Stock market crash refers to a dramatic decline of stock prices across a significant cross-section of a stock market, resulting in a significant loss of paper wealth. Numerically, it applies to steep double-digit percentage losses in a stock market index over a period of several days. It is driven by panic and underlying economic factors. Selling by some market participants drives more participants to sell.
12.1 The Wall Street crash of 1929
Due to the technological innovations of the time, the U.S economy was growing rapidly and the companies that had pioneered these advances (e. g General Motors) saw their stocks soar, and so did financial corporations and Wall Street bankers. Some innovations included radio, automobiles, aviation and telephone companies. Some investors were so infatuated with the returns from the stock market that they started using leverage through margin debt.
On August 24, 1921, the Dow Jones Industrial Average (DJIA) stood at a value of 63.9. By September 3, 1929, it stood to 381.2. By that summer, the economy started to contract as the stock market went through a series unsettling price declines. This increased anxiety among investors leading to the events on October 24, 28, and 29 (known as Black Thursday, Black Monday and Black Tuesday).
On Black Monday, the DJIA fell 38 points to 260, a drop of 12.8%. A rush of selling overwhelmed the ticker tape system that normally gave investors the current prices of their
prices. The system’s telephone lines and telegraphs were clogged and unable to cope. The following day, Black Tuesday was a day of chaos. Investors flooded the exchange with sell orders because they were forced to liquidate their stocks. The Dow fell 30 points to close at 230 on that day. From Black Tuesday to Black Thursday, the Dow fell by 23%.
By the end of the weekend of November 11, the index stood at 228, a drop of 40% from the September high. Although the market tried to recover in the succeeding months, this was a false recovery that caused unsuspecting investors into further losses. The Dow lost 89% of its value before in finally reached its lowest point in July 1932. This was followed by the Great depression, the worst economic crisis that plagued the stock market globally.
12.2 The Crash of 2008-2009 On
September16, 2008, failures of massive
financial
institutions in the USA rapidly developed into a global crisis, resulting in a number of bank failures in Europe and sharp reductions in the value of stocks and commodities worldwide.
Beginning October 6 and lasting all week, the DJIA closed lower for all five sessions. Volumes levels were also record breaking. The Dow fell over 1.84 points (18%). The S&P 500 fell more than 20%.
On October 8, the Indonesian stock market halted trading, after a 10% drop in one day. After having been suspended for 3 successive trading days, the Iceland stock market reopened with the main index, the OMX Iceland 15, closing at 678.4 indicating fall of 77%. This was due to the fact that the value of the 3 big banks that formed 73.2% of value of the OMX Iceland 15 had been set to zero.
Since September 2008, the world’s stock markets’ performance fell substantially as the stock indices dropped to between five-nine year lows (CMA). This led to Banks tightening lending standards and credit terms. As of October 208, stocks in North America, Europe and the Asian Pacific region had all fallen by 30% (Krugman, 2008). Stock markets recorded a 21% fall in Uganda, 24% in South Africa and 27% in Kenya between September 1 and November 30 (Wanjohi, 2011).
As at October 2008, the Bank of England reported that the world’s financial firms had lost USD 2.8 trillion as a result of the crisis. This was 133 times Kenya’s current GDP in absolute terms (CMA). Tax payers around the world, Kenya inclusive spent around USD 8 trillion trying to revive the world’s banks.
Africa’s liquid financial market suffered from the impact, mainly attributed to the over valuation of stocks and outflow of portfolio investments. African investors especially Egyptians and Nigerians recorded six months on average loss of more than half the wealth invested at the end of July 2008.
The cost of external debt for emerging countries on international financial markets started to increase in July 2007. The crisis increased the cost between 45 and 50 points. During an attempt to issue bonds on the international financial markets, Tunisia had to increase its offer by 25 points to attract and entice investors.
There were increased currency fluctuations especially against the US dollar and the Euro. The depreciation was attributed to the impact of crisis on commodity prices and the decline in foreign exchange reserves. The 65.8% drop in copper prices led to a fall in Zambia’s foreign reserves.
The Kwacha exchange rate to the US dollar depreciated sharply in 2008 by as much as 50%.
The global Foreign Direct Investment (FDI) showed a sharp decline of 21% in 2008. The FDI inflow to Africa was steady at a low level of USD 61.9 billion, an increase of 16.8% from 2007.
However, there were large discrepancies across countries, as Egypt and Morocco respectively reported a decline of -5.6% and -7%.
Tourism suffered a big hit from the crisis as a result of declining incomes in developed and emerging countries, where most tourist flows originated. Kenya announced a 25% to 30%
decline in tourist arrivals. Kenya Airways posted a 62.7% drop in profit for the half year at the end of September 2008. Egypt also announced a 40% cancellation of hotel reservations. The Seychelles announced a 10% fall in tourism revenue.
Several textile factories were closed in Madagascar and Lesotho. This led to a decline in external textile demands from South Africa and the US, their major trading partners. This led to a decline in economic activity and employment opportunities. A local textile company in the West of South Africa closed, causing the loss of 4000 jobs.
