So what should you do? Should we join the herd and invest more or should we cash in while the going is good and reinvest after the market crashes? Let us see what the history of Dow Jones tells us about what is to happen.
Wall Street Crash of 1929
This was the first historic crash of the US Stock Market. The US economy was booming in the "Roaring Twenties". The US stock market had been on a six year Bull run that saw the Dow Jones Industrial Average increase five fold in value. The Dow peaked at 381.17 on September 3, 1929.Then suddenly economic disaster struck in October 1929. The stock markets crashed. On October 24 ("Black Thursday"), the market lost 11 per cent of its value at the opening bell on very heavy trading.
Some big financiers tried to halt the slide by aggressive buying in an effort to repeat the strategy that ended the “Panic of 1907”. But it did not work. On Monday, October 28, more investors decided to get out of the market, and the slide continued with a record 13 per cent loss in the Dow. The next day, October 29, 1929, about 16 million shares were traded, and the Dow lost an additional 12 per cent.
The market continued to fall arriving at an interim bottom on November 13, 1929 with the Dow closing at 198.60. The market recovered for several months reaching a secondary closing peak of 294.07 on April 17, 1930 before embarking on another, much longer, slide from April 1931 to July 1932 when the Dow closed at 41.22, its lowest level of the 20th century. It would not return to the peak of September 1929 until November 1954, a gap of about 25 years.
The Bursting of the Dot-com Bubble 2000-2002
This was the first major stock market crash of the US stock market in the 21st Century. The Dow had been rising steadily. It made three peaks. The first was on September 1987 when it reached 2570 and corrected to 1876 in Dec 1987. It peaked again in Apr 1998 at 9063 and corrected to 7539 in Aug 1998.
It peaked again for the third time in Dec 1999 at 11, 497 and crashed to 7591 by Sep 2002. The dot-com bubble (also referred to as the Information Technology Bubble) was a speculative bubble that formed during the period 1995 to 2000. On March 10, 2000, the NASDAQ peaked at 5132 in intra-day trading before closing at 5048 more than double its value a year earlier.
On March 20, 2000, the NASDAQ lost more than 10 per cent from its peak. Financial magazine Barron's shocked the market with its cover story "Burning Up". The article pointed out: "America's 371 publicly traded Internet companies have grown to the point that they were collectively valued at $1.3 trillion, which amounts to about 8 per cent of the entire U.S. stock market."
By 2001 the bubble was deflating at a full speed. A majority of the dot-com companies ceased trading after exhausting their venture capital. Many of the companies having high share value had never made a net profit. The 9/11 terrorist destruction of the World Trade Centre's Twin Towers accelerated the stock market drop. The NYSE suspended trading for four sessions due to the attack.
Several communication companies could not weather the financial burden and were forced to file for bankruptcy. One of the biggest players, World Com was found practicing illegal accounting practices to exaggerate its profits on a yearly basis. World Com's stock price fell drastically when this information went public, and it eventually filed the third-largest corporate bankruptcy in U.S. history.
Many dot-com companies ran out of capital and were acquired or liquidated. Several companies and their executives were accused or convicted of fraud for misusing shareholders' money, and the Securities and Exchange Commission fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors.
A few large dot-com companies, such as Amazon.com and eBay survived the turmoil. Others, such as Google have become industry-dominating mega-firms. The stock market crash of 2000 - 2002 caused the loss of $5 trillion in the market capitalization of companies from March 2000 to October 2002.
The Sub-Prime Crisis 2007 to 2009
This was the second major US stock market crash of the 21st Century and took place 7 years after the first. The Dow stood at 7591 on Sep 2002. Then it began to rise and peaked at 10583 in Feb 2004. After a correction it peaked again at 10766 in Feb 2006. It peaked for the third time at 13930 in Feb 2007 and crashed to 7602 in Feb 2009. The "Sub Prime Mortgage crisis" and a declining dollar were the main reason for the crash.
The bulk of sub prime losses were reported in the third quarter of 2007. By January 2008, the world's largest banks had already admitted losing more than $100bn from mortgage related bonds and derivatives. The chief executive of Citigroup, resigned in Nov 2007. US bank JP Morgan Chase said its earnings for the last three months of 2007 fell 34 per cent as a result of its exposure to soured US mortgage loans.
Wall Street banking giant Merrill Lynch lost over 14 billion in 2007. Many mortgage companies in the US, Europe and UK came close to bankruptcy. The largest mortgage company in the US, Countrywide was taken over by Bank of America while the British Government poured billions of pounds of taxpayer’s money into the British Bank, Northern Rocks, to save it from going bankrupt.
What will happen in 2014?
The Dow began to recover after 2009 on the back of "Quantitative Easing" and bailing out of the banks and US auto giants by US and European governments. It made its first peak of 10856 on Feb 2010 and corrected to 9774 in June 2010. It made its second peak of 12810 in Feb 2011 and corrected to 10713 Sep 2011. The Dow has been rising up, up and up since. It rose from 14659 on June 24, 2013 to its third peak and all time high of 16924 on June 6, 2014.
What happens now?
Will it continue to rise and make new peaks or is it about to crash? The Rational Pessimist (me) sees a crash coming for the following reasons: The market has crashed every 7 years in the 21st Century. It is now 7 years since the 2007 crash. The Dow has made three peaks after the last crash and reached an all time high. The Dow reached the same stage before the last two crashes.
"Quantitative Easing" is being scaled down and will reduce liquidity in the market. There are possibilities of an auto loan bubble and property boom bubble. US and EU will impose sectoral sanctions on Russia over Ukraine in July 2014 with unknown economic consequences for EU and the world. China and Vietnam are close to a limited war over China's drilling for oil in waters of South China Sea claimed by Vietnam.
Government debts of the developed world are at all time high and many governments in the developing and developed world are broke and political unrest is increasing. With greed and profiteering at all cost dominating corporate activity and investor preferences, can disaster be far behind?
Are the stock markets of the world really going to crash? Well, it is any body's guess. It is for those who have invested in the market to decide whether to cash out while the going is good or suffer another disastrous crash. I do not have a dime of investment and so I am not really concerned about what happens. But many people close to me have invested in the market and I hope better sense will prevail in them. If you cash out and survive the crash, please share some of it with me.