2020 Crash Compared With 1929, 1987, 2000, And 2008-2009

Mar. 18, 2020 9:14 AM ETSPDR S&P 500 Trust ETF (SPY)QQQ, RZV, SPHQ, VFINX, XLF, XLP, XLV20 Comments

Summary

  • During crashes like the one we are seeing now, it can help to compare how similar crashes played out historically.
  • In this article, we compare the coronavirus crash of early 2020 with the market crashes of 1929, 1987, 2000, and especially 2008-2009.
  • We also look at how the economic backdrop of each crash differed, to assess what conditions to look for in buying opportunities after this crash.
  • I do much more than just articles at Long Run Income: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

I find history to be an invaluable guide to understanding the world today, and keeping rational about what to expect for the future. While technologies, relationships, and economic conditions may change, human behavior in many ways does not. In this article, I take a step back to look at that historic "big picture" of how this most recent market crash compares with the market crashes of 1929, 1987, 2000, and 2008-2009. Although the S&P 500 index is not the only benchmark of "the market", and I spend much of my time deviating far from it, it is the "de facto" benchmark index many of us will be following, especially during this period of extreme market volatility. For that reason, I will be focusing on the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) when looking at the latter two crashes, and the most similar benchmarks to it available for the two earlier crashes.

Market Crash #1: 1929

The market "crash of 1929" was actually just the start of a very long bear market that lasted into 1932, and signaled the start of the great depression of the 1930s. This crash / bear market is the most noticeable drawdown we can see on long-term logarithmic charts of the Dow Jones Industrial Average:

Chart
Data by YCharts

Zooming in, we can see that $10,000 invested in the Dow Jones Industrial Average on September 17th, 1929, ignoring dividends, would have fallen in value to around $2,500 by mid 1932, and still only be worth less than $6,000 ten whole years later.

Chart
Data by YCharts

Zooming in even further, this is the three years of decline from September 17th 1929 to 1932 visualized.

Chart
Data by YCharts

This is a very well documented period in history, and was what led to the US's leading securities regulation (the "33 Act", "34 Act" and "40 Act"), and books like Graham and Dodd's 1934 Security Analysis, and analysis of the depression by John Maynard Keynes. Much of the financial writing from the 1930s I have read focuses on how to understand what securities actually are, and how to reform stock markets from their reputation as a place for speculators to the actual hubs of capital financing they should be. The main points I will attempt to summarize about these writings are:

  1. Much of the run up to the stock market high of 1929 was due to individual chasing of rising stock prices, without concern for fundamentals, and fueled by excessive margin leverage, often as high as 10:1.
  2. In addition to falling valuations, the Great Depression also depressed the earnings denominator of companies for most of the 1930s, and perhaps through the end of World War II in 1945.

The hope of this market crash (and, for that matter, the crashes of 1987, 2000, and 2008-2009) to not become as bad as that of 1929-1933 is likely based on:

  1. Stricter margin rules
  2. Greater attention to fundamentals
  3. More institutional and corporate buyers of shares to support prices on dips, and
  4. Sufficient fiscal and monetary response from national treasuries and central banks to prevent another great depression.

Market Crash #2: 1987

The great "flash crash" many of us might remember in our lifetimes was "Black Monday" on October 19th, 1987. Two ways that the crash of 1987 at first seem very similar to the crash of 2020 (so far) are:

  1. The crash happened very quickly, and
  2. The crash only wiped out gains over the previous year.

The optimist looking at how the crash of 2020 has so far only wiped out gains in the S&P 500 since the low in late 2018/early 2019 might be expecting a repeat of the smooth recovery of to the pre-crash high within 2 years after the crash of 1987. It is important to note, however, that the crash of 1987 was largely driven by trading mechanics, and not by any actual economic recession. As the chart below shows of a leading S&P 500 index fund at the time, the Vanguard 500 Index Fund Investor Class (VFINX), the next US recession did not occur until late 1990 / early 1991. During the 1990-1991 recession, the market fell less and recovered more quickly than in the crash of 1987.

