free' Govt bonds or generally safer (in the capital structure) corporate assets seem to have walked on water, even as the waters rise in level. How long can that go on now? Can QE still avert it? Even without my somewhat Coro-doomish scenario of rampant inflation, I remember well bricks starting to come of the wall in the financial system back in 2008.. God forbid it should happen again.

18ELI5781

1st Apr '20

Decline of America has begun. Significantly since Year 2007/2008. Most of the decline is due to the middle class’s Inability to resuscitate from : 1. Outsourcing. 2. Boom/Bust economics. 3. Foreign war BLUNDERS. In other words, American capitalism is detrimental to its own economic well-being. Thus China has risen. By default.

eli segal

RobC

9th Apr '20

Hi Alex,

Interesting article.... but I would question two things:

1. Drip-feeding. This does not really give the investor “optionality” as described in Antifragile. This approach depresses returns while “averaging-in” to avoid large adverse losses. It also does nothing to avoid large low probability losses when fully invested.

Antifragile advocated bar-bell strategies. i.e. a mix of high risk and no/minimal risk assets. The high risk assets provide both above average returns for the portfolio and very high convexity payoff for adverse outcome from extreme events.

2. Market timing and portfolio management.

It's not a given that portfolio managers or even individual investors need to be concerned about long haul versus flash-in-the pan outlooks to time their investments.

The most well-known practitioner of Taleb’s ideas is Universa. This is a hedge fund run by Mark Spitznagel (and has Nassim Taleb as an advisor and board member). The fund’s strategy has two components:

Invest in the economy's productive capacity (i.e. shares).
Use positively increasing CAGR as the main performance measure under as broad a range of operating environments as possible. (This includes environments such as the current pandemic and its market fallout).
Risk reduction should be achieved through adoption of an insurance style hedging model.

This implies that the fund has been to be overweight (long only) in marketable equities and then tail-hedges with deep out-of-the-money index puts. This achieves the holy grail of the private investor of:

generating acceptable above average returns with low insurance costs in low volatility environments, and
avoiding large portfolio losses in high volatility and adverse operating environments, thereby providing large amounts of immediately available cash for reinvestment.

Does this work? Well, the track record is promising. In a letter sent yesterday, Spitznagel has just informed the fund’s investors of a +3,612% net return on capital for March 2020, YTD of +4,144%, and a life-to-date net return of 239%. (By contrast S&P down was down 26.2% at lowest and 12.35% at month close). There was a similar experience for the fund in 2008.

It would be interesting to create a guru screen to backtest this approach on UK all shares portfolio. Would need index and/or share option pricing capability.

The ‘Corona Crash’: A Historical Perspective

1973: A Steeper Fall Than 1929

Unlock the rest of this article with a 14 day trial

About the Author

Alex Naamani

53 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...