7 Things We Learned From the Stock Market Crash of 2008

September 29th 2008 has been your afternoon once the asset marketplace, as reflected by the Dow Jones Industrial Average dropped 777.68 points throughout your afternoon, signaling the asset marketplace crash. This had been the greatest point drop in virtually any single trading day at the annals of the Dow Jones.

Stock marketplace crashes, both financial bubbles and recessions are not anything new for all investors. When these events frequently come back, they are sometimes devastating for investors that aren’t willing, or people that harbor ‘t taken the time to understand similar events in the past.

Stock Market Crashes Over the Years

The year 2008 started off on a grim note as the BEA announced a 0.6% GDP growth rate for the U.S. in the fourth quarter of 2008. The U.S. economy was weak, shedding 17k jobs for the before all else time in the past four years. But the Dow Jones shrugged of the news and was seen trading within the levels of 12,000 – 13,000 during the before all else quarter of the year.

It was in mid-March the Federal Reserve intervened to save Bear Stearns, the investment bank, which was the before all else casualty of the subprime mortgage crisis. The Dow index fell briefly but managed to recover later in the day as back then the prevailing wisdom was that rescuing Bear Sterns would keep the marketplaces from selling off and avoid a bear marketplace. Over the next months, the Dow Jones rose back to the 13,000 levels by May with many investors believing that the worst was over.

However, the subprime mortgage crisis continued to spread, this time to government sponsored agencies, namely Fannie Mae and Freddie Mac, both of which required a government bailout with the treasury department guaranteeing $25 billion in loans as it purchased the stocks of Fannie Mae and Freddie Mac. This was in July and the Dow was seen hovering near the 11k handle by mid-July 2008 and remained trading at this level for the most of summer.

By September 2008, the marketplaces were overwhelmed by the news of Lehman Brothers declaring bankruptcy which set the ball rolling. The Dow fell over 500 points on the news on September 15th and a day later the Federal Reserve announced that it was bailing out AIG, the insurance giant to the tune of $85 billion for 79.9% of equity in effect taking over a controlling ownership in the company. AIG fell prey to the subprime crisis as it fell short of cash to pay off the credit default swaps it issued previously against falling mortgage backed securities. A day later, the money marketplaces lose over $144 billion as investor panic spread pushing yields on the ultra-safe treasury notes lower as a result of developed demand. The Dow index continued to shed another 449 points on the day.

Around September 18 and 19, the Dow posted a modest recovery as the marketplaces learned about a new bank bailout package. The Dow locked the week at 11,388.44 as the Fed established the asset-backed commercial paper money marketplace mutual fund liquidity facility. The Fed loaned over $122.8 billion to banks to purchase the commercial paper from the money marketplace funds and by September 21st, the Treasury guaranteed $50 billion worth to nearly frozen money marketplaces.

The following week saw the Treasury secretary Hank Paulson and Fed Chairman, Ben Bernanke send the bank bailout bill to Congress which was rejected on September 29th sending the Dow Jones into a tailspin.

The contagion spread across the globe as equity marketplaces fell sharply while sending safe haven stock highs. Gold for example jumped to $900 an ounce.

In an effort to restore financial stability the Federal Reserve along with other major central banks opened up currency swap lines to the tune of $620 billion with the governments being forced to provide the liquidity for the frozen credit marketplaces.

A month later, Congress passed the bailout bill but by then panic swept across the marketplaces globally. In the U.S. the labor department’s payrolls report showed that the U.S. economy shed 159k jobs during September and on Monday, October 6th the Dow Jones fell another 800 points before closing near 10,000 for the before all else time in over four years.

Meanwhile the Fed continued to fight the liquidity crisis by lending another $540 billion to meet the barrage of redemptions as businesses started hoarding cash as LIBOR rates jumped. The Federal Reserve coordinated with other central banks as it was forced to lower the short term interest rate to 1%. Despite the attempts, the LIBOR rate remained high at over 3.4%.

Despite repeated attempts, the Dow continued to fall, losing over 13% during the month and by October end, the BEA released more grim news noting that the U.S. economy contracted 0.3% during the third quarter of 2008 and officially called it a recession. Meanwhile the economy continued to lose jobs as in October; the labor department report showed the economy shedding 240k jobs during the month. The U.S. Treasury later announced that it was using part of the $700 billion in bailout to purchase preferred asset in the country’s banks which saw the big three automobile makers also coming forward to seek a government bailout.

A month later, the Fed had to cut the short term rates further to zero percent, making it the lowest level of interest rates in its history. By December 2008, the Dow Jones was down 34% for the year.

Seven things, the 2008 marketplace crash has taught us

Lesson #1: Investing is risky

Very often, it is easy to forget the risks involved when it comes to investing especially when major asset indexes break out to new highs. The euphoria that follows such events often blinds investors to the downside in the marketplaces.

In 2008, investors were just recovering from the dot com bubble earlier in the decade. The Dow Jones was posting a steady recovery for nearly five years or so and the benchmark index was bursting into new territory with other indexes also hitting record highs. Investor sentiment at the time was convinced of the bull marketplace and that the shares would go on to keep rising.

The wave of optimism led to complacency among the investors who were unprepared for the risks. While some seasoned investors might have had contingency plans, at the center of the risk was the average Joe who got sucked into the marketplaces, tempted by the bullish performance in the marketplaces.

