Reasons for the US stock market plunge and its chain reaction: A market risk guide every investor must read

From the Great Depression in 1929 to the tariff shocks of spring 2025, the reasons behind major declines in the U.S. stock market are often complex and multifaceted. Each sharp fluctuation has far-reaching impacts on global financial markets, especially for Taiwanese investors. Understanding the logic behind U.S. stock volatility is crucial. This article will delve into the true drivers of the past century’s stock market crashes and how investors should respond to these market risks.

The Common Logic Behind Market Crashes: The Deadly Combo of Bubble Expansion and Trigger Events

Careful examination of multiple historical U.S. stock downturns reveals a recurring pattern: before each major decline, the market accumulates severe asset bubbles, which are eventually burst by specific policy shifts or external shocks.

The key to understanding this pattern is recognizing that U.S. stock crashes are not caused by a single sudden event but are the result of long-term structural imbalances that erupt at a certain moment. During bubble phases, market optimism becomes irrationally high, valuations diverge significantly from economic fundamentals; when a trigger occurs, investor confidence collapses, leading to self-reinforcing panic-driven declines.

Seven Major Crashes: Iconic U.S. Stock Market Downturns and Deep Analysis

The 1929 Great Depression: Leverage Bubble and Protectionist Trade War Double Blow

In the 1920s, American investors widely used leverage (borrowing) to speculate, causing stock valuations to severely disconnect from real economic growth. When signs of economic peak appeared, the leverage effect reversed, triggering the Dow Jones to plummet 89% over 33 months—a historic disaster.

Worse, in 1930, Congress passed the Smoot-Hawley Tariff Act, raising tariffs on over 20,000 imported goods. This extreme protectionism provoked retaliatory tariffs from other countries, sharply shrinking global trade and transforming a localized financial crisis into the Great Depression. This history shows that trade wars can be more damaging to markets than economic recessions themselves.

Black Monday 1987: Liquidity Crisis from Program Trading

On October 19, 1987, Black Monday introduced a new risk: technical collapse. Institutional investors used quantitative strategies called “portfolio insurance,” which involved automatic futures selling to hedge risks during downturns. When the market started falling, many institutions triggered sell orders simultaneously, creating a vicious cycle of algorithmic trading and liquidity crunch.

The Dow plunged 22.6% in a single day, and the S&P 500 fell 34%. This event marked the start of the high-frequency trading era and led to circuit breakers. It also reflected that the Federal Reserve’s prior rate hikes had tightened liquidity, fueling panic selling.

The Dot-com Bubble Burst 2000-2002: Illusory Prosperity Ends

In the late 1990s, the rise of the internet fueled irrational optimism. Massive capital flowed into unprofitable tech companies, causing the Nasdaq to soar to 5,133 points before crashing to 1,108—a 78% decline. Many well-known internet firms vanished overnight.

The Fed’s rate hikes starting in late 1999 were the final straw that popped the bubble. This lesson underscores that when valuation bubbles can no longer be supported by monetary easing, a crash becomes inevitable.

The 2007-2009 Subprime Crisis: Domino Effect of Financial Derivatives

The U.S. housing market built up a massive bubble, with excessive expansion of subprime mortgages. When home prices declined, many borrowers defaulted, igniting the subprime crisis.

More deadly was the spread of risk via financial derivatives. Banks packaged subprime loans into complex products sold globally, causing the crisis to cascade like dominoes. The bankruptcy of Lehman Brothers in 2008 symbolized the collapse of confidence in the financial system. The Dow fell from 14,279 to 6,800—a 52% drop. This crisis highlights how leverage and complex derivatives can severely underestimate systemic risk.

The COVID-19 Pandemic Shock 2020: Black Swan and Liquidity Flash Crash

The global outbreak of COVID-19 forced lockdowns worldwide, disrupting supply chains, halting factories, and reducing consumption. Investor uncertainty peaked, causing multiple circuit breakers in U.S. markets, with the Dow dropping over 30% in a short period.

Simultaneously, oil prices collapsed amid a price war between Saudi Arabia and Russia, intensifying panic. Fortunately, the Fed quickly launched quantitative easing, and governments enacted fiscal stimulus, allowing markets to recover all losses within six months and reach new highs.

The 2022 Rate Hike Bear Market: Inflation Out of Control and Rapid Monetary Policy Shift

In 2022, U.S. inflation hit 9.1%, a 40-year high. The Fed raised interest rates by a total of 425 basis points, from near zero to 4.25-4.5%, the fastest tightening since the 1980s. The S&P 500 declined 27%, and Nasdaq fell 35%.

Adding to the pressure, the Russia-Ukraine war pushed energy and food prices higher. Investors faced a dilemma: continue rate hikes risking recession, or halt to control inflation. By 2023, markets rebounded as the rate hike cycle ended.

