Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn’t affect our editors’ opinions or evaluations. Global stock markets have taken a battering in 2022 over fears of high inflation, rising interest rates and economic recession. US technology share prices have been hit particularly hard, with the tech-heavy Nasdaq Composite Index falling by over 30% since November.
The UK stock market has been more resilient, but there are signs that this is coming to an end, with the FTSE falling to below 7,000 last week (from a year-high of 7,700), including a 2% single-day fall.
Investors may therefore be wondering how best to protect their investments against a possible stock market crash.
Here’s a look at what triggers such a collapse, what’s happened in the aftermath of previous large crashes, the outlook for shares generally, and how investors can protect their portfolios.
Remember that when investing, your capital is at risk. Investments can go down as well as up, and you may not get your money back. If you are unsure as to the best option for your individual circumstances, you should seek financial advice. 1. What is a stock market crash?
A stock market crash refers to a rapid, often unexpected, fall in share prices. Typically, this is defined as a drop of at least 10% on a stock exchange or major index in a day, or over a few days.
A stock market crash may be temporary, with prices recovering in days or weeks. However, a crash can also signal the start of a longer downturn that can last for months, or even years.
Major stock market crashes in living memory include Black Monday (1987), the bursting of the dot.com bubble (2001-2002), the global financial crisis (2008-2009), and the COVID-19 pandemic (2020).
The infamous Wall Street crash of October 1929 plunged the US into the so-called Great Depression lasting several years. 2. What causes a stock market crash?
A crash typically occurs at the end of a bull market, where share prices have risen for several years, and investors start to question whether companies have become overvalued.
If investors start to sell shares as they believe share prices are unrealistic and will fall, this can trigger wide-scale panic selling. This creates a downward spiral of further share price falls as investors lose confidence in holding shares and hit the sell button.
Macro-economic factors can also play a role in triggering stock market crashes. Inflation rates are at a 40-year high in the UK and US, which has led to the central banks increasing interest rates to try to control inflation.
Rising interest rates tend to have a negative impact on stock markets for the following reasons: Valuations of ‘growth’ stocks: higher interest rates reduce the valuations of growth stocks, such as US technology firms, by decreasing the current value of future cash flows.
Reduced consumer spending: companies may face reduced demand from consumers with less money to spend if the cost of debt increases, along with a rise in the cost of everyday items due to inflation.
Relative return on savings: higher interest rates may encourage investors to move out of shares into cash-based products.
The US and UK are also reducing their quantitative easing (QE) programmes, which provided economic support during the pandemic.
QE activity helped sustain share prices during the pandemic by stimulating economic growth. A tapering of this programme is likely to have a negative effect on the economy, leading to a more bearish market. 3. What happened after previous stock market crashes?
Investors naturally focus on how long stock markets have taken to recover after previous crashes. To provide some insight, we’ve analysed the major stock market crashes in the FTSE 100 since 2000: Source of historical FTSE 100 data: WSJ Markets
What can we learn from this? First, that the stock market is naturally cyclical, with major falls of around 20% to 50% every eight to 10 years on average.
Unsurprisingly, the stock market has taken longer to recover from steeper falls, taking over four years to rebound from the 50% fall during the crashes caused by the dot.com bubble and the global financial crisis.That said, more recent stock market falls have been shorter-lived, with the FTSE 100 recovering its pandemic losses within two years and within less than a year for the dip in 2015-2016.Overall, the FTSE 100 has risen around 15% since 2000, although investors buying in at the bottom of the market in 2003 and 2009 […]
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