The advice of investing your money in the stock market has been recommended for so long and it has stood the test of time.
It has always been a constant recommendation because it has been working for several years already. There’s a reason why almost every wealthy people has had their hands in the stock market.
In this blog post, I’ll be talking about the largest stock market drops in the US beginning from the year 2000. I do think it’s important to learn the history of the stock market in order to understand more on how it works and how you can take advantage of them the next time.
And I think it’s because of these drops are what causes some people to have fears in investing in the stock market.
But according to my research, the most common reason would be because they don’t know how the stock market works, they think it’s for the rich, and the most mind-boggling reason I read was that the stock market is a scam.
Any investment, if you don’t know how they work can be a scam to you.
Stock market drops are only natural and it happens from time to time. But the largest ones have a story as to why it dropped that significantly and some people have made a fortune investing during those times.
If you want to know the stories behind the largest stock market drops and how you too can benefit from it, then continue reading! 🙂
The Largest Stock Market Drops: How You Can Learn & Benefit From It
Before we dive in further, you need to understand the demand and supply concept. If there is a lot of demand, then prices tend to go up and when there is less demand, then prices will go down.
So when we talk about the drops in stock market, it means that investors are selling their shares (demand goes down, same goes to the price).
Investors selling their shares can be caused by a variety of reasons. It can be because of political tension, negative economic news, speculations, or a market bubble.
These reasons are enough to make a country go into a recession.
I’m pretty sure you guys know what recession is – basically when there’s an economic decline wherein trade, manufacturing, and business in a country are reduced.
Technically, a country is in a recession if it produces two consecutive quarters of negative economic growth or GDP (value of all finished goods and services made by a country within a certain time period).
Basically GDP measures how productive a country is.
So a positive GDP means that a country is doing well and is progressing. A country that produces a negative GDP means that in a certain time period, they were having difficulties in their economy.
Terms like recession and GDP are important to know because they affect the stock market. And if you’re invested in the market, then it affects you too. So pay attention everyone!
The Stock Market Has Cycles
Just like any trend, the stock market also has its ups and downs.
It’s important to know this because it can help you with your expectations when you’re investing.
Your investments don’t shoot up easily at a fast rate. It takes time for your investments to grow and sometimes you’ll see them drop temporarily.
Some people call the stock market a scam because they thought that investing in it would compound their money immediately. And as soon as they saw their investment lose money for the first month or two, they’re quick to call it a scam.
The chart above is a weekly timeframe of S&P 500. The S&P 500 or the Standard And Poor’s 500 Index is a stock market index that tracks the movement of the 500 largest companies that are publicly traded.
As you can see, the graph doesn’t move in a straight line. It has its ups and downs.
The ones in a circle would be the time when the market made a big drop.
The first one happened in the year 2000. That drop was known as the dotcom bubble. The second drop was because of the 2008 financial crisis, the next circle would be because of the US-China trade war, and the most recent was because of the COVID19 pandemic.
Before we get into the history of those drops, you’ll encounter the word “bubble” a lot below.
A bubble happens when something increases in price rapidly because everyone wants to have a piece of it.
There comes a point where almost everyone has the asset and no one’s willing to buy anymore. This then causes selling pressure which makes the bubble pop.
So let’s learn more about what happened to the stock market during those times.
The Dot-Com Bubble
The 1990s was the era of technological advancement. The internet was made during this era. But unlike today, there was only a small percentage of people who have access to the internet.
It was hard to navigate it at first and not everyone knew how to do it. But when Netscape (a computer services company) entered the scene, they released their own web browser that was free for the public to use.
Since a lot of people used their application, Netscape decided to enter the stock market through an IPO.
An IPO or initial public offering is when a private company becomes a public company where more investors can fund their business through the stock market.
The Rise of Dot-com
Netscape’s IPO was a success.
It more than doubled its stock price within the day.
With more and more people using the internet and with the success of Netscape in the stock market, this has inspired a lot of dot-com companies to enter the stock market as well.
The thing is, these companies have barely made any profits but because of the low-interest rates, they can just loan from the bank to fund their business.
When they entered via IPO, a lot of these companies experienced success as well. They saw their stock prices went up significantly.
This happened because investors saw that these internet companies were the “hot stocks” – the stocks where the most money is. (Think Bitcoin in 2017!)
It was also during this time where fear of missing out or FOMO was prominent. If you didn’t have any internet stock in your portfolio, you’re missing out big time!
Having a FOMO feeling is what caused the stock prices of these companies to go further up. Investors didn’t bother studying the company, they didn’t care if the companies were profitable, all they cared about was how much money will they be making.
