E A Look At Market Crashes

In his recent book, "A History of the United States in Five Crashes," Scott Nations details stock market crashes in terms a layman could understand.  The first of the crashes was the Panic of 1907, which led to the creation of the Federal Reserve. The last was the so-called "Flash Crash" in 2010 (and lesser ones since).  There was also 1929, then 1987 and the plunge during the financial crisis in 2008-09. 

Each was created by circumstances unique to the time, but most have common elements. In each, the crash occurred after strong multi-year rallies.  Stocks jumped 96 percent in 1904-05 and 91 percent in 1927-28, both shortly before crashes. In 1985-86 the Dow climbed 56 percent.  Eventually, the excesses for some reason were unseen by nearly all until they became obvious to everyone. 

Another common element was complex financial products that were not fully understood. Trust companies in 1907 and 1929, portfolio insurance products in 1987, mortgage-backed securities in 2008, and hedging through high-frequency trading in 2010. What is the next product to lead to a crash?  I worry about certain exchange-traded funds, such as the leveraged ones and those that hold thinly traded securities.  We’ll see.

Even with knowledge of these crashes, the next event will be hard (read impossible) to predict  I’m reminded of the saying about investment advisers like myself, “He will know tomorrow why the things he predicted yesterday didn’t happen today.”  Scott Nations said the crashes were similar in that at their heart it wasn't about money or numbers or individual stocks but about fear and greed. There is almost always too much greed, he said. There is rarely enough fear -- of the unknown or an arcane man-made financial contraption that could again behave in ways never anticipated and trigger a crash.  We don't know what we don't know; that is reason enough to be somewhat cautious and have some cash.
That said, the crashes are never remembered for the enormous upside and record highs that followed, only the brief selling. In retrospect, each created an extraordinary buying opportunity.  That message is being lost on those who run TV commercials peddling gold or annuities. They compare the stock market to a roller coaster and instead talk of gold’s performance from 2009 to 2012, ignoring what happened since,or recommend annuities with commissions of six percent or more and high expenses. In 1900 the Dow was 60. In 2000 it was above 12,000 and now it's north of 21,000.  A roller coaster with its ups and downs but going nowhere?  Not exactly.
 

Disclaimer: David Vomund is a fee-only money manager. Information is found at vomundinvestments.com or by calling 775-832-8555. Clients hold the ...

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