Financial Crisis Impact on Different Asset Classes
A financial crisis is a severe disruption in the financial markets and banking system of a country or even the entire world. It typically involves a sudden and widespread loss of confidence in the financial system, leading to a range of negative economic consequences.
In this article, we provide a comprehensive overview of how different asset classes tend to behave during turbulent times of financial and economic crises. Some prominent historical examples uncover the dynamic interplay within these markets.
Impact of Financial Crisis on Equities
Shareholder investments depend heavily on company-specific factors; however, general economic conditions and market sentiment play a decisive role as well. Equity markets typically plummet during financial crises.
During a financial crisis, investor sentiment turns bearish as confidence in the stability of the financial system wanes, causing a domino effect through massive sell-offs on equity markets. Increased risk aversion imposes a higher risk premium to borrowing costs, and businesses may encounter significant challenges in securing loans for expansion or even daily operations. This difficulty in accessing capital negatively impacts corporate earnings, further eroding investor confidence in equities. Higher volatility is common in such conditions as well, and traders could turn the situation into an opportunity for short-term shorting profits.
Economic Crisis Examples Causing Stock Market Crashes
The Dot-Com Crash unfolded in the early 2000s, following a period of excessive overvaluation of internet-related and technology stocks. Having no earnings or clear path to profitability but going public on overhyped expectations, these companies enjoyed skyrocketing stock prices. The bubble burst when major technology companies initiated large sell orders for their own shares, confirming the extreme overvaluation and triggering a wave of panic selling. The Nasdaq Composite Index lost over 76% of its value, while the shock wave reached retirement accounts, investment portfolios, and mutual funds.
The housing market collapse in 2008 and the subsequent banking crisis also resulted in a severe stock market downturn. Major stock indices, such as the S&P 500, plummeted in early 2009, causing substantial losses for investors.
Financial Crisis Affects Fixed-Income Asset Classes by Risk
At times of financial crises, investors often seek safety in government bonds from stable countries, leading to increased demand and higher prices. Therefore, government bonds are widely used as safe-haven asset classes for investments. On the flip side, concerns about creditworthiness during financial turmoil can cause bond prices from corporate issuers to decline.
The scenario is different for corporate bonds. Negative sentiment causes panic selling and declining corporate bond prices, while positive sentiment, often due to government interventions or stimulus measures, can boost corporate bond prices.
Central banks also respond to crises by adjusting interest rates, affecting bond prices: lower rates can make existing bonds with higher coupon rates more attractive, driving up their prices, while raising rates can lead to falling bond prices.
Global Financial Crisis: The 2008 Mortgage Collapse
The global financial crisis of 2008 triggered diverse reactions in the bond market. As the crisis unfolded, the huge demand for government bonds caused yields to drop to historically low levels, driving prices up in early 2009.
In contrast, bonds tied to the housing and mortgage markets, such as mortgage-backed securities and collateralised debt obligations, experienced significant declines in prices due to heightened credit risk and concerns about mortgage defaults. A liquidity squeeze in the market exacerbated the pricing volatility, making it more challenging for investors to buy or sell bonds at desired prices. Central banks responded with measures like interest rate cuts and bond purchases to stabilise financial markets, influencing bond prices further.
Financial Crisis Impact on Asset Classes Like Commodities
The effects of financial crises on commodities are complex, with both safe-haven and risk-off assets experiencing fluctuations as investors seek to adapt to evolving market conditions.
Financial crises impact supply and demand dynamics in commodity markets. Traders can profit from significant fluctuations, taking long or short positions in different commodity types.
Precious metals like gold and silver are considered safe-haven assets by investors seeking refuge from volatile equities and currencies, which can drive their prices up. Conversely, industrial commodities, such as oil and base metals, may face declining prices due to reduced demand resulting from economic slowdowns and decreased industrial activity. Additionally, fluctuations in exchange rates due to monetary policies in response to the crisis can influence commodity prices.
Impact of the Global Financial Crisis: Examples
The 1997 Asian financial crisis caused severe economic contractions and currency devaluations. Key players like South Korea and Indonesia faced significant downturns in manufacturing and construction activity, leading to diminished consumption of copper and aluminium and a sharp decline in their prices. In Russia, the devaluation of the ruble in 1998 made it more profitable for Russian oil companies to export their crude, leading to an increase in oil production. Thus, a surge in supply combined with the reduced demand in Asia the year before resulted in a global oversupply of oil. Consequently, oil prices experienced a sharp decline.
A more recent oil price decline in 2018 and 2019 was also triggered by oversupply concerns, primarily due to the rapid growth in oil production. Trade tensions, the global economic slowdown, and uncertainty in the face of slowing economies were also contributing factors.
