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17 March 2020

Reflections on the Great Financial Panic – are there parallels we can learn from?

Graham Bishop's sobering analysis of the latest financial developments and how the situation is likely to evolve.

Looking at the market reactions to the weekend central bank moves, one can only be deeply disturbed – another 12% decline in US equity markets yesterday, taking them fully into normal “bear market” territory.

The big question is what happens next when many EU economies were only growing at 1% annually – supported by record low interest rates. We now have a massive shock to confidence of consumers and commerce. Behaviour patterns are likely to be changed fundamentally by the coronavirus shock and it will probably take years before new patterns are fully established, or old ones recovered.

One of my sons asked me over the weekend if the 1987 stock market “crash” is a parallel – and my answer is No. Then the economies were growing at 3% annually – and continued after what was the first big “technical” correction of markets in modern times – driven by automatic systems. Sell-offs have always had a severe phase that was triggered by stop-loss orders and margin calls (look at the charts of 1929!), but this is now being accentuated by algorithmic trading that recognises the patterns and sells short for the purpose of triggering further margin calls. That is followed by a brief bounce when the short sales are covered by buying the shares back.

The next phases may well reflect the new economic reality rather than market mechanisms and the prospect of low growth at the very best – or prolonged recession – is very real. I am afraid the model may be Japan where the Nikkei index peaked at nearly 40,000 in late 1989 and finally bottomed at 7,000 in 2009 - moving roughly sideways for the next three years.

I still recall vividly that the UK market fell to almost 1/4 of its previous level between 1972 and 1974 – just as I started working in the City.  But equities did then rebound dramatically in the next few months - before developing into the bull market that has just ended so dramatically. That dramatic plunge and recovery reflected first the realisation that much of UK industry would be bankrupted by corporation tax payments on illusory profits generated by the wave of inflation sweeping the UK. But the government was able to take “administrative action” to avert impending doom by a "stroke of the pen" to remove that tax doomsday machine. No government can remove coronavirus with a corresponding administrative action today.

© Graham Bishop

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