June 1, 2010, 12:01 a.m. EDT · Recommend (1) · Post:
Darkest before the dawn?
Commentary: A review of past sovereign debt crises provides some solace
ANNANDALE, Va. (MarketWatch) — We’ve been down this road before.
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That is one of the more important things for investors to keep in mind as we enter the month of June. Yes, the stock market was sent reeling during May by concerns over Greek solvency and the future of the European Monetary Union, leaving the Dow Jones Industrial Average (DJIA 10,024, -112.61, -1.11%) about 10% lower than where it stood at its bull market high in late April.
But this isn’t the first time that the markets have had to struggle with sovereign debt and currency crises. In fact, over the last two decades, I count at least four other major ones. And though each of those crises led to lots of soul searching and worries that the world economy wouldn’t survive, disaster was averted.
That doesn’t mean it will this time around, needless to say. But it is a source of some solace to know that when similar crises occurred before, during which the future felt every bit as insecure as it does now, the stock market soon recovered.
Those at least are the conclusions I drew upon reviewing the most serious sovereign debt and currency crises of the last two decades. They were:
The Mexican peso devaluation and associated crisis, which began in December 1994
The “Asian Contagion,” which began in the summer of 1997, commencing with a government debt crisis in Thailand and a corresponding run on its currency, and in turn precipitated similar crises throughout the region — leading many on Wall Street to fear that the crisis might eventually spread around the world and bring down global stock markets
The Russian ruble devaluation in August 1998, which led to (among other things) the bankruptcy of Long-Term Capital Management
The Argentinian government debt/currency crisis that began in November/December 2001
To be sure, as you can see from the accompanying chart, the stock market’s average reaction to these four crises involved lots of volatility. But also notice that the stock market, on average, was 17% higher one year after those crises erupted into investors’ consciousness.
How does the stock market’s recent reaction to the Greek debt crisis stack up to this composite? It’s below the average, as you can see — about 8% below. Still, given the volatility of the market’s reaction to the four individual past crises, this is hardly unprecedented. And notice, furthermore, that the stock market at the end of May is not lower than where it stood when the Greek crisis erupted last fall.
If you’re like many of the investors with whom I have in the past shared these results, however, you’ll be inclined to dismiss them on the grounds that the past crises weren’t as bad as the current one. And it is undeniable that the Greek debt crisis is different than prior crises in several important ways.
Still, it would be a mistake to think those prior crises weren’t every bit as scary as the current one. Our minds play tricks on us as we write history after the fact. We tend to rewrite it as though the outcome was preordained, thereby discounting — if not completely overlooking — how bad it felt at the time.
To illustrate, I went back and scoured the comments made in October 1998 by the investment newsletters I monitor, as well as by The Wall Street Journal and the New York Times. That month was the point at which the stock market was some 14% below where it stood when that year’s crisis erupted. In other words, the stock market at that time was sitting with a bigger loss than we are currently.