It's 1987 All Over Again
There’s been a series of unlikely events, and there is still a debate. I’m not talking about the current stock market meltdown, but the crash of 1987. That was the first stock market meltdown I lived through as an investment professional. It was a brutal day for me as a stockbroker finally living my dreams and seeing it all come crashing down. I thought that was the case that day, where I cut out of the office for a couple of hours to wait for the final tally.
I walked back into the building, and I asked a colleague, “how bad?” and when he told me, I was sure my career was over. As a young broker, I was somewhat oblivious to the accumulation of events and shifting the mentality of daily news, which culminated on Black Monday.
I believe the current market swoon most closely resembles those that surrounded Black Monday.
Like any so-called Black Swan event, that single day took time and several human errors in assumptions, judgments, and actions:
· A five-year raging bull market
· Surging interest rates and exaggerated concerns about inflation
· Oil prices surged after collapsing in 1986
· Government panic: Treasury Secretary James Baker voiced concern over a plunging stock market, which he attempted to soften, but at the same time, reminded observers that stocks were coming down “from a very high level”
· The surging Federal deficit
· The surging trade imbalance with Asian countries
· Iranian aggression and the attacks on American ships on October 15 and 16
· Panic from the London market being closed since the Great Storm on October 16
On the morning of October 19, 1987, news that U.S. warships pounded an Iranian oil platform rattled the market out the gate.
The crash wasn’t a one-day event as the Dow Jones Industrial Average peaked on August 25 at 2,722, up 44% in the trailing twelve months.
The market took hits in several sessions, prior to that fateful day that saw the index down more than 12% from the August high by the close of trading on October 15.
Dow Jones Industrial Average Dec 1985 to Dec 1987
The Aftermath, Parallels & The Blame Game
The biggest one-day decline in the history of the stock market was the so-called Black Monday of October 19, 1987, which saw the Dow -508 points or 22.61%.
Valuation: In August 1987, the S&P 500 trailing price-earnings (PE) ratio was 20.8. Coming into October, the ratio was 23, although the forward price-to-earnings (PE) ratio was based on strong earnings and guidance, it was below historical norms.
Program trading, Portfolio Insurance, & Black Box Short-Selling were creatures of big Wall Street firms, and private equity was designed to soften the blows during any market downturn. They failed miserably; instead of finding bottoms and mitigating the risk, they dug the hole deeper and deeper, and the human counterparts had to follow along. Many are blaming the current meltdown on algorithms, which swing into action with certain triggers that seem to trigger additional reactions until the entire system triggers a series of selling.
Old Wall Street pros tell me not to worry about the algorithms, or the ability to short stocks without an uptick. In the end, that stuff blows up on the folks that incorporate and abuse them, but the collateral damage is the losses in portfolios of individual investors.
In the aftermath of 1987, the 304-page Brady Report to Congress put most of the blame for Black Monday on program-trading and so-called portfolio insurance. This is an area that must be addressed once and for all if the United States wants individuals to put their faith into the stock market.
Government Panic: I think Steven Mnuchin’s stunt was just like that of Treasury Secretary Baker, adding more fear to the market than necessary. I’ve pleaded with the administration to stop “talking” so much about the market and negotiations, and simply get the job done.
The fact is that back in 1987, Democrats led by Dick Gephardt were pushing for better trade deals, and to ease massive trade imbalances. I don’t think the powers of Wall Street liked that idea then, and they obviously don’t like that idea now.
The financial media isn’t going to give the administration the benefit of doubt, or even acknowledge when it’s successful unless they up think the moniker “Trump bounce” was really the right description of the stock market in 2017.
Yesterday, President Trump talked about great American companies and buying stocks. While the media pounced, it was unlike when President Obama said buying stocks was a potentially good bet in 2009. The difference is President Obama used the stock market as a wedge issue, suggesting it was only for the rich.
That limited his ability to point to the stock as a great symbol of success under his administration, and even today, it mitigates how much Democrats talk about the market.
I don’t mind President Trump touting ownership of great American companies as long-term investments. I like the notion that all Americans can and do invest in the stock market. It has a much better ability to empower and enrich than any governmental attempt to redistribute wealth. That said, wealth always turns into crumbs by the time it’s taken from the “rich” and churned through the government.
I think the mistakes made are to try and defend policies and actions each day, and the “tariff man” tweets that empower those opposing his agenda.
Differences Between 1987 & 2018
There are things that are decidedly the opposite of 1987, including the crash of oil prices and very low interest rates.
The administration is removing Americans from the Middle East, not trading blows with dangerous actors.
Bond yields are not sky high, and crude oil is plunging, not soaring. In fact, inflation is benign, which leads us to the Federal Reserve. Just fresh on the job in 1987, Alan Greenspan took decisive actions to mitigate potential damage from Black Monday.
I believe the current market swoon is the same