Critical Lessons from the 4 Massive Stock Market Meltdowns of Our Time...

A market crash or its evil big brother, ‘the bear market’, create an aura of horror in the minds of investors and traders alike. (REUTERS)
A market crash or its evil big brother, ‘the bear market’, create an aura of horror in the minds of investors and traders alike. (REUTERS)

Summary

  • These lessons will help you prepare for the next bear market.

Whenever the stock market crashes, everyone hears about it…and everyone talks about it.

In fact, everyone loves to talk about it. Even those with no money invested in the market will have an opinion about the crash.

The media dutifully does its part. Headlines speak of ₹‘X’ lakh crore in wealth, wiped out in a day.

Most Indians who have never seen even one crore in their entire lives, wonder how so much money can be ‘lost’ so fast.

A market crash or its evil big brother, ‘the bear market’, create an aura of horror in the minds of investors and traders alike. Many have big money at stake when the ‘bear’ comes calling. Most never had the appetite to take a big loss in the first place.

And if they didn’t sell in time, their losses are usually so severe, that they’re left shell shocked. Sad stories of people committing suicide due to these losses find their way into the news.

But in all the doom and gloom, what can we learn? How can we use the experience and knowledge gained in these bad times, to help us in our wealth building journey?

Let’s look at what happened during the last 4 major market meltdowns and the critical lessons we should learn from them…

The Harshad Mehta Crash

1992.

The shock suffered by first time Indian investors was so great that many never returned to the market.

When the shocking scale of Mehta’s manipulation came to light, the market crashed 40%. Never before had the Indian stock market suffered a blow like this.

Many reforms were initiated. The NSE was set up. Trading became computerised. The stock market opened up to the entire country. Stricter corporate governance and banking rules were enforced.

But what did investors learn?

Well, for many there was only one lesson. They came to the conclusion that the stock market was one big scam, a gambler’s den, and nothing more.

At that time, they were justified in thinking along these lines. After all, they had lost their life savings.

But those who remained invested, and those who invested more after the crash, learnt a very different lesson – ‘Long term investing can make you rich’.

The market recovered as early as the very next year. Although, the Sensex did not set new highs for a long time, many high quality stocks become multibaggers in the 1990s.

This decade also saw the rise of software firms. Early investors in these stocks are among the wealthiest people in the country today.

Despite all the wealth creation that followed, there are big lessons to be learnt…

• Never invest all your life savings into the market. If you do, then a big crash will devastate your financial status.

• Never borrow to invest/trade in the market. The debt will not go away when the market crash erodes your net worth.

• Don’t blindly buy smallcap stocks based on tips from brokers or anyone else. There are countless examples of such stocks in the 1990s that just disappeared.

• If the benchmark stock market index doubles in a few months, you should be selling your shares and not buying them.

The Dot Com Crash

2000.

The turn of the millennium. It was a time when modern thoughts were just starting to replace traditional Indian thinking. India had become a nuclear power but not yet a modern nation.

The same was true in the stock market.

New technologies had come in. Computerised trading was taking over from the open outcry system.

The news media covered the stock market very closely. Investors and traders had begun to keenly watch global markets, especially the NASDAQ, and how they affected our market.

There was a level of sophistication in the Indian stock market that had never existed before.

Alas, the Indian investor had not learnt from the past.

People were swept up in the dot com craze. The software stocks that had made humble debuts in the 1990s – the Infosys IPO wasn’t fully subscribed initially – were now the heroes of the market.

TMT was the talk of the town – Technology, media, and Telecom.

Valuations of these stocks went to the roof. It was a global phenomenon. Tech stocks everywhere were on fire.

A new name was created – ‘New Economy’. Anything that was not related to technology was called ‘Old Economy’.

And then sure enough, the party came to an end. The Indian stock market did not recover for three years. Once again, many thousands lost their shirts.

So what can we learn from the dot com bust?

One sector can’t drive the market higher forever.

• No matter how exciting any new technology might be, the normal rules of valuing stocks will still apply. In the long run, earnings decide stock prices and nothing else.

• Don’t be swayed by narratives and paradigms in the market e.g. ‘new economy’.

• Even the high quality, fast growing companies can become so overvalued, that their stock prices may not recover for many years.

The Global Financial Crisis

2008.

It’s perhaps the most important year in history for any student of finance or economics.

It was the year of the global financial crisis. It was the year of the worst economic downturn since the Great Depression.

The wealth destruction caused by this event all around the world was immense. So much so that most people couldn’t believe what was happening.

Millions of jobs were lost. Trillions in wealth just disappeared as if it never existed. Derivatives in financial markets converted a real estate downturn in the US, into a full blown global recession.

Countless books have been written on the causes that led to the crisis and its aftermath.

But what about the lessons we should learn?

• All bull markets end. No matter how powerful.

• The bear market that follows will be brutal.

• Derivatives trading is not for retail investors.

• ‘Caveat Emptor’ is true in investing too. Investors must look after themselves.

• Markets are all interconnected. A downturn in any market can trigger a chain reaction.

The Covid Crash

2020.

It was a year that will be remembered for only one thing.

As SARS-CoV-2 spread quickly, markets collapsed. As lockdowns became the new normal, economies seized up.

Along with consumption, global trade and investments slowed to a crawl. Millions lost their livelihoods all around the world.

In a few short weeks, fear had completely replaced optimism in the markets. All hope seemed lost. It looked like the 40% crash was just the start of a long bear market.

Many financial experts were convinced that 2020 would be far worse than 2008. We now know that things turned out very differently.

So what can we learn from the historic market crash of 2020?

A ‘black swan event’ can happen at any time.

• Markets are so volatile that a 40% crash could be a ‘normal’ event from now on.

• Don’t blindly follow the ‘experts’. They can’t predict what’s going to happen to stock prices.

• Buying high quality stocks when they are cheap is always a good idea.

• Don’t believe ‘end of the world’ theories. Markets will always recover.

So, there you have it. These are some of the lessons from the 4 big stock market crashes of our times.

We recommend you keep these in mind, dear reader, as you navigate the market.

When the next bear market comes around, you should be prepared.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

 

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