It was a hell of a day. Actually, the days before and after October 19, 1987, were hells of a day as well. The most vivid memory I have of “Black Monday,” twenty years ago, is of standing in the Standard and Poor’s 500 futures trading pit at the Chicago Mercantile Exchange in mid-afternoon and being shocked to discover that this usually crowded, bustling, noisy place was deadly quiet. Many of the traders had left altogether. Others stood around, hands in their pockets, not buying, not selling, just watching as the indicator board displaying the current value of the S&P 500 index ticked down and down and down in what seemed to be a free-fall.
By the time the trading day had come to a close, the S&P 500 index had fallen 20.5%. The Dow Jones 30 -- the industrial average -- had lost 22.6% which, in those days, was 507.99 points. The DJIA closed at 1,738.74. This is the biggest one-day percentage decline in market history.
The cause, the subject of many studies in the weeks and months that followed, was never clear. Then, as now, the value of the dollar was falling; a foreign power was on the economic rise (Japan then, China now); real-estate values were collapsing; markets were volatile; and there had been a severe shock to the credit markets (the savings and loan crisis then, the subprime mortgage crisis now).
But interest rates in 1987 were double-digit. They are nowhere near that today. The Fed was tightening then. Today, it is easing. And today there are a series of “circuit breaker” rules in place which would have the effect of slowing a market free-fall. Those rules weren’t in place 20 years ago. Markets today are also much more “global,” and investors have diversified not only between investment vehicles but also between investment locales. Companies themselves are far more likely to be “multi-national” and derive significant portions of their revenue from foreign sources. It is rare that all national economies move in lock-step.
Which means the answer to the question, “Could it happen again?” is a resounding, “Of course.” But it is, IMHO (Internetese for “In My Humble Opinion”). less likely than it was then, barring some extraordinary geopolitical event, say, the detonation of a nuclear weapon or two. Note that at the 14,000 level, 22.6% would be 3,164 points!
Which does not mean a sharp sell-off can’t occur at any time and any place. In 1987, as today, market professionals seem to believe they are smarter than everybody in the room. They hire the most skilled mathematicians and statisticians who design complex trading instruments which supposedly insure the trader against all risk. In my experience, about once every five years, the something happens that proves them wrong and triggers a mini-panic and a bloody sell-off.
In 1987, it was “index arbitrage,” “program trading,” and “portfolio insurance.” These strategies all became possible with the rise of the derivatives markets and the availability of sophisticated computers and electronic trading systems. First was the idea that you could profit from differences between the values of a basketful of stocks, (for example, all 500 of the issues which make up the S&P 500 index and the value of the S&P 500 futures contract). That’s the arbitrage part. Second was the idea that you could insulate yourself from risk by hedging your stock holdings. You did this by entering into an opposite futures or options position (which requires a much smaller capital investment). That’s the portfolio insurance part. Finally, you program your computers to place large numbers of orders to implement these strategies in a matter of seconds when the formulas indicate. That’s program trading.
It looks great on paper, but it assumes the markets are open and functioning. Sounds obvious, right? Well, not apparently to many of the hot-shots who design these strategies. In 1987, according to many of the after action reports, the strategies failed because the massive numbers of program trades overloaded the system, both human and electronic. The humans just went home. The machines fell far behind both in order delivery and in price reporting.
The exchanges have come a great distance in upgrading their electronics to handle huge order flows. Trading volumes which would have swamped the 1987 infrastructure are routinely handled today. But the human factor is not so easily changed. The circuit breakers help by forcing a “time out” to allow the human players to take a breath and evaluate the situation.
But you can only force humans to do so much. Like deer in the headlights, we tend to freeze in the face of uncertainty and the sooner Wall Street realizes that the better. At the end of the 90s, the bursting of the Internet bubble struck me as an event similar to 1987. After first believing analysts who concocted all sorts of explanations as to why high valuations were justified for dot-coms without profits, investors sent the sector and the broader market into free-fall when it became obvious that the dot-com emperor had no clothes.
Today, we have the subprime market crisis, a result of Wall Street hot-shots bundling poor-quality mortgages into so-called mortgage securities in the hope investors would pay great attention to the high credibility of the packager and not so much to the contents of the package. Once again, the smartest people in the room came up short when the mortgage default rate rose and it became impossible to compute the fair value of the mortgage securities, leaving investors unwilling to buy at any price.
What will be the next event to trigger a big sell-off? I haven’t a clue. But I am certain it will be something, probably in about five years or so. But I don’t expect to be standing on a quiet trading floor like I was in 1987. They seem to be going the way of the dinosaur. I suspect we’ll be in front of our computer screens watching the free fall, alone. And cursing the latest generation of Wall Street hot-shots who got us into the mess.
Comments
I watched the entire NBR broadcast from 10-19-87 online. Paul didn't say his unusual sign-off message in this one. Back then, the Dow was only at 2,000. Nowadays, it's pretty close to 14,000.
Neil Cavuto is now on Fox News Channel. Notice reporters signoffs were very different back then. "In (city), this is (name) for the Nightly Business Report." I sometimes watch it on WQED in Pittsburgh at 7pm. Hopefully, this will never happen again.