Lesson #2: Just because something that didn’t happen lately doesn’t mean it won’t

The classic “expect the unexpected” holds authentic for its marketplaces. The largest lesson which the wreck of 2008 educated investors would be to simply take action to get ready for the hardest, as the marketplace facts might be worse what you have envisioned. That’s basically because when investors are under stress, the marketplaces begin to act appropriately and also this eventually become less successful.

Nassim Taleb popularized the definition of “black swan” in a conference that’s rare and hard to predict. While nobody knows as it happens, it is going to happen sooner or later. Investors, that turn complacent or overly greedy wind up accepting greater risk, ergo place their portfolio at the whims of their marketplaces. Additionally, it brings to light the well-known truth that traders and notably the retail community have a tendency to obtain bullish directly close to the surface of a share marketplace rally.

Dow Jones stocks rally after all 2003 – 2008

The preceding chart indicates the Dow Jones stocks throughout the phases of 2008 and the years earlier at which the Dow Jones had been at a bullish rally. During hindsight there were definite signals of cost payable out, the truth is retail dealers would have already been bandied around the Dow Jones ongoing its winning series a happening quite common before a significant correction or an accident at the asset marketplaces very similar to 2008 catastrophe.

Lesson Number 3: Take predictions Using a p1 of salt

Prior for the 2008 marketplace accident, Wall Street has been optimistic. The prevailing evidence of this point was that house costs will go on to maintain going higher, without a justifiable argumentation given at all. Many people in prominent places, just like the Treasury Secretary, Hank Paulson were quoted as saying,” “We looked at the data after all 1945 and we concluded house costs don’t move down. ” Likewise other general wisdom was that equity marketplaces produced on average, 9% returns a year. Ask why and the answer simply is because of “historical averages, either ” or whatever else Wall Street or other prominent names can conjures.

For an investor who simply took the forecasts at face value would have no doubt come face to face with a harsh reality check and perhaps an expensive lesson as well. As retail traders, the Internet and the financial media is often pounded by tons and tons of experts giving advice on what you should do with your money and where to invest. It can obtain easy for an investor to fall prey to the constant images of these so called experts and their mega returns as the argumentation behind the nicknames.

In reality, investors should always be prepared for the inevitable. Even if conventional wisdom dictates that shares will always go up, investors should not for a moment take that for granted.

Lesson #4: The people in charge do not have crystal balls

When the 2008 crisis hit, even the best of the economic minds were taken by surprise. For example, officials at the International Monetary Fund were stunned by the crisis. Even the officials at the U.S. Federal Reserve thought that the blowup of the subprime mortgage crisis would be contained with some if not many economists getting it defame on the recession.

One of the common themes that we see even now is the general feeling by the marketplace participants that the officials know a lot more than the average investor. This is seen during the monthly FOMC meetings and especially when there are key policy decisions to be made. Regardless of a rate hike, or a rate cut or even keeping rates steady, the marketplaces and by extension the marketplace participants tend to behave as if the Fed officials know a lot more. If you take a step back at think objectively, you will realize that the members who decide on whether interest rates should rise or fall are merely reacting to the economy, just like everyone else.

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Lesson #5: Too Much of a Good Thing

Bubbles are nothing new to the investing community. The 2008 financial crisis saw the subprime mortgage bubble burst which had rather widespread repercussions which snowballed into something bigger than what it initially was.

Bubbles tend to occur all the time in the marketplaces and in reality no one knows about the bubble until it has burst. While there is no scientific or an objective way to identify a bubble or to predict a financial crisis, age old common sense dictates that too a lot of of a good thing is bad.

Lesson #6: There are always opportunities to invest

Even in midst of the storm, investing opportunities are aplenty for the savvy investor. As the 18th century nobleman Baron Rothschild famously said, “Buy if there’s blood at the road,” sums up the contrarian investing. Usually, shares hit rock bottom during the financial crisis.

While not all shares recover strongly, for the trained eye, an investor can pick just the right shares at a bargain cost and thus position themselves for some big returns. Starbucks (SBUX) is one of the many such examples. As the asset bottomed in 2009, many experts felt that with the tough times, people would purchase less coffee. Starbucks, which was trading at around $4 a share has been in a strong bull run after all then.

Starbucks asset rally from $4 in 2008 – 2009

Lesson #7: There is life after a marketplace crash

Talk about a marketplace crash and chances are that you will hear about the doom and gloom. However, if history is everything to go by, there is life after a financial crisis or a share marketplace crash. Every time the marketplaces enter a period of stress, the doomsayers often circle around calling it the next big crash that the marketplaces won’t get over. This had been the similarly through the 1980’s and also sooner and also the 2008 marketplace wreck wasn’t different either.

Dow Jones Industrials, recovery after nearly 4 hours from the bottom in 2009

Most investors don’t really obtain a opportunity to recoup from their losses because then have a tendency to market their holdings once the marketplaces crash. While shares absolutely persuade ‘t recover overnight, history shows that over a period of time, the marketplaces tend to recover and break ground into new highs.

There are many other lessons that one can learn from the asset marketplace crash of 2008 and even the previous marketplace crashes. However, if there was just one lesson to learn, then it is the fact that investing is a very risky business and just because the marketplaces are continuing to rally doesn’t imply they are going to go on to rally. Most traders frequently fall prey to greed and wind up not making time for risk. It’s frequently said from the trading and investing community which traders manage hazard, bad traders pursue benefits, and also this couldn’t be further from the truth.

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