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13 January 2021
Just as night follows day, it seems part of the regular cycle of the world’s share markets that downturns and falling prices follow good times and rising prices.
The impact of the COVID-19 global pandemic has been typical of such downturns, prompting a 35 percent sell off in world share markets and a dramatic fall in economic activity.
For many, it has prompted memories of other equally, and sometimes more devastating, downturns in the world’s share markets.
The most famous was ‘Black Thursday’ in 1929, which led to an 80 percent collapse in share prices and sparked the Great Depression, lasting for more than 10 years.
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What caused it? The wild excesses of the Roaring 20s when consumer confidence was at a record high and the introduction of margin loans, where people could borrow up to 80 percent of the value of shares.
This created a classic investment bubble, where optimism overwhelmed caution, and people started buying shares with the mistaken belief they would always increase in value.
A drop in agricultural production due to droughts and a fall in economic production caused a sudden reversal in sentiment.
A similar situation occurred 60 years later in 1987, where panic selling on Black Monday wiped about 30 percent from the value of the key US market index, the Dow Jones – its biggest one-day fall. It put an end to the ‘greed is good’ mentality of the 80s and prompted a review of the relatively new, computerised share trading systems.
Yet it seems investor’s memories are short.
Not long after this, markets got caught up with a new investment bubble prompted by the development and growth of the internet.
Companies raced to find their place online and suddenly all internet companies were considered a sure bet.
This speculative buying ran out of steam when the ‘Dot Com’ bubble finally burst in 2000, wiping 45 percent off the value of shares.
While sharing commonalities with previous crashes, the Global Financial Crisis of 2008 was also in many ways unique.
It was the direct result of dodgy lending practices in the US housing market, which created a toxic class of home loans, commonly referred to as sub-prime loans.
Typically, these lenders ignored the individual’s ability to repay the loans and instead focused on the belief property prices would continue to rise and there would always be people prepared to rent these properties.
It created a typical investment bubble in the US housing market.
Eventually, people found they could not meet their repayments, nor could they sell the properties held as securities, causing enormous problems within the US banking system and the collapse of several international banks.
The lesson to be learnt from all these devasting crashes is that while no two were the same, they were all similar in nature.
All were created by exaggerated investor beliefs that prices would never fall.
Therefore, it is essential to think carefully before investing, ensuring each investment is made with a long-term mindset, and that sudden market corrections do not lead to panic selling.
As history has shown, market downturns follow upturns, but as long as the investment is fundamentally sound, it will fully recover any lost value.
• The information provided in this article is general in nature only and does not constitute personal financial advice.
The entire January 13, 2021 edition of The Weekly Advertiser is available online. READ IT HERE!