A Financial Crisis Is a Pivotal Moment for Currency Markets
A complex interplay of forces can create substantial volatility in the forex market during a financial crisis, reshaping exchange rates.
Heightened uncertainty and risk aversion among investors drive a flight to safety found in stable currencies, causing their values to appreciate. On the other hand, currencies of countries affected by the crisis, like emerging markets, often face depreciation due to economic uncertainty. Monetary policy adjustments by central banks, like interest rate cuts or quantitative easing, influence currency values further.
The European Debt Crisis
In 2010-2012, the depreciation of the euro significantly impacted currency markets. Concerns about the fiscal stability of several Eurozone countries led to investors seeking refuge in other major currencies like the US dollar and the Swiss franc. The European Central Bank's policy interventions played a critical role in managing the crisis's effects, highlighting the intricate relationship between regional economic and political developments and their impact on the global currency market.
Alternative Asset Classes: Cryptocurrencies*
Major cryptocurrencies* like Bitcoin and Ethereum can be seen as a hedge against crises in the traditional markets. Despite their different characteristics, purposes, and risk profiles, many major players see them as alternative investments because of an observed negative correlation at times.
In the early stages of a financial crisis, cryptocurrencies* have sometimes been seen as "digital gold" or a safe-haven asset by some investors. This perception can lead to an initial increase in demand and higher prices for them. However, while some investors see cryptocurrencies* as a hedge against traditional financial system risks, others view them as speculative assets. This duality can result in varying responses during crises, with some investors flocking to cryptocurrencies* and others selling off to raise cash or reduce risk exposure.
Bitcoin: The “Digital Gold”
At the end of 2020, the COVID-19 pandemic accelerated the narrative of Bitcoin being a digital safe-haven asset. Extensive monetary stimulus during the pandemic raised extreme inflation concerns, while fear of worldwide economic recession kept stocks from rising, making many investors see Bitcoin as a superior store of value. Additionally, the pandemic fueled the rise of decentralised finance (DeFi) and digital payment solutions, boosting cryptocurrency* adoption.
If you are willing to explore how various assets react to changing market conditions and hedge risks by diversifying your portfolio, you can visit FXOpen’s free trading TickTrader platform.
Conclusion
Financial crises bring to light the diverse behaviour of various asset classes. Stocks tend to collapse, bonds respond to interest rates and credit concerns, and commodities and currencies get volatile to reflect global dynamics. Amidst these, cryptocurrencies* emerge as an alternative store of value. Ready to extend your trading experience? You can open an FXOpen account and explore the opportunities.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
In this article, we provide a comprehensive overview of how different asset classes tend to behave during turbulent times of financial and economic crises. Some prominent historical examples uncover the dynamic interplay within these markets.
Impact of Financial Crisis on Equities
Shareholder investments depend heavily on company-specific factors; however, general economic conditions and market sentiment play a decisive role as well. Equity markets typically plummet during financial crises.
During a financial crisis, investor sentiment turns bearish as confidence in the stability of the financial system wanes, causing a domino effect through massive sell-offs on equity markets. Increased risk aversion imposes a higher risk premium to borrowing costs, and businesses may encounter significant challenges in securing loans for expansion or even daily operations. This difficulty in accessing capital negatively impacts corporate earnings, further eroding investor confidence in equities. Higher volatility is common in such conditions as well, and traders could turn the situation into an opportunity for short-term shorting profits.
Economic Crisis Examples Causing Stock Market Crashes
The Dot-Com Crash unfolded in the early 2000s, following a period of excessive overvaluation of internet-related and technology stocks. Having no earnings or clear path to profitability but going public on overhyped expectations, these companies enjoyed skyrocketing stock prices. The bubble burst when major technology companies initiated large sell orders for their own shares, confirming the extreme overvaluation and triggering a wave of panic selling. The Nasdaq Composite Index lost over 76% of its value, while the shock wave reached retirement accounts, investment portfolios, and mutual funds.
The housing market collapse in 2008 and the subsequent banking crisis also resulted in a severe stock market downturn. Major stock indices, such as the S&P 500, plummeted in early 2009, causing substantial losses for investors.
Financial Crisis Affects Fixed-Income Asset Classes by Risk
At times of financial crises, investors often seek safety in government bonds from stable countries, leading to increased demand and higher prices. Therefore, government bonds are widely used as safe-haven asset classes for investments. On the flip side, concerns about creditworthiness during financial turmoil can cause bond prices from corporate issuers to decline.
The scenario is different for corporate bonds. Negative sentiment causes panic selling and declining corporate bond prices, while positive sentiment, often due to government interventions or stimulus measures, can boost corporate bond prices.
Central banks also respond to crises by adjusting interest rates, affecting bond prices: lower rates can make existing bonds with higher coupon rates more attractive, driving up their prices, while raising rates can lead to falling bond prices.
