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It would be an understatement to say that it’s been a volatile 2 week on global markets.
Donald Trump’s announcement of levies against multiple countries last Wednesday kicked off a trend of investor uncertainty, wiping US$2.5B from Wall Street as threats of retaliation trickled in. By Friday, China had made good on the threat – hitting US goods with a 34% tariff (following Trump’s bump up to 54% of the levy against Chinese goods), and Wall Street inevitably ended the week in a panic.
The S&P 500 ended Friday’s session with a slump of 6%, while the Nasdaq dropped 5.8%, setting up Australia’s bourse for a bloodbath on Monday. On that day, the ASX200 opened with a slump of 6.2% – representing the single worst intraday fall for Australian markets since the beginning of the Covid-19 pandemic.
Throughout this week, global markets, including the ASX have been up and down like a fiddler’s elbow, as Trump destabilised things again by promising to boost the levy against China to 104%, and then calming them down by retracting tariffs against all other countries – for the time being at least.
This provoked a euphoric reaction on Wall Street on Wednesday, with the S&P 500 marking its biggest gain in five years – rising by 9.5%, while the Dow Jones picked up its biggest gain since 2020, with a jump of 7.9%, and the Nasdaq zoomed up 12.1% – its largest one-day rise since 2001.
However, it is understood that the President’s walking back of his tariff announcements was provoked by a shocking development: investors’ retreat from US government bonds, which indicated a lack of faith in the stability of the world’s largest economy. And alongside that, the R word is still in the air.
With all that in mind, it’s worth looking back at where the global economy has slumped and recovered in the past.
Black Monday, October 1987
To find the first contemporary example of a global financial crash, we have to go back to October 1987 – specifically Monday 19 October, when the Dow Jones Industrial Average collapsed by 22.6%, this marking the biggest one-day stock market drop in history, and the most significant downturn since the Great Depression (1929-1939).
This event, dubbed ‘Black Monday’ was largely caused by the overrepresentation of foreign investors in the US financial system, who had been behind an escalation in stock prices in the lead-up to the crash. Alongside this, the crash was accelerated by the recent introduction of ‘portfolio insurance’ by US investment firms; these involved the large-scale use of options and derivatives which contributed to the crash.
What was interesting about this crash is that the period leading up to it – the first half of 1987 – had been marked by a bull market, in which the DJIA had gained 44% in 7 months, prompting murmurs of an asset bubble.
However, in the background, economic growth was slowing, while inflation was on the uptick, and US exports were under pressure due to the country’s strong currency. After the Commerce Department announced a larger than expected trade deficit on 14 October, the dollar fell in value, interest rates rose and there were heightened expectations that the Federal Reserve would tighten its policy.
The week which followed saw several markets begin to post large daily losses, followed by an incident of ‘triple witching’ (when monthly expirations of options and futures contracts occur on the same day) on Friday 16 October, which occurred alongside selloffs, with the DJIA losing 4.6% by the end of the session. The next day, Treasury Secretary James Baker sought to narrow the growing trade deficit by threatening to de-value the US dollar, and by the time the bell rang on Monday, Asian markets had begun to tumble.
The reverberations were felt around the world, with global bourses experiencing sharp losses (with the worst being New Zealand, which plunged by 60%), and the Financial Times 100 Index in London falling by 25% between 19 and 23 October, while the Nikkei Dow Jones in Tokyo was down 25%.
Indeed, the lesson of this crash was the importance of watching the interconnectedness of world markets, and this could be seen in the behaviour of investors who stayed up late to watch how the Japanese market’s performance might provide clues to what would happen the next trading day on Wall Street.
It was, in the end, rectified mostly by the US Federal Reserve’s decision to pump liquidity into the market, as announced on 20 October.
The Great Recession of 2007-2009 (or the GFC)
More recent was the economic turmoil which goes by several names, including the Great Recession and the Global Financial Crisis (better known as the GFC in Australia), which saw the most severe economic downturn since the Great Depression, and the longest recession since World War II.
It was precipitated by a collapse in the US housing market, starting in early 2007, when mortgage-backed securities (MBS) tied to US real estate (plus their derivatives) slumped in value, causing a liquidity crisis which grew throughout the year, spreading to global institutions.
Behind this was a trend which had been growing throughout the early noughties, of banks issuing consumer credit at a lower prime rate (the interest rate charged to ‘prime’, low-risk customers), as well as issuing it to those with a riskier financial profile, at higher interest rates.
Consumers spent the cash on a range of goods, but especially houses. This was fine so long as housing prices remained high, but by 2005, they began to fall, and by June 2006, the Fed had raised interest rates to 5.25% (from 1.25 in June 2004), meaning buyers experienced increasing difficulty in paying back their loans. Unable to sell, they often ended up owing more than their home was worth.
What connected this to US markets was the growing practice of securitisation, in which banks tended to parcel hundreds and occasionally thousands of subprime mortgages together with more stable forms of debt, selling them as securities (bonds) to other banks or investors. Those associated strongly with sup-prime mortgages became known as MBS. As housing prices began to fall, this impacted the latter’s value.
With multiple subprime lenders beginning to file for bankruptcy, and investment banker Bear Stearns needing a bailout in early 2008, the crisis continued to build, culminating in the bankruptcy of Lehman Brothers – the United States’ fourth largest investment bank – in September that year.
This was the iconic moment of the recession, and it sparked slumps on numerous stock exchanges around the world, many of these falling by around 10%. The S&P 500 Index ended the year 2008 almost 40% lower, its largest yearly fall in history.
The solution was a new and tentative policy from the Federal Reserve called quantitative easing (QE), which involved injecting liquidity into the system to maintain credit flows. This was introduced to the US in early 2009, with Europe and Japan soon following suit.
Other countries took a different route: such as China, which pumped US$600 billion into its economy via a spending program, while interest rates around the world were also reduced, often to zero or below.
Australia was another which chose the spending approach, with the government sending cheques valued at $900 to millions of households, and providing wider subsidy programs. As a result, the country was able to avoid entering recession during the period, and unemployment never tipping beyond 5.8% (compared to 10% in the US).
While all this may appear behind us, it is worth noting that talk of an escalating US-China trade war continues to spur uncertainty, with the ASX200 turning red again on Friday (down 1% in the afternoon), so there may be another turn in the rollercoaster yet to come.
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