Chart
Data by YCharts

One other view on "how things have changed" is to see how oil prices moved during the crash of 1987, the recession of 1990-1991, and the crash of 2020. That the crash of 1987 was driven by "portfolio insurance" traders, and not by economics, can probably be seen by the lack of move in oil prices during the crash of 1987. The 1990-1991 recession, on the other hand, was very much paired with the spike in oil prices, which I remember being connected to Iraq's invasion of Kuwait and following Gulf War.

Chart
Data by YCharts

Market Crash #3: 2000

The "dot com" bubble and bust started within the first two years of my professional and investing career, and so remains one of the main ones I keep in mind when judging market risk. It so happened that I was living in San Francisco and working in Silicon Valley at that time, so the rise and fall of the dot com companies definitely hit near my home at that time more than it might have hit those living and working near other industries. In the below chart, I compare the S&P 500 tracker SPY with the tracker of the tech-heavy Nasdaq-100 index, the Invesco QQQ Trust (QQQ). Compared with other "crashes" this chart makes 2000 seem like a year of normal volatility for SPY, and really only a 70% crash for the (most technology) stocks weighted heavily in QQQ. As far as the economy, the recession only hit in 2001, after QQQ had already lost most of its value, and despite the horrible disaster of 9/11, buy and holders of either QQQ or SPY almost anytime in 2001 likely had no financial regrets many years later.

Chart
Data by YCharts

The main lesson I took away from 2000 was the importance of paying attention to valuation, and understanding the actual source of profit underlying any business you buy shares in. These are reflected in my list of 20 stocks I actually bought in 2000, though that article still focuses more on the business and less on valuation. The best valuation chart I could find on SPY vs QQQ at the time was the below one plotting SPY's dividend yield, versus no dividend for QQQ. If I'm reading this page on Nasdaq.com correctly, QQQ only started paying dividends in 2003. While dividends are far from a perfect value indicator (and the lack of one wouldn't stop be from buying Berkshire Hathaway), it remains one of the simplest indicators of whether the companies you own stock in can and will return cash to you.

Chart
Data by YCharts

Market Crash #4: 2008-2009

Last, but certainly not least, the most recent major market crash many of us will be comparing 2020 to will be the crash of 2008-2009.

Unlike 1987, 2000, or 2020, the crash of 2008 actually happened well into a US recession, and over a year after the collapse of two Bear Stearns hedge funds that signaled the start of the global financial crisis. I happen to have been at Bear Stearns / JP Morgan during this period, which is why the memory of these events is very vivid to me. Part of that memory, which doesn't even register on this chart, was the surreal St. Patrick's Day parade on March 17th, 2008 as Bear Stearns was being taken over. Perhaps like when the coronavirus was mostly in China, most of the market didn't seem to consider the mortgage default "virus" any harder to contain than Bear Stearns's liquidity problems. It was only six months later, almost exactly, when Lehman Brothers was allowed to default on its debt, that ripples were sent throughout the financial system and the economy. The first chart of SPY below shows the whole period from March 17th 2007 to March 17th 2010, and how its total return held up before and after the Lehman crash. For reference, I also included a line showing that overall SPY dividends were flat to slightly down over this period, again indicating that the price move was an over reaction to actual lost profits.

Chart
Data by YCharts

Zooming in, here are the two months where SPY fell 27% from mid-August to mid-October 2008. Many observers have pointed out that were we are now in the 2020 crash is similar to where we were in mid-October 2008, where there was still a double-digit decline to go before the market hit bottom.

Chart
Data by YCharts

Even though volatility continued for months, it seems that buyers who spread out purchases just after the Lehman crash, throughout 2008Q4, would have seen a drawdown of another 25%, but then were up 20% within a year.

