Inflation has reached a 40-year high with central banks lifting rates to stop inflation. The fear is this will send the economy into a recession, with share markets rapidly dropping in response to the news.
There's no universal percentage drop that counts as a market crash, but generally they occur at the end of an extended bull run, with investors overreacting to unexpected poor economic news.
The most famous stock market crashes include the 1929 Great Depression, Black Monday in 1987, the dotcom bust of 2001, the GFC in 2008 and most recently the 2020 COVID-19 crash.
Market crashes are fairly common. Since 1950 the US S&P 500 has declined by more than 20% 12 times, while markets fall into correction territory (down 10%) on average every 12 months.
What is a market crash?
A stock market crash occurs when a market index has a severe drop over just a few short days of trading. In Australia, our main index is the ASX 200, so when the ASX 200 rapidly falls, Australia is having a market crash.
Unlike a market correction, when the market is down 10% from its peak, or a bear market, which is down 20% from the peak, there is no universally agreed-upon percentage fall that counts as a market crash.
While the actual percentage is up for debate, you'll feel it if you're a shareholder. They are short, sudden downturns which are usually much sharper than a correction which happens over a number of weeks.
Finder survey: Are Australians worried about a stock market crash in the next 12 months?
Response
A little
51.29%
Not at all
37.85%
Yes very concerned
10.86%
Source: Finder survey by Pure Profile of 1004 Australians, December 2023
What causes market crashes?
A market crash typically occurs when share prices are high and an unexpected event occurs that negatively affects the index. Because it is unexpected, it hasn't been factored into the share price.
A crash will usually happen at the end of a bull market, where the price of shares are relatively high compared to the company's underlying earnings.
Take for example the 2021 market rally, post the initial COVID-19 panic selling. In 2021 the ASX200 grew by 17%, while the tech heavy nasdaq 100 was up around 27%.
In 2022, the market had a reversal and at one point was off to its worst start since WW2.
When unexpected poor economic news hits a market, shares that are currently at higher prices react even worse than usual, triggering what is known as a market crash.
In the current market, investors are selling off due to fears of inflation. Inflation in 2022 is at a 40 year high which is a double whammy for businesses who face rising costs of inputs and rising debt due to hiking interest rates. At the same time, the risk free rate for investors changes, making unprofitable tech especially less valuable in today's dollars.
How long does a market crash last?
Unfortunately, there's no real way of knowing how long a stock market crash will last. It all depends on what triggered the market collapse.
The more extreme the market shock, the longer it takes to recover.
Historically with typical crashes, it takes between 11 months and 2 years for shares to recover back. However, it can last as long as 5 years.
To help illustrate this point, Fidelity shows how the market reacted to previous market crashes based on investing $10,000 in the Australia market.
Event
Starting Balance
Lowest Balance
Largest daily fall
Recovery time
1929 crash
$10,000
$6,118
Black Thursday -11 %
Black Monday - 12.8%
The following Thursday - 11.7% (US figures)
3 years 1 month
1987 crash
$10,000
$5,648
All ords down 26%
5 years 8 months
Asia financial crisis
$10,000
$8,629
7.18%
76 days
9/11 terrorist attack
$10,000
$9,045
14%
36 days
Global financial crisis
$10,000
$4,956
7.3%
5 years 10 months
The US market has fallen 20% or more since the Great Depression on 13 occasions including in 1945, 1948, 1960, 1964, 1969, 1971, 1976, 1992, 1997, 2001, 2011, 2015 and 2020.
The worst thing to do in a stock market crash
While it might be painful at the time, the worst thing investors can do during a market crash is to sell for cash.
"Investors tend to react emotionally more to a loss than they do when they make a gain," Zhong says. "So people put too much weight into making a loss. This is why you see panic selling in the market characterised by heightened volatility."
The associate professor also notes that investors will be better off simply staying the course and avoiding the temptation to go to cash. Even if the market continues to fall.
"This is because they switch back to growth options like shares in good times. So effectively they sell low and buy high," Zhong says.
What should young investors do instead?
While the COVID-19 crash was severe, its recovery was relatively quick, with investors having to look back to 2007 for the start of the last prolonged crash.
As such, there's an entire generation that has never experienced a downturn.
While it is painful to see red in your portfolio, it is important to line up your investment time frame with the market conditions.
This means, if you're a younger investor who is still accumulating assets, you could use the market downturn as an opportunity to add to your portfolio. Even if the market continues to fall.
Commodities – look at both hard and soft commodities
Dividend-paying stocks
Essential sectors – look at consumer staples, energy, healthcare and utilities
Frequently Asked Questions
During a market crash, the worst thing you can do is pull your money out of the market. You've already had a paper loss, but selling will mean you crystallise it. In most cases you would be better off waiting out the crash.
The biggest stock market crash remains the Wall Street Crash of 1929 during the start of the Great Depression. It took 10 years for the economy to recover, but the broad-based share index recovered in just a little over 3 years.
Whether or not you buy stocks is a personal choice. But the earlier you buy, the longer you have for compound interest to work its magic.
Cameron Micallef was a utilities writer for Finder. He previously worked on titles including Smart Property Investment, nestegg and Investor Daily, reporting across superannuation, property and investments. Cameron has a Bachelor of Communication and Media Studies/ Commerce from the University of Wollongong. Outside of work Cameron is passionate about all things sports and travel.
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