Those who do not learn from the lessons of history are doomed to repeat them---Abraham Lincoln

Stock as long term investment

Professor Jeremy Siegel made a study of the long-term returns of stocks, gold and bond at various periods from 1871 to 2001. He presented his findings in his book, “Stock for the Long Run”.

For a 130-year period from 1871-2001, stocks’ total real annual return including dividend yield and after adjusting for inflation of 2% is 11.4%, or a gross return of 13.4%, compare to gross return of 4.8% for bonds and 1.9% for gold. The recent period of 1982-2001 provided the highest gross return of 16.6% per year for stock. For the 15-year period of 1966-1981, US stock’s total real return was only 3.5%, eroded by the high inflation of 7% during that period. However, this return is still much better than bonds of -4.2% although gold performed much better at a real return of 8.8%.

My own analysis of the Malaysian stock market based on the monthly KLCI data from 1973 to 2006 from the Global Financial Data shows that the total return of the broad Malaysian market is 1% a month, or 12% per annum with a standard deviation of 31%. For the last 10 years until end of year 2014, the compounded annual return has been higher at 14%. It is noted that the market started at a lower base has been in the uptrend for a prolong period of 6 years already.

The above data shows that stocks historically has been a better investment for long term. However, the volatility and hence the risk in equity investment is higher. There have been a number of severe stock market crashes which had serious consequences to the wealth of investors.

Stock Market Crashes in the US and around the world

The crash of 1929 of the US stock market is arguably the most well-known stock market crash in history. It started in October of 1929 after the Roaring Twenties economic boom which finally popped. Many Americans speculated in the stock market, often with large amounts of borrowed money, and became extraordinarily wealthy. By the fall of 1929, the stock market peaked and then plunged, financially-ruining many stock investors.  As the Crash of 1929 unfolded, thousands of banks failed, unemployment skyrocketed and the United States entered into the Great Depression, which lasted until the late-1930s. Many jumped out of tall city buildings to their deaths. The legendary trader Jesse Livermore, who has been the most spectacular speculator in the stock market in history, shot and killed himself.

The crash was followed by a number of other crashes in US and around the world notably the Black Monday of October 19 1987, The Japan Bubble Economy of the 1980s and its subsequent crash in 1990s, The Dot-com Bubble of the late 1990s, The 1997 Asian financial crisis, and most recently the US subprime crisis of 2008. These are just a few out of many crashes around the world.

Stock Market crashes in Malaysia

The Malaysian stock market is not spared of crashes since its inception. The crash of 1973 was one of the earlier crashes known, followed by the crash of 1981, 1984, and of course the effect of the Black Monday in October 1987.  The most severe and damaging crash in Malaysia was none other than the 1997 Asian Financial Crisis, followed by the sacking of Anwar Ibrahim as the Deputy Prime Minister. The plunge of the Second Board Index from its dizzy high level was phenomenon during the same period. The external factors from the Dotcom Bubble in 2001 and the US Sublime housing loan crisis in 2007/08 also severely and adversely affected the Bursa performance.

 We will examine each of the crashes at home in more detail to see what we can learn from these experience investing in the stock market with the total return data of KLCI from the proprietary Global Financial Data.

Stocks were first publicly traded in Malaysia on 6^th May 1960 under the Malayan Stock Exchange. The present FTSE Bursa Malaysia KLCI Index (Kuala Lumpur Composite) started in January 2, 1977 with a base value of 100. It is a major stock market index which tracks the performance of 30 largest companies by full market capitalization listed on the Main Board of the Bursa Malaysia. It is a free-float (minimum of 15%), capitalization-weighted stock market index.

Figure 1 below shows the KLCI Index from 1^st January 1975 to 31^st December 2001. One can see there were a number of sharp dips notably from June 1981, March 1984, July 1987 in tandem with the Black Monday, February 1997, February 2000 at the same time of the Internet Bubbles, and the most recent November 2007 during the US subprime housing mortgage crisis. It must be noted that though there were a number of crashes, the broad index was still in obvious uptrend.

The Crash of 1981

The severe crash of 1981 occurred eight years after the previous crash in 1973 when the KLSE Index then dropped by 66% in two years from 434 points at the beginning of 1973 to 148 points at the end of 1974. That was the time when the infamous stock OCBC then was bidden up from RM7.00 to RM50 a piece before dropping down to just RM3.60.

After the crash in 1973, the stock market was in doldrums for a number of years until at the middle of 1979 when a bull run occurred as the KLCI ran up from 180 points to 540 points in just two years up to 30^th June 1981 as shown in Figure 2 below. It dropped by a whopping 42% in just four months to 313 points on 30^th October 1981. The index started to recover to 363 points, or 16% three months later. Just as when everyone thought it was safe to go swimming in the sea again the index retreated sharply by another 32% to 247 points 7 months later on 30^th August 1982. The total drop of the 14 months period was a whopping 54%, a very rapid fall by any standard.

