Investors have not seen the back of the Covid-19 market crash, if history is any guide

The rebound in stocks may seem reassuring, but a look at the biggest bear markets of the past century warns of the likelihood of a ‘post-crash crash’. Given the extent of the contractions all round, it may be prudent to hold out for another market fall

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People walk past a stock market indicator board in Tokyo on April 27. Tokyo stocks rose sharply after the Bank of Japan unveiled new stimulus measures to counter the impact of the coronavirus pandemic. Photo: EPA-EFE

Published: 9:30am, 1 May 2020Updated: 10:18am, 1 May 2020

In 1971, Amos Tversky and Daniel Kahneman published a paper called “Belief in the Law of Small Numbers”. We forget that finance is a very young subject – a mere 200 years or so, and investment techniques were only modernised 70 years ago through the brilliant portfolio techniques of Nobel laureate Harry Markowitz.

We think we are so smart, but human intuitions about probabilities are not. In a recent paper, it was found that the optimism bias of individuals made them give a lower probability of getting Covid-19 for themselves than for others. People also believe the chances of catching the coronavirus are significantly higher than they really are.

Numbers in finance are actually very short term and represent a small proportion of the potential outcomes. We don’t really know where the boundaries are. Who ever thought that we would see interest rates, oil prices, and European electricity prices fall below zero?

I therefore went back over 100 years to look at what the US S&P 500 index, and its predecessor, have done. I took the nine biggest bear markets, not in terms of a single-day collapse (the kind that generates the headlines), but in terms of the total fall from top to bottom.

We all get frothy at the mouth at a big daily fall, but it is the long, drawn-out falls in value that destroy confidence and wealth.