Re-Visiting the 1998 Bear Market

Beginning in the summer of 1997 a number of southeast Asian countries experienced a financial crisis that would wreak havoc on their currencies and the broader emerging markets in general. Countries like Thailand, Indonesia and South Korea all experienced a severe depreciation in their currencies.

The MSCI Emerging Markets Index proceeded to get chopped in half over the next year or so, dropping 56% from August 1997 to August 1998. U.S. markets brushed off the turmoil for the majority of this period. From August 1997 to June 1998, the S&P 500 was up 21% while emerging markets fell 40%.

Then in August of 1998, the Russian government was forced to devalue their currency and default on their debt as their own problems came to light. Hedge fund Long-Term Capital Management blew up in the process and markets everywhere were affected.

The losses were swift and unforgiving for stock markets around the globe as you can see the damage done in just two short months:

  • S&P 500 -15.4%
  • Small Caps (S&P 600) -25.5%
  • Mid Caps (S&P 400) -21.8%
  • Emerging Markets (MSCI EM) -26.7%
  • Foreign Stocks (MSCI EAFE) -11.5%

The crazy thing is that stocks recovered relatively quickly following the dramatic fall. These were the total returns from September 1998 through March 2000:

  • S&P 500 +59.8%
  • Small Caps (S&P 600) +48.4%
  • Mid Caps (S&P 400) +81.2%
  • Emerging Markets (MSCI EM) +113.9%
  • Foreign Stocks (MSCI EAFE) +49.0%

This was the last leg higher before the tech bubble burst and the S&P 500 was eventually cut in half over the ensuing 2-3 years.

Some market observers seem to think that we may have experienced our own 1998 moment in the latter part of 2015 and early 2016. Here were the returns in those same markets in that time:

  • S&P 500 -15.3%
  • Small Caps (S&P 600) -22.3%
  • Mid Caps (S&P 400) -23.2%
  • Emerging Markets (MSCI EM) -39.8%
  • Foreign Stocks (MSCI EAFE) -25.5%

Anything is possible, but it doesn’t feel like the recent downturn had the same type of macroeconomic backdrop as its 1998 counterpart. Here’s Peter Bernstein on the 1998 affair:

We now digress briefly to discuss an important instance of high macro volatility in August 1998, when stock prices fell by over 14 percent, the largest one-month decline since the famous crash of October 1987. A monetary crisis had been moving across Asia for some months, but on August 17, without warning, the Russians abruptly defaulted their government bonds, devalued the ruble by 25 percent, and declared a three-month moratorium on foreign obligations of Russian banks. The Russians had issued $3.5 billion of euro-denominated debt as recently as July 24. The most shocking feature of this debacle was in the default on bonds denominated in rubles as well as in foreign currencies; defaults on bonds denominated in foreign currencies have been all too frequent in financial history, but defaults on obligations in a country’s own currency have been rare. Financial markets worldwide responded to the shock with steep price drops in price.

I guess you could say oil falling roughly 80%, the potential for a huge slowdown in China and negative interest rates around the globe set the stage for this latest bear market, but it hardly seems as bad as the 1998 episode.

Regardless, it makes sense for investors to understand risk from a historical market perspective. People seem to assume that market volatility has been far above average since the financial crisis, but swift market downturns are not a new phenomenon. Markets have always had air pockets that get filled to the downside (and the upside as well). It’s best that investors remember this now as we continue to inch closer to new all-time highs in stocks.

There is always a risk of an uncertain event throwing a wrench into your best laid plans. I don’t think it’s necessary for investors to constantly shy away from volatility, but it’s worth remembering that unexpected shocks come with the territory when investing in risk assets.

Capital Ideas Evolving

Further Reading:
Even Bull Markets Aren’t Easy


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