I’ve been in a FOMO mode before and it’s never worked out well for me. Trust me. You need to leave your FOMO feeling at home when it comes to investing your money.
Anyway, these companies dominated the market from 1995-2000. Until the Federal Reserve announced that they will increase interest rates in 2000.
The Downfall of Dot-com
This announcement caused volatility in the market. There were rapid swings to the up and downside.
Investors had mixed feelings on whether these companies can sustain their business when the interest rates have gone up.
To add to that uncertainty, Japan has entered into a recession in that year as well. When one of the major economies enter a recession, smart investors start cashing out their money in the market due to the effect that it might bring to other global economies like the United States.
With the hight interest rates and the recession of Japan, this was enough reason to cause a panic selling to the investors. The panic selling caused a domino effect and every investor was looking to cash out their investments in those companies which caused the bubble to pop.
Since it was expensive to borrow from the bank and these dot-com companies were barely profitable and no investor wants to put their money in the market anymore, those companies went out of business and were deemed worthless by investors.
In March of 2001, the US entered a recession.
But before they announced that, the stock market was already going down significantly. There were some companies that survived this bubble. Famous companies like eBay and Amazon are still being traded in the market today.
They survived also because they have a strong business model that users still need till today.
So when you are thinking of investing your money, do your research on those companies. Ask yourself whether you believe in their business model and how much potential growth can they get over the years.
The 2008 Financial Crisis
Mortgage as you all know is when someone borrows money from the bank to fund their purchase of a house. The borrower pays the principal amount plus the interest rate.
If they stopped paying the loan, it’s what we call “default”.
Ideally, applications for mortgages are only approved to people who have good credit. (that’s why I push on aiming for a good credit score?)
But there was a time in the mid-2000s that this was not the case. ?
In those times, investors were looking for investments that give out a low risk but high reward. That’s when they were offered Mortgage Backed Securities or MBS by banks.
The Introduction of MBS
MBS is an investment that is made up of individual mortgages that are offered by banks to large investment institutions.
In an MBS, the bank acts as a middle man between the borrower (the homeowner) and the large institutions (the investors).
This investment was a win-win situation for banks. Why? Because they get to make their clients happy by approving their mortgages and the bank sells that loan to investors and in return, they receive a ton of money.
MBS was like a shiny object for investors because it gave out a low risk but high reward – I mean, who doesn’t pay their mortgages right? Well, well….
Plus their ROI here is much higher than traditional investment vehicles.
And to add to that low-risk feature, if the homeowner defaults, the investors get to acquire their house and sell it to others.
What a deal, right???♀️
Since it was a low-risk investment and there was no angle where they can lose money, investors became greedy and desperate to have more of MBS.
So the banks did their best to provide more securities for investors. But there’s ONE PROBLEM with this, there’s not a lot of people that have good credit.
To satisfy these investors and for them to make more money, what the banks did was to lower the standards in approving mortgages. ?♀️?♀️?♀️
This made them approve mortgages to people who have low income and bad credit standing. This type of mortgage is called a subprime mortgage.
One odd thing in all of this was the credit rating agencies gave these securities AAA ratings – the highest and safest investment grade. (Maybe they too invested in these securities ??)
Anyway, since these securities had AAA ratings, you’d have more confidence in buying these investments. So that was exactly what investors did, they bought more and more of subprime mortgages.
It’s important to note that during this time, the interest rates were low. This means that more people kept borrowing money and applying for mortgages. Since there’s an increase of borrowers that are approved of mortgages, this drove the housing prices up – more demand increases the value of an asset.
With the increase of housing prices, subprime mortgages became more enticing than what it is because again if the homeowners default, investors get to acquire the house!
A win-win investment! What could possibly go wrong? ??
As mentioned earlier, a bubble pops if there’s no one willing to buy anymore.
America’s Housing Bubble
America’s housing market became a bubble…and it popped.
The homeowners have reached a point where they’re not able to pay their mortgages anymore. Some of them even had a house and a condo even though they were receiving minimum wage and had bad credits.
You might be thinking that investors still get to acquire the houses right??
Yep, they did acquire the houses, but no one was willing to buy houses anymore.
There was a lot of house for sale but there were no buyers to be seen. And if you have a lot of something, the lesser its value.
Because of this bubble, the stock market crashed, and the US economy went to a recession. People were left jobless and a lot became homeless. Many lost all of their savings too.
The effect of this crisis led to several bankruptcies, unemployment, and business failures even the giant Lehman Brothers went out of business..
