How Does This Crash Compare to 2020 and 2008?

The tariff shock is more stagflationary than deflationary. And it may be beyond central banks to fix.

Where does this market hit rock bottom?

Well, it’s another stimulating day at the market for falling knives. Watch those fingers!

Joking aside (you’re not in the mood, I can tell), we’re now firmly in selling mode, and although there are signs at the moment that US markets might have a less wild day than Asia and Europe have had, I wouldn’t want to stake money on that.

I do think that those of you with watchlists for individual stocks or funds should be looking at them intently and thinking about the impact tariffs may or may not have on them.

I feel a lot of stuff is being sold indiscriminately at this point (probably because people want to either lock in the gains they’ve made, or need to sell to meet margin calls elsewhere). Forced selling is always good news for buyers with cash.

You look at the dividend yields on the FTSE 100 right now, for example, and you have to think that some of these stocks are very cheap indeed. (Obviously dividends can be cut or scrapped — but that’s why you do your research.)

So as I’ve already repeated several times, you should continue not to panic.

That said, it’s always easier not to panic if you feel you have a rough idea of what’s going on. So today I wanted to have a think about what kind of shock this is, and what we might expect from here, and compare it to the more recent crashes that I suspect most of you will recall.

The usual caveat: I don’t know any more than you, but I do probably spend more time thinking about it because it’s my job, whereas many of you have proper jobs. So you can take my opinion, stick it in your mental blender, and see if it adds anything useful to your own thought processes.

Inflation or Deflation?

First off, let’s think about the economic fundamentals. How does this compare with previous big crashes and the shocks that caused them? Is it a demand or a supply shock?

In those terms, 2008 and the aftermath was mostly a demand shock. Consumers had got in over their heads and borrowed and spent too much. This was supported by the “wealth effect” of ever-rising house prices.

The collapse of the financial system was a symptom of an underlying problem, which was that the private sector needed to deleverage, despite the best efforts of central banks. This deleveraging process was deflationary.

The lockdown crisis, by contrast, was inflationary. Both supply and demand were shut down in the early days. But demand was propped up by government spending in order to maintain the health of consumer finances (they had no other choice, given that they mandated the shutting down of the businesses employing these consumers).

This fueled demand that supply (which had been curtailed) simply could not keep up with once consumers were unleashed again, first in the “stuff you do in your house” sectors, and then once lockdowns ended in the “stuff you do outside your house” sectors. Thus high demand and clogged supply drove up prices.

The tariff shock is clearly a supply shock rather than a demand shock. Tariffs are a tax, they drive up the cost of supply and also disrupt it depending on what companies try to do to get around it. From that point of view, it’s quite straightforward.

The complexity arises when you try to consider what the immediate effects of this disruption might be. If I have a factory in China and I sell stuff to American consumers, my margins are going to take a hit, one way or the other. I might go out of business. Or I might not be able to afford to hire people. Or I might have to fire people. That’s recessionary.

If I’m a consumer in the US, I’ve seen the stock market crash (so my psychological wallet is hurting and the “wealth effect” is going into reverse). Moreover, the prices of any imported goods I may want will be going up. So maybe I don’t buy as much. That’s recessionary.

So in the short term you can make an argument for deflation or at least stagflation. But overall, it’s inflationary. Particularly if the Trump government responds to expected higher tariff revenues by cutting taxes on consumers.

But When Do We Hit Bottom?

OK so let’s say it’s a stagflationary to inflationary shock. That’s fine. But a bigger question on your mind right now is probably: when does the market stop falling?

This is a harder question. The acute part of the 2008 financial crisis ended when the world’s central banks, and the Federal Reserve in particular, underwrote their country’s banking systems and printed money in order to drive down interest rates.

The acute part of the Covid crisis ended in March 2020 — and the market rebounded that same day — as soon as the Fed came out and basically did what it had done in 2008, only on steroids. It virtually outlawed bankruptcy. The market was an obvious buy at that point.

By the way, if you want to cast back further to the 1987 crash, the Fed also stepped in to prop up the system then too.

In other words, all of those big crash crises ended at least partly because of the central bank “put”. It’s much harder to say where that “put” is today.

I’ll be blunt, I’m not convinced there’s a “Trump put” at all. I don’t think there’s a level on the S&P 500 where he changes his mind. I certainly wouldn’t bet on it, put it that way.

What about the “Fed put”? Depending on the level of panic in markets, you may get to a situation where the central bank feels forced to step in. That wouldn’t be because share prices are falling, as such. It would be because the speed and scale of the turnaround detonates something within financial markets.

This wouldn’t be a massive surprise (LDI/Liz Truss and the collapse of Silicon Valley Bank in the US are two recent examples of “things blowing up” in markets that required a bit of central bank mopping up).

But the fundamental issue is more a political one and I’m not sure that it’s at all easy for the Fed (or any other central bank) to draw a line under this one. It might put out individual fires, but propping up the market as a whole does not look like it’s the Fed’s job this time around.

Put very simply, the chaotic tearing up of a global consensus (however sound the reasons are — and there are good reasons, we’ll discuss that another day) means that the number of potential future scenarios has widened dramatically and that in turn suggests to me, a lengthier process than we may have grown used to with recent crises.

Jim Reid’s team at Deutsche Bank put out a good piece today. They suggest that “perhaps the most important thing to watch for is whether the US administration tries to find an elegant off-ramp or doubles down.” Clearly the former would be more market-friendly than the latter.

Good luck out there. And remember — don’t panic.