The manufacturing sector was affected by both falling global demand and rising cost of imports of intermediate goods caused by the currency depreciation. As a result, factories run at low capacity and employment was seriously threatened. In Uganda, the Uganda Manufacturers’
Association reported that 15 factories closed in 2008. South Africa announced a significant drop in the sale of new cars, reflecting the crisis facing vehicle manufacturers worldwide.
Effect of the crash on the Nairobi Securities Exchange
(Capital Markets Authority, 2008)
By mid-July last year, the key NSE 20 Share Index had dipped 10.5% to 4578 points. As a result, local investors became cautious when buying shares so as to avoid the risk of getting locked into higher buying prices at a time the market would be on downward trend. Foreign investors started exiting to curb any further losses on their portfolios due to the weakening shilling. (Business Daily July 23, 2015).
By October 8th, 2015, the NSE Equity markets had been in the red zone for seven consecutive trading days. The NSE All Share Index slacked by 0.30 points to end at 142.40 points. The NSE 20 Index sagged by 30.21 points to close at 4041.35 points. The NSE 25 plunged by 0.20% to close at 187.58 and the FSE NSE 25 sagged by 0.19% at 187.58 points. (Capital Markets in Africa, October 8, 2015).
As a result, volume of shares traded dropped 77.49% to close at 10.53 million and total turnover also went down to close at KES 276.55 billion. The losers included Bamburi Cement Limited by dropping 5.42%, Mumais Sugar Company Limited sagged by 2.63% and UNGA Group Limited tumbled by 2.11%.
By December 19th 2015, all indices were down with NSE 20 Index at 0.16%, NASI at 0.53% and the NSE 25 at 0.90%. As a result most of the participants were foreign investors who were mostly sellers (Standard Chartered market report). As a result, share prices of half of the companies linked to the NSE 20 Share Index fell as some foreign investors sold e.g. Britam, Equity Bank, Kengen and CFC Stanbic. (Business Daily Sunday December 20th 2015).
By the end of December, the NSE 20 Index was down 23% from the beginning of 2015. The overall market declined 12% over the same period as captured by the NSE All Share Index.
Some of the 14 wealthy stock holders that saw a steep decline in the valuation of their portfolios were Peter Munga and Pradeep Paunrana. (Business Daily Sunday December 29 2015).
11.3 Mitigation strategies to curb the impact of stock market failure on stock index 11.3.1 Trading Curbs
A trading curb is a point at which a stock market will stop trading for a period of time in response to substantial drops in value. For example, on the New York Stock Exchange, one type of trading curb is a circuit breaker. This limit was put in place after Black Monday in order to reduce market volatility and massive panic sell-offs, giving traders time to reconsider their transactions.
At the start of each quarter, the NYSE sets three circuit breaker level of 7% (level 1 ), 13% (level 2) and 20% (level 3) of average closing price of the S&P 500 for the preceding month, rounded to the nearest 50 point interval. Depending on the point drop that happens and the time of day when it happens, different actions occur automatically.
Level 1 and Level 2 declines result in a 15 minute trading halt unless they occur after 3:25pm, when no trading halts apply. A level 3 decline results in trading being suspended for the remainder of the day, in Japan, the stock trading will be halted in cases where the criteria for the Central Bank are met. The trading halt time is 10 minutes.
In China, a circuit breaker mechanism began a test run on January 1st 2016. If the CSI 300 Index rises or falls by 5% before 14:45 (15 minutes before normal closing time), stock trading will halt for 15 minutes. If this happens after 14:45 or the index change reaches further to 7% at any time,
trading will close immediately for the day (full breaking). However, the use of circuit breaker was suspended in China.
12.4 Mitigation strategies in Kenya
The Capital Markets Authority, being the Government Regulator charged with licensing and regulating the capital markets in Kenya listed the following strategies to mitigate the effects of a future global crisis (CMA report 2008);
12.4.1 The right regulation model
This is because the deregulated and fragmented model of the US and Europe didn’t foresee the collapse because the institutes which collapsed were considered too big to fail and monitoring was left in the hands of institutions. Memorandum of Understanding was signed between all the financial sector regulators to share information on risk and other cooperation to ensure no gray areas are unregulated. This included the regulations on asset backed securities. Stockholder exposure and presentation on the proposed changes was held in November 2008.
12.4.2 Investor education and public awareness
CMA encouraged measures to make the public more knowledgeable on products so that they make informed investment decisions because an informed investor is a protected investor.
12.4.3 Good Corporate Governance
This was required to restore market confidence, attract FDI and capital inflows, and investments so as to promote economic growth. This would be achieved by increasing;
The accountability of directors
The transparency of corporate structures
Valuation models
Transparency of financial transactions 12.4.5 International Surveillance
This was mainly encouraged to police the global financial system and warn of potential trouble spots, crisis and define its extent. This would enable Kenya to utilize the surveillance information available and act quickly to prevent any crisis. All financial sector regulators
adoption of risk based supervision. Financial institutions have to carry out risk management, with the regulator risk profiling and continuously reviewing the risks independently. More information sharing by the financial sector regulators in Kenya on the risk profiles as well as other pertinent information was encouraged.