Why stock markets tend to crash at regular intervals?
A stock market crash refers to a sudden decline in stock prices across a sizeable cross-section of the stocks listed on a particular stock exchange. These are driven as much by the economic factors underlying the market as by the investors’ sentiments. The markets begin to go on a downward slide, primarily driven by certain economic factors, but once the slide starts, there is a significant crowd behavior that is witnessed subsequently. The markets around the world have been seen to be crashing at regular intervals. The first major crash in the US stock market occurred in 1929 and the markets have crashed at regular intervals since then.
The analysis of stock market crashes has indicated that this phenomenon repeats itself due to the existence of certain economic conditions in the market. The primary reason is the prolonged period of high stock prices and excessive amount of economic optimism witnessed in the market, high price earning ratios for stocks across a wide spectrum exceeding their long-time averages implying a high expected return by the investor, and a widespread use by investors of margin debt and leverage raising the risk exposure of market participants to an unusually high level. The market gets overheated and it crashes to make the necessary correction in the market expectations and risk exposure. However, once the slide in the market begins, the human sentiments play a very important role and investors start behaving as a crowd in the panic that prevails. This further leads to the downward slide, and it is generally seen that the market recovers a little, once it has reached down to a level when the demand exceeds the supply conditions substantially in the market, and the market comes back to reflect the price driven by the equilibrium of supply and demand conditions.
The frequency and regularity of the stock market crash is witnessed due to the fact that the economic reasons underlying this phenomenon keep on repeating at certain intervals. As the market recovers slowly from the crash, the money supply in the market is tight, the risk exposures are low and the investors’ expectations are down to the level of long time average. As the economy heats up, companies start on the investment path again for growth, bringing about more money in the market. With more investment, the investors’ expectations begin to rise again and they start taking investing on margin money increasing the leverage and thereby the risk exposure in the market. It goes on up to a certain points beyond which the market is not able to sustain the level reached, and it crashes.
The globalization of the economy is another factor that is responsible for the frequent occurrence of this phenomenon. The different economies are getting so intertwined with each other in recent times that a crash in one market results in a crash of equal or sometimes more severe proportions, depending on the level of foreign investment in that market. That is the reason; we have witnessed the ripple effect of South East Asian markets in late 90’s to markets world over. The market crash in the US in 2001-02 resulted in slowdown in various economies worldwide.
The analysis of stock market crashes has indicated that this phenomenon repeats itself due to the existence of certain economic conditions in the market. The primary reason is the prolonged period of high stock prices and excessive amount of economic optimism witnessed in the market, high price earning ratios for stocks across a wide spectrum exceeding their long-time averages implying a high expected return by the investor, and a widespread use by investors of margin debt and leverage raising the risk exposure of market participants to an unusually high level. The market gets overheated and it crashes to make the necessary correction in the market expectations and risk exposure. However, once the slide in the market begins, the human sentiments play a very important role and investors start behaving as a crowd in the panic that prevails. This further leads to the downward slide, and it is generally seen that the market recovers a little, once it has reached down to a level when the demand exceeds the supply conditions substantially in the market, and the market comes back to reflect the price driven by the equilibrium of supply and demand conditions.
The frequency and regularity of the stock market crash is witnessed due to the fact that the economic reasons underlying this phenomenon keep on repeating at certain intervals. As the market recovers slowly from the crash, the money supply in the market is tight, the risk exposures are low and the investors’ expectations are down to the level of long time average. As the economy heats up, companies start on the investment path again for growth, bringing about more money in the market. With more investment, the investors’ expectations begin to rise again and they start taking investing on margin money increasing the leverage and thereby the risk exposure in the market. It goes on up to a certain points beyond which the market is not able to sustain the level reached, and it crashes.
The globalization of the economy is another factor that is responsible for the frequent occurrence of this phenomenon. The different economies are getting so intertwined with each other in recent times that a crash in one market results in a crash of equal or sometimes more severe proportions, depending on the level of foreign investment in that market. That is the reason; we have witnessed the ripple effect of South East Asian markets in late 90’s to markets world over. The market crash in the US in 2001-02 resulted in slowdown in various economies worldwide.
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