A number of “games” were played during the euphoria in 1981; the Conglomerate Game and the Property Injection Game. In the Conglomerate Game, continuous stream of announcements of bonus, rights, merger and acquisitions, share swaps, optimistic profit and growth forecasts plucked from the sky were made all over the media and investors went nuts over them without knowing that no values were actually created with all those corporate exercises, and forecasts were ridiculously optimistic. It is noted that the share price of MUI Berhad (price at 23.5 sen now) was bidden up to RM15.50 a piece with price-to-earnings ratio of 176!

In the Property Injection Game, private properties were sold to the listed company with ridiculously high valuations detrimental to the interest of minority shareholders. Perak Carbide (Malaysian Resources now), one belonged to an MCA strong man who eventually went to jail, was bidden up from 75 sen to RM5.75!

Many speculators and small retail investors were badly burnt in the 1981 crash after 54% loss. In individual stocks, the losses were much higher. One would expect the market would continue to stay low for a while after that severe crash ended August 1982. However, it was not the case to be.

“... the vintage of history is forever repeating ~ same old vines, same old wines!”
― E.A. Bucchianeri,

The Crash of 1984

When KLCI reached its bottom in August 1982, it started to climb up unabatedly to 405 points, or 64% in just one and a half year at the end of February 1984 as shown in Figure 3 below. Speculators were ecstatic and trading halls of the broker firms were filled again. Optimistic forecasts and projections were aplenty from the “experts” that the market would continue to climb higher.

Unfortunately the year of 1984 had many untoward happenings; the Bank Bumiputra Finance Crisis, the Malaysian Chinese Association Internal Crisis, and the introduction of the Computerized stock-clearing system.

The broad market made up of the blue chips retreated by 26% by the end of the year. However, the actively traded speculative stocks fell by a much higher percentage. Alcom (now at 74 sen) with losses in the year, dropped from its highest price at RM3.50 to RM1.36 by the end of the year, or a loss of 57%. John Holding, at its highest at RM2.75 with a PER of 113, plummeted by 50% to RM1.36.

The bear market did not stop then. The saga of the collapse of the Pan-Electric Industry happened in the year worsen the situation and the broad market retreated by another 24% by the end of 1985, and then another 26% for the year ended May 1986. The total drop was 58% for the two years and three months period. As usual, the individual stocks dropped much higher than the broad market and thousands of retail investors and speculators had their savings wiped out and left licking their wounds for a long time. Margin traders had to sell off their underwear to pay off debts.

This severe crash in the Malaysian Stock Exchange in 1984 happened just three years after the 1981 crash. Had a lesson learnt? Apparently not. This time was due to an important external factor.

The Black Monday on October 1987

Within fifteen months, the KLCI climbed back by 162% to 448 points at end of July 1987. Wow, how I love the excitement of the stock market.

Abroad, Dow Jones Industry had climbed by more than 40% in the first nine months of the year. It started to fall by 10% from October 12 to October 16. On Black Monday of Oct 19, it plunged 22.6%, or 508 points, within a day. The loss in market capitalization was a staggering $500 billion. It was the largest single fall since 1929, in both absolute and percentage terms.  

There were widespread contagious effect on the stock exchanges all over the world. The stock market In Malaysia was not spared as the KLCI tumbled by 12.4% on Black Monday. As a result of the overnight crash in US, the KLCI plunged another 15.7% the next trading day. By the end of November 1987, it has dropped by a whopping 46% to 243 points, in just four months. Speculative individual stocks dropped by much bigger margin as usual. What happened to the margin traders? Blood was all over the street as shown in Figure 4 below.

After the Black Monday, it appears that a period of calm after the storm reigned in the Malaysian Stock Market into the 1990s, but not for too long.

Conclusion

The stock market does provide good opportunities to build long term wealth as shown above. It can also be seen that some of the biggest gains in the market came in spurts and short periods of time. One can only profit from these opportunities if he is armed with the necessary knowledge and well prepared.

Market cannot go up forever. Many severe market declines and crashes resulting heavy losses happened in just as fast and furious without any warnings and punish those who are ignorant.

"When you combine ignorance and leverage, you get some pretty interesting results."

Warren Buffett

It is extremely hard to predict the next market movement and to time the market consistently well. Hence utilize the opportunities provided by the stock market to build long term wealth, but avoid the perils of heavy losses.

Listen to what Benjamin Franklin says:

“An investment in knowledge pays the best interest.”

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