Global Financial Crisis: The 2008 Mortgage Collapse
The global financial crisis of 2008 triggered diverse reactions in the bond market. As the crisis unfolded, the huge demand for government bonds caused yields to drop to historically low levels, driving prices up in early 2009.
In contrast, bonds tied to the housing and mortgage markets, such as mortgage-backed securities and collateralised debt obligations, experienced significant declines in prices due to heightened credit risk and concerns about mortgage defaults. A liquidity squeeze in the market exacerbated the pricing volatility, making it more challenging for investors to buy or sell bonds at desired prices. Central banks responded with measures like interest rate cuts and bond purchases to stabilise financial markets, influencing bond prices further.
Financial Crisis Impact on Asset Classes Like Commodities
The effects of financial crises on commodities are complex, with both safe-haven and risk-off assets experiencing fluctuations as investors seek to adapt to evolving market conditions.
Financial crises impact supply and demand dynamics in commodity markets. Traders can profit from significant fluctuations, taking long or short positions in different commodity types.
Precious metals like gold and silver are considered safe-haven assets by investors seeking refuge from volatile equities and currencies, which can drive their prices up. Conversely, industrial commodities, such as oil and base metals, may face declining prices due to reduced demand resulting from economic slowdowns and decreased industrial activity. Additionally, fluctuations in exchange rates due to monetary policies in response to the crisis can influence commodity prices.
Impact of the Global Financial Crisis: Examples
The 1997 Asian financial crisis caused severe economic contractions and currency devaluations. Key players like South Korea and Indonesia faced significant downturns in manufacturing and construction activity, leading to diminished consumption of copper and aluminium and a sharp decline in their prices. In Russia, the devaluation of the ruble in 1998 made it more profitable for Russian oil companies to export their crude, leading to an increase in oil production. Thus, a surge in supply combined with the reduced demand in Asia the year before resulted in a global oversupply of oil. Consequently, oil prices experienced a sharp decline.
A more recent oil price decline in 2018 and 2019 was also triggered by oversupply concerns, primarily due to the rapid growth in oil production. Trade tensions, the global economic slowdown, and uncertainty in the face of slowing economies were also contributing factors.
A Financial Crisis Is a Pivotal Moment for Currency Markets
A complex interplay of forces can create substantial volatility in the forex market during a financial crisis, reshaping exchange rates.
Heightened uncertainty and risk aversion among investors drive a flight to safety found in stable currencies, causing their values to appreciate. On the other hand, currencies of countries affected by the crisis, like emerging markets, often face depreciation due to economic uncertainty. Monetary policy adjustments by central banks, like interest rate cuts or quantitative easing, influence currency values further.
The European Debt Crisis
In 2010-2012, the depreciation of the euro significantly impacted currency markets. Concerns about the fiscal stability of several Eurozone countries led to investors seeking refuge in other major currencies like the US dollar and the Swiss franc. The European Central Bank's policy interventions played a critical role in managing the crisis's effects, highlighting the intricate relationship between regional economic and political developments and their impact on the global currency market.
Alternative Asset Classes: Cryptocurrencies*
Major cryptocurrencies* like Bitcoin and Ethereum can be seen as a hedge against crises in the traditional markets. Despite their different characteristics, purposes, and risk profiles, many major players see them as alternative investments because of an observed negative correlation at times.
In the early stages of a financial crisis, cryptocurrencies* have sometimes been seen as "digital gold" or a safe-haven asset by some investors. This perception can lead to an initial increase in demand and higher prices for them. However, while some investors see cryptocurrencies* as a hedge against traditional financial system risks, others view them as speculative assets. This duality can result in varying responses during crises, with some investors flocking to cryptocurrencies* and others selling off to raise cash or reduce risk exposure.
Bitcoin: The “Digital Gold”
At the end of 2020, the COVID-19 pandemic accelerated the narrative of Bitcoin being a digital safe-haven asset. Extensive monetary stimulus during the pandemic raised extreme inflation concerns, while fear of worldwide economic recession kept stocks from rising, making many investors see Bitcoin as a superior store of value. Additionally, the pandemic fueled the rise of decentralised finance (DeFi) and digital payment solutions, boosting cryptocurrency* adoption.
If you are willing to explore how various assets react to changing market conditions and hedge risks by diversifying your portfolio, you can visit FXOpen’s free trading TickTrader platform.
Conclusion
Financial crises bring to light the diverse behaviour of various asset classes. Stocks tend to collapse, bonds respond to interest rates and credit concerns, and commodities and currencies get volatile to reflect global dynamics. Amidst these, cryptocurrencies* emerge as an alternative store of value. Ready to extend your trading experience? You can open an FXOpen account and explore the opportunities.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
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