How the decline of U.S. stocks affects global investment strategies: Lessons from seven historic crashes

The U.S. stock market plays a leading role in the global economy, and its fluctuations often trigger chain reactions. However, the reasons for U.S. stock declines are never singular—they involve complex interactions of economic, policy, and market psychology factors. By analyzing seven major U.S. stock crashes, this article aims to help investors understand the fundamental mechanisms behind stock market declines and how to make accurate judgments before risks emerge.

From Bubbles to Crashes: Recognizing Patterns in Seven Major U.S. Stock Declines

History repeatedly confirms an investment rule: most major stock crashes originate from asset bubbles bursting. Investors need to understand the underlying logic behind this.

Examining the evolution of these seven events reveals that the causes of stock declines have deep structural logic: when bubbles reach their peak, any policy shift or external shock can become the final straw that breaks the market.

The Three Main Mechanisms Behind Stock Market Declines: Bubbles, Policies, External Shocks

To accurately predict when the U.S. stock market will fall, investors must understand three primary trigger mechanisms:

Type 1: Asset Bubble Bursts

The leverage bubble of the Great Depression era (1929)

In the 1920s, U.S. investors widely used high leverage to speculate, pushing stock valuations far beyond economic fundamentals. The “Black Thursday” was not an accident but an inevitable result of bubble bursting. The market had inflated to a point where self-correction was impossible.

More critically, in 1930, Congress passed the Smoot-Hawley Tariff Act, sharply raising tariffs on over 20,000 imported goods. This protectionist move provoked retaliations worldwide, causing a sharp contraction in global trade. The local financial crisis escalated into the Great Depression—this 89% decline was the result of bubble collapse compounded by policy mistakes.

The dot-com bubble (2000-2002)

In the late 1990s, internet industry frenzy attracted massive capital inflows, inflating many unprofitable internet companies’ stock prices to sky-high levels. Nasdaq soared from 5,133 to a peak of 1,108, a 78% drop.

The key was: when the Fed began raising interest rates at the end of 1999 to cool overheating markets, investors realized these companies couldn’t sustain profits. The bubble burst, and monetary policy shifted, leading to a revaluation of tech stocks.

Type 2: Policy Shift

Aggressive rate hikes triggering the 2022 bear market

To combat unprecedented inflation (CPI once hit 9.1%), the Fed in 2022 raised interest rates seven times, totaling 425 basis points. The federal funds rate jumped from near zero to 4.25–4.5%, reversing years of easy money.

The S&P 500 and Nasdaq fell 27% and 35%, respectively. This decline was not due to deteriorating corporate fundamentals but a market reaction to “rising rates → discounted cash flows decrease → asset valuations fall.” When policy environment shifts dramatically, liquidity is quickly reallocated.

Program trading’s vicious cycle (Black Monday, 1987)

On October 19, 1987, the Dow plunged 22.6% in one day. The cause was not economic fundamentals or bubble bursting but a combination of Fed tightening and technical factors.

Institutional investors used “portfolio insurance” strategies: automatic selling of futures when markets declined. When the market started falling, many institutions triggered sell orders simultaneously, creating a vicious cycle—algorithmic selling led to further declines, which triggered more selling. Only rapid Fed intervention stabilized the panic.

Type 3: External Shocks

Collapse of financial derivatives during the 2007–2009 subprime crisis

The U.S. housing boom created a massive bubble, with excessive subprime lending. When housing prices fell, many borrowers defaulted, triggering a wave of credit losses.

The danger was the domino effect of derivatives: financial institutions repackaged subprime loans into complex derivatives, spreading toxic assets globally. When these assets plummeted in value, financial institutions suffered huge losses. Lehman Brothers’ bankruptcy ignited systemic risk, with the Dow dropping 52%.

COVID-19 pandemic and oil price war (March 2020)

The sudden outbreak of COVID-19 led to lockdowns worldwide, halting economic activity and disrupting supply chains. Major indices fell over 30% in short order.

Adding to the chaos, Saudi Arabia and Russia engaged in an oil price war, causing oil prices to crash and intensify global panic. However, swift Fed actions and large fiscal stimulus expectations helped markets recover within six months, illustrating how policy speed influences crisis severity.

Trump’s tariffs and trade uncertainty (April 2025)

In April 2025, Trump announced a 10% “minimum tariff” on all trade partners, with higher tariffs on countries with trade deficits. This aggressive move exceeded market expectations, sparking fears of supply chain disruptions.

On April 4, the Dow dropped 2,231 points (5.50%), S&P 500 fell 322 points (5.97%), and Nasdaq declined 962 points (5.82%). All three indices fell over 10% in two days, the worst since March 2020. This shows that stock declines are not always due to economic data deterioration but often stem from policy uncertainty threatening future supply chains and profits.

How Risk-Averse Capital Flows Shake the Global Financial Landscape During Major Declines

When U.S. stocks plunge sharply, investors immediately switch to “risk-off” mode—moving funds into safe havens. This shift impacts other financial assets.

Bond Market Safe-Haven Effect

U.S. Treasuries, especially long-term bonds, are considered “ultimate safe assets.” During stock crashes, large capital outflows from equities flow into bonds, pushing prices up and yields down.