If you want to learn more about this, I really recommend you watch The Big Short on Netflix.
The US-China Trade War
The United States and China are two of the biggest economies in the world. These two countries are trading partners as well.
Trading partners means that both countries conduct business with each other regularly. The US buys and sells goods and services to China and vice versa.
In 2017, the US imported around $500 billion worth of goods from China. While China imported only $100 billion of goods from the US.
A big difference, right? The numbers aren’t even close.
Donald Trump saw this as an unfair situation. He and his administration felt that the trade relationship was lopsided or it favored China more.
So to fix this imbalance, Trump imposed tariffs on goods and services that’s coming in the United States. Which makes it more expensive for China to sell their products.
A tariff is a tax on imports or exports of goods and services.
Between US and China, these goods could be electronic parts, clothing, electrical equipment, plastic, rubber products, furniture, machinery, and many more.
Since Trump imposed a tariff on these goods, China wouldn’t just take this and do nothing about it. They retaliated with their own tariffs as well. China said that American producers who want to sell their products in China should pay a 25% tariff.
But how does this problem affect us?
Since tariff means companies need to pay more money to sell products overseas, to compensate that, companies increase their prices for consumers. This means that the products that they are selling would increase in price.
Remember that news when US bans Huawei in the US? That was one of Trump’s move to fight back against China.
With all this tension between the two economic giants, investors were already speculating the effects of this trade war. Investors were thinking whether these tariffs will affect the GDP of the country? Will there be less spending on the consumer side?
Those questions were enough to cause a market drop.
It wasn’t just the US stock market that experienced a drop, China’s market suffered volatility as well.
This just shows that no one comes out a winner in this trade war.?
The COVID-19 Pandemic
If you’ve watched the news these past months, you might have seen reporters talking about the stock market crash because of this pandemic.
It wasn’t just the US stock market that crashed though, almost all stock markets in the world have fallen.
Most of them have dropped massively because investors worldwide weren’t sure how bad this COVID19 pandemic could be.
They weren’t sure about how bad the effects would be to the global economy but they were sure with one thing, it was going to have a negative effect.
Investors around the world have panicked because coronavirus was spreading all over the globe at a fast rate. Plus with the government mandating to shut down businesses, they saw that this move can cause a recession.
The February to March drop was the fastest decline in the US stock market history! ??
What’s surprising now is that even though there’s no clear date when the vaccine will be provided, the US Stock Market has gone up quite significantly after its drop.
So that means for those investors who weren’t part of the panic mode that happened February to March 2020, they have been rewarded because their portfolio didn’t suffer any significant losses.
Plus to those who took advantage of the drop and started investing during that time, their portfolio would probably have seen a 40-50% increase by now.
Historical Data After The Drops
Every stock market drop reminds me of what Warren Buffet said:
”Be fearful when others are greedy and be greedy when others are fearful”.
That quote simply means to buy when others are in panic mode and sell when others are greedy.
To look back in hindsight on what happened after the largest stock market drops, let’s pull out a chart of the S&P 500.
After the drop of the DotCom Bubble, the S&P 500 went up at least 90% before the crash of 2008: ?
After the 2008 Financial Crash, the S&P 500, increased by a whopping 300%: ?
After the drop of the US-China Trade War, S&P moved up 40% from the drop: ?
And with recent COVID-19 crash, which visually has the fastest drop and the fastest recovery, the S&P 500 is now up 40%: ?
Historical data shows that after every drop, the stock market always recovers and goes up again. It might not happen immediately but eventually, it does.
And if you observe this image again, you’ll see that the market doesn’t move in a straight line, it swings up and down.
Since this movement always happens, then its only natural that large drops occur.
How Can We Benefit From Panic Selling?
With this fact, should we panic if we see a large stock market drop?
In a way, we should be cautious but we shouldn’t panic. Panic causes us to make decisions irrationally.
One thing I’ve learned when researching about investing in the stock market is that we should have a long term perspective.
Long term doesn’t mean to have a 5-year plan, it should exceed that. If you invested in 2000 and you didn’t bother selling at those drops but instead you added money to your portfolio, your investments would have probably more than doubled by now.
Sure, you can argue that I’m talking about this in hindsight, but it doesn’t change the fact that it’s true.
What’s important here is to not let market drops sway you from your long term goals and panic sell.
The benefit that we can get from the historical data above would be mentally preparing ourselves to know our investments will go down in the meantime. Another thing that we can do is probably add more to our investments when the market has become stable after it dropped.
So which story above were you familiar with? Were you able to invest during those times? Let me know below! 🙂