Chart
Data by YCharts

When trying to "be greedy when others are fearful", I also tend to look at the volatility index, or VIX, as the "fear index" of how afraid the market is. The VIX can basically be thought of as a measure of what percentage, up or down, the market expects the S&P 500 to move on an annualized basis over the next 1 month, with roughly 67% confidence. Divide the VIX by the square root of 12 (about 3.46), and you get a back of envelope estimate for how much the market is betting the S&P will move, up or down, over the next month. The current VIX level above 70 may be read to imply an expectation of a 20% move over the next month (not hard when SPY has been moving 10% a day), but just as much indicates how much traders are willing to pay to buy options to protect against such moves. As we can see historically, the bottoms in late 2008 coincided with times the VIX spiked above 60, but the lower bottom in early 2009 came when the VIX had already fallen to much lower levels. Short summary of this VIX lesson: there is some pick up to be had in buying SPY when the VIX spikes, but be prepared for more drawdowns, and know the VIX may not be as high at the bottom.

Chart
Data by YCharts

One reason I don't buy S&P 500 index funds, or most passive index funds for that matter, is that I don't like how allocations to companies and sectors are chosen, especially to financials. Financial stocks are fundamentally different than almost any other sector, and I often wish they would be separated out the same way US and non-US stocks are in many funds. The 2008-2009 crisis was very much a financial crisis, which hit the rest of our lives mostly via its impacts on banks and the financial system. Hard times for banks meant tighter credit, less lending, less trade finance, and less of many other accelerants of money through our economy. Even though other sectors were hit, a very large percentage of the drawdown fell on the financial components of the S&P 500, tracked by the Financial Select Sector SPDR ETF (XLF). The following chart compares the performance of SPY versus XLF and the trackers of two other S&P 500 sectors: the Consumer Staples Select Sector SPDR ETF (XLP) and the Health Care Select Sector SPDR ETF (XLV). Financials clearly weighed down SPY, and investors tilted towards other sectors saw smaller drawdowns and higher balances for years to come.

Chart
Data by YCharts

Two other factor I wanted to check to see how they performed versus the the "core" S&P 500 are the "quality" factor, and "small value" stocks. I know the S&P SmallCap 600 is a different index of 600 companies all smaller than the smallest S&P 500 component, and that value is different than size, but I prefer to go straight to the "small value" quadrant to compare with "core" and "quality". For these two, I use the Invesco S&P 500 Quality ETF (SPHQ) and the Invesco S&P SmallCap 600 Pure Value ETF (RZV). What surprised me most in the chart below is how SPHQ tracked SPY before and during the crash, and then underperformed after the crash. Small value, as represented by RZV, had a much more dramatic 75% drawdown to the 2019Q1 low, but eventually came out ahead of both SPY and SPHQ. It might have required far more courage, but it seems whether you bought RZV after the crash 50% or 75% off its highs, you would have ultimately been more handsomely rewarded.

Chart
Data by YCharts

Conclusion

These four examples can obviously only tell us what happened in past crashes, and there will of course be ways that this crash is different, but human nature tends to remain the same, and the way large institutions manage economic and markets cycles as evolved in ways we've seen in the past three crashes.

Although my tendency after crashes is to bargain hunt for quality, I would want to understand why SPHQ underperformed SPY after the last crash, and how much of that might have had to to with an allocation to financials (only about 6% today). Small value, on the other hand, while more volatile and often not coming with quality filters or tilts, seems like it may be even more rewarding the lower we can buy it. All this of course assumes we don't enter another great depression, and that 2022-2030 corporate earnings are on trend with what they were earlier.

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This article was written by

Tariq Dennison profile picture
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Clear ideas to grow your capital and income without the noise

Tariq Dennison TEP runs GFM Asset Management, a registered investment adviser for cross-border families and retirement plans between the US and Asia. His marketplace service "Long Run Income" focuses on dividend growth and dividend alternative ideas for generating investment income over multi-decade time horizons. Tariq is the author of the book "Invest Outside the Box: Understanding Different Asset Classes and Strategies", spends most of his time in Hong Kong and around Asia, and teaches two classes at the Masters in Finance program at ESSEC Business School in Singapore.

Disclosure: I am/we are long RZV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are also short XLF

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