I remember October 16th, 1986 best. I was a relatively new stock broker (read telephone solicitor) for Blinder, Robinson and Son (Time Magazine Cover--Blinder Robinson....Blind 'em and Rob 'em). Naive as I was, something felt all wrong that day. I had about $15,000 in an IRA which was invested in some Putnam funds. At about 1PM, the DOW was down about 120 points and may have closed at about negative 90. That was a lot for the times, but it wasn't the first time that year. There had been two other days, much earlier in the year, where the DOW dropped more than 100 points. I fretted all afternoon. God is my witness: at 3:45PM I called Putnam and had all moved into money market.
Monday morning arrived and by about 9:45AM, I was numb! I just couldn't believe it. I reinvested half on Wednesday and the other half sometime in December......and then held on for dear life for a long time.
I want you all to know that I agree with Bob Adams, the second commenter just above. You can do well in the market if you just trust yourself and pay attention. Be prudent and don't quit your day job.
PS...I was starving by 1990 when I left the business, but I've never lost my taste for it. Buy the big dips....don't be invested when the bomb goes off...... get out before the baby boomers.
i had just got done watching the black monday video when i posted....i qoute scott gurvey from the blog he said "then as now the dollar was falling"
i didnt notice that the dollar actually went up on black monday i just watched the video read scott gurveys blog then posted...i assume the dollar was falling the days before the crash and after .but rose slightly on black monday.
Thanks for the great summary of Black Monday. At that time I was investing through a full service broker, and relied completely on his advice. However I knew enough about the history of the Market to expect it to go up, long-term. I called the broker Wednesday to ask if we shouldn’t be buying. I can still hear the plaintive voice saying “You want to buy?” He quickly recovered however and agreed. (grin)
Since that time I educated myself and for the past 16 years have been investing without “professional” advice through a discount broker. By educating myself and investing long-term, I’ve beat the market average by more than one-third during that 16 year period. In fact, I’ve underperformed the market only one of those years--by three-tenths of one percent--in 2001.
I get upset when I hear “experts” saying the individual investor cannot out perform the professionals. I have news for them.
Now, like then,"the only thing we have to fear is fear it's self!" The dollar may become as weak as the Mexican peso some day, because our boarders remain flimsy; our job market may continue to be represented by false statistics that even include our military as "employed" now; the price of living does not factor in our gas prices anymore... and the gold standard... forget about it (he said he was 'not a crook' and many believed him).
But this country has alot going for it: Ingenuity,
a relatively free market system, open press and expression, and the eyes of the world looking at it (either hatefully or trying to imitate).
We set the pace, and if there is any set-back, the U.S. and "in God we trust" can always bounce back because we ARE not only innovative but also the home of the brave. President Reagan knew it then, and I believe even President Bush knows it now (though his comments are bound to be biased).
TOM F., Portland, OR
I enjoyed viewing the Black Monday 10/19/87 video and your blog. Though I was only 14 on that date, I remember scenes from that evening's newscast. You noted many of the parallels between Black Monday and today. One thing I have learned about era parallels: when too many "experts" on TV and newprint say "it's different this time," it's time to do the opposite of what they say. Scott, thank you for your reality-check blog.
Interesting segment. Being fairly young (27yrs) I like reflections on the past, because it gives a glimpse of situations I have not yet seen for myself.
Jonathan Black: If I recall from the NBR video I just saw (recorded the day of the crash in '87) they very briefly stated that the dollar actually went UP that day, though I think only slightly. This is not all that surprising since the dollar was then the "safety" currency of choice. Whether history would repeat itself in this sense (i.e. flight to dollar in times of unease) is anybody's guess.
I'd imagine we'd see a much higher run up in gold than the dollar, assuming the dollar didn't go into freefall. The day of the crash, gold was the only asset class which ended substantially higher - treasuries did ok too.
If anyone has taken the time to read the post from Scott and read these comments, I'd highly suggest you watch the vid from NBR on 1987. It can be found on this site. I've been watching NBR since I was 15, and I think it's a great show!
G'day Scotty.
I can see your comments rising to fruitition ! !
One only has to view the demographics cycle of the next wave of Wall Street hot-shots likely to take over from the baby boomers and realise that rampant inflation is on the cards with Gen Y.
The "I want it all and I want it now" mentality is unsustainable as we can see from the rapidly ageing population of every industrialised country where more resources will need to be focussed on keeping these oldes alive instead of feeding the younger upstarts in ever decreasing numbers dude ?
Our Chinese neighbours have already Feng Shu'ed an indicative date of post 2023 when I'll be 50 and which IMHO life will start to turn backwards.
Time to plan my future retirement smoking tobacco underneath the cocoa trees in tropical paradise.
Cheerio,
BongoNo1
Perth, W.A.
AUSTRALIA
So there were some paralels with today between black monday and now. Japan was the chief emerging market where as China is the chief emerging market today, the biggest things i see is that the dollar is sliding now like it was back then....but my question is how much did the dollar slide in the great correction compared to now?
another similarity that stands out is that precicius metals went up alot then and are going up now.
Disclosures i own two stocks
Infinicall Corp..........INFL....bought 5-9-06
Maverick Oil & Gas......MVOG.....bought 9-27-07