Spring 2025 Tariff Shock: New Trade War Sparks Market Volatility

In April 2025, the Trump administration announced a minimum 10% tariff on all trade partners, with higher tariffs on countries with trade deficits. This aggressive move triggered fears of supply chain disruptions. On April 4, the Dow plunged 2,231 points (5.50%), the S&P 500 fell 322 points (5.97%), and Nasdaq dropped 962 points (5.82%). Within two days, all three indices declined over 10%, the worst two-day drop since March 2020.

The Butterfly Effect: How U.S. Stock Crashes Impact Taiwan, Gold, Bonds, and Other Assets

U.S. stock declines often trigger a “flight to safety,” causing capital to flow from high-risk assets to low-risk ones, creating chain reactions globally.

Bonds and the US Dollar: Safe Havens

During stock crashes, investors flock to U.S. Treasuries, especially long-term bonds, pushing prices up and yields down. Historically, bond yields tend to fall about 45 basis points within six months after a correction or bear market.

The dollar, as the ultimate safe-haven currency, also appreciates. Investors sell risk assets and buy dollars, leading to dollar strengthening. When deleveraging occurs, investors unwind dollar loans, further boosting the dollar.

Gold: Traditional Hedge with Dual Drivers

Gold is a classic safe haven. During panic, buying gold hedges against uncertainty. If a stock crash coincides with expectations of Fed rate cuts, gold benefits from both risk aversion and falling rates. Conversely, if the market declines during rate hikes, higher interest rates may dampen gold’s appeal.

Commodities and Cryptocurrencies: High-Risk Assets in Sync

Industrial commodities like oil and copper usually fall with stocks, signaling economic slowdown. However, geopolitical events causing supply disruptions can push prices higher, creating stagflation.

Cryptocurrencies, often dubbed “digital gold,” behave more like tech stocks—high risk and high volatility. During stock crashes, investors often sell crypto to cover losses elsewhere, causing prices to decline sharply.

Taiwan Stock Market’s Vulnerability: Why U.S. Market Declines Will Hit Taiwan

Historical data shows a strong correlation between U.S. and Taiwanese markets. Major U.S. downturns impact Taiwan through three channels:

First, direct contagion of sentiment

As a global risk indicator, a U.S. market crash triggers panic worldwide. Risk aversion leads investors to sell Taiwanese and other emerging market assets, creating “panic selling.” The 2020 COVID crash saw Taiwan’s index fall over 20% alongside the U.S.

Second, rapid foreign capital withdrawal

Foreign investors are key players in Taiwan’s market. During U.S. volatility, they often withdraw funds quickly to meet liquidity needs or reallocate assets, exerting downward pressure on Taiwan stocks.

Third, real economic linkages

The U.S. is Taiwan’s largest export market. Economic downturns in the U.S. reduce demand for Taiwanese tech and manufacturing products, lowering corporate earnings and stock prices. The 2008 financial crisis also caused significant declines in Taiwan’s market, exemplifying this mechanism.

Risk Identification and Proactive Defense: Investor Early Warning System

Before a major U.S. stock crash, investors should learn to recognize warning signs. Four key areas deserve daily attention:

Worsening economic data

Slowing GDP growth, rising unemployment, declining consumer confidence, and downward revisions of corporate earnings are early signs of recession. Markets tend to react ahead of these indicators.

Shift in monetary policy

Fed rate hikes or cuts greatly influence markets. Rate hikes increase borrowing costs, suppress investment and consumption, and usually pressure stocks; rate cuts tend to boost markets. Monitoring Fed signals is essential, especially when policy shifts suddenly.

Geopolitical and trade policy changes

International conflicts, political events, and tariff policies can swiftly alter investor sentiment. The 2025 tariff escalation is a recent example, with markets reacting immediately.

Market sentiment indicators

VIX, risk appetite measures, margin levels, and liquidity indicators reflect market mood. Sudden deterioration often signals an impending shift.

Timely awareness of these signals is critical. Platforms like Mitrade provide real-time financial news, trading insights, economic calendars, sentiment indices, and categorized information to help investors identify market trends promptly.

Learning from History and Practical Strategies: Retail Investors’ Risk Management

When facing significant U.S. market corrections, investors should stay alert and adopt proactive risk management rather than passively waiting for rebounds.

Dynamic asset allocation

In periods of potential correction, reduce risk assets like stocks and increase cash and high-quality bonds. This approach buffers portfolio volatility during downturns and allows for opportunistic buying at lows.

Advanced hedging strategies

For knowledgeable investors, options and derivatives can be used prudently. For example, purchasing protective puts (buying put options) can provide downside protection, offsetting stock losses during sharp declines.

Psychological resilience and long-term perspective

Every major U.S. market crash has eventually been overcome and followed by recovery. Retail investors should cultivate a long-term view, avoiding panic selling. Maintaining rationality during extreme pessimism is key, just as avoiding euphoria during booms.

While causes of U.S. stock declines are complex, their patterns are recognizable and manageable. By understanding history, identifying risk signals, and adjusting asset allocations, investors can protect their wealth amid volatility.