CRASH IN STOCK MARKET
Markets mostly run on sentiments of the investors. If they believe that the newly elected government is going to bring a massive change in the economy, then investors will feel more confident and they will start investing in the equity markets of the country. Identically, if there is any event that has adverse implications such as investors losing faith in the market of a particular economy, then investors start to dump stocks of the country frantically which leads to a crash. Logical and rational thinking will never lead to a crash as the main reason behind the crash is always panic.
REAL LIFE INCIDENT OF A CRASH
From the year 2002 to 2007 the real estate market of the US was at its peak and booming. Real estate prices were going up like crazy and every year they were going up by approximately 40%. All the financial institutions and banks were giving loans with the house being the mortgage. They were the most secure loans as if anyone would default on the repayment, the banks can easily recover the money by selling the house.
Banks then started coming up with a new type of product referred to as mortgage backed securities. They coupled the loan papers into several streams and tranches and started issuing its bonds. Rating agencies gave the highest possible rating to these bonds as they were the most secured loans backed by the growing real estate. It gradually led to creation of a bubble that finally burst in the year 2008. The event was so big and huge that several stock markets across the world faced its implications.
CAUSES OF CRASH IN MARKET
1. Bubble bursts:
A bubble is a scenario when the stock prices of a particular sector or multiple sectors initiates to rise significantly and limitlessly. The PE ratio crosses the all time high and the index touches it's all time high. So all this coming together is like a bubble as so much money has been pumped into the market and the market has crossed its intrinsic value by multiple times. At this moment, single negative news can cause a lot of panic and the whole bubble will burst down. This bubble burst will lead to the crash.
War is the most serious and critical issue that can lead to a market crash. Whenever countries go on war with one another, the faith in those countries goes down significantly. War is very expensive to keep going, so the government of the country is at war to deploy resources from all sectors to the defence sector. War creates a lot of panic and investors panic and start to dump their stocks.
There have been crashes in stock markets due to scams several times. Scams lower the confidence that investors have in their economy. It created a huge negative implication and can lead to crashes that may take several months or even years to recover.
4. Government change:
Investors invest in countries with an ethical and strong government. If there is a change in that government and the new one is not favoured by the investors, then there will be a lot of panic and dumping will start eventually leading to market crash.
Outbreaks of global diseases such as the Covid - 19 that spreads much faster than anticipated causes uncertainties in the investor market as countries take measures to prevent this disease from spreading further. Such pandemic causes distrust and fear leading to crash in the markets.
PREVENTION OF STOCK MARKET CRASH
If there was a defined formula through which the crashes could have been prevented, then there would have never been a crash in the world. So having said that, there are still a pre signals through which we can predict that a crash is about to hit the market:
- The government should not indulge in wars with other economies as it will have very adverse implications in the market.
- Strong monitoring should be placed by the government to prevent frauds and scams.
- If an economy’s index reaches its all time high and it does not stop there and keeps growing, then there are high chances that it can crash. It is not possible for a market to keep on growing without any corrections in it. The market will always grow but at a steady rate as it is designed to be like that.
CRASH VS RECESSION
- Crash is created due to panic for investors. It creates a massive impact on existing wealth and takes a lot of time to recover. Recession can be controlled if proper steps are taken and the government focuses more on economic growth by increasing the expenditure.
- Recession is a slowdown in the economy. It is a general term when a country’s GDP portrays negative GDP for 2 consecutive periods in quarters. Hence it is when a particular country has stopped consuming at a faster pace.