Historical data shows that whether in bull or bear markets, U.S. bond yields tend to fall about 45 basis points over the next six months. However, if the decline is driven by hyperinflation (like in 2022), the Fed may hike rates aggressively, causing a rare “bond and stock sell-off”—bond prices fall as rates rise, and stocks also decline due to monetary tightening.

U.S. Dollar Appreciation and Deleveraging

In times of global panic, the dollar is the second most safe asset after Treasuries. Investors sell emerging market assets and other currencies to buy dollars, causing the dollar to appreciate.

A deeper mechanism is deleveraging: as stocks fall, investors unwind leveraged positions, often borrowed in dollars. This creates huge dollar demand, further strengthening the currency. This explains why global stock crashes often coincide with dollar appreciation.

Gold and Commodities Diverge

Gold, as a traditional safe haven, benefits from market declines and expectations of Fed rate cuts—driving both safe-haven demand and lower interest rates. Conversely, if the decline occurs early in a rate-hiking cycle, higher rates diminish gold’s appeal.

Industrial commodities like oil and copper usually fall with stocks, signaling slowing economic growth. But if declines are due to geopolitical supply disruptions (e.g., war in oil-producing regions), prices may rise countercyclically, creating stagflation.

Cryptocurrencies as High-Risk Assets

While some supporters see Bitcoin as “digital gold,” in market volatility, it behaves more like high-risk tech stocks. During stock crashes, investors often sell cryptocurrencies to raise cash or offset losses, causing crypto prices to typically fall alongside equities.

Why Taiwan’s Stock Market Cannot Escape the Chain Reaction of U.S. Stock Declines

Taiwan’s stock market is highly correlated with the U.S. market. Major U.S. declines impact Taiwan through three channels:

1. Global Sentiment Spillover

U.S. stocks are a global investment barometer. When they crash, panic spreads rapidly. During the COVID-19 outbreak in March 2020, U.S. stocks plunged, causing Taiwan stocks to fall over 20%. Fear spreads like lightning, creating “panic selling.”

2. Foreign Capital Outflows

Foreign investors account for over 40% of Taiwan stock trading volume. During U.S. market turbulence, international investors often withdraw funds from emerging markets, including Taiwan, to meet liquidity needs or reallocate assets, exerting downward pressure.

3. Fundamental Economic Linkages

The core impact stems from economic ties: the U.S. is Taiwan’s largest export market. Economic downturns in the U.S. reduce demand for Taiwanese exports, especially in tech and manufacturing sectors. When profit expectations decline, stock prices fall accordingly. During the 2008 financial crisis, Taiwan stocks dropped 60%, exemplifying this linkage.

How Investors Can Detect Early Warning Signs of a Crisis Before U.S. Stocks Fall

Every major U.S. stock decline is preceded by observable signs. Savvy investors should monitor these four key signals:

Economic Data Indicators

GDP growth, employment figures, consumer confidence, corporate earnings—these reflect economic health. Rising unemployment, falling consumer confidence, and downward revisions of corporate profits often precede market declines. Pay attention to deviations between expectations and actual data; persistent underperformance signals trouble.

Monetary Policy Shifts

Fed interest rate policies directly influence stocks. Rate hikes increase borrowing costs and lower valuations; rate cuts do the opposite. Monitoring Fed minutes, policy statements, and market rate expectations helps anticipate shifts. Turning from easing to tightening is often a risk signal.

Geopolitical and Trade Policies

International conflicts, political instability, and trade policy changes impact investor sentiment and valuations. Trump’s tariffs, for example, caused volatility. Keeping track of policy developments and regulatory changes is crucial.

Market Sentiment and Technicals

VIX (volatility index), leverage levels, and extreme sentiment indicators reveal market psychology. Rising VIX and extreme fear often foreshadow sharp corrections.

Practical Strategies for Retail Investors During Major Market Declines

In the face of significant declines, investors should adopt proactive risk management rather than passive reactions:

Defensive Asset Allocation

When economic data worsens or policy signals turn negative, reduce risk assets like stocks and increase cash and high-quality bonds. This is not about exiting the market entirely but adjusting positions based on risk assessment. For example, during Fed rate hike signals, increasing bond holdings is prudent.

Use of Derivatives for Hedging

For knowledgeable investors, options can provide downside protection. For instance, buying put options on holdings acts as insurance against further declines.

Gradual Buying and Dollar-Cost Averaging

History shows rebounds after crashes often present buying opportunities. Long-term investors can implement dollar-cost averaging during panic periods, acquiring assets at lower prices. The 2020 COVID crash saw the S&P 500 recover all losses within six months, exemplifying this approach.

Avoiding Information Gaps

Lack of timely information can lead to panic. Staying informed through financial news, Fed policy updates, geopolitical developments, and market sentiment tools helps in early risk detection.

Conclusion: The Investment Philosophy Behind the Causes of U.S. Stock Market Declines

Analyzing seven major crashes reveals a common pattern: the root cause of declines ultimately relates to a mismatch between asset prices and real economic fundamentals. Whether driven by leverage, policy shifts, or external shocks, the core mechanism is valuation reversion.

For investors, understanding the true causes of stock declines is more important than predicting exact timing or magnitude. Once the mechanisms are clear, one can stay vigilant during bubbles, adjust swiftly during policy shifts, and respond orderly when crises emerge.

Stock market declines are not disasters but part of market self-correction. Knowing how to find opportunities amid volatility and maintain rationality during panic is the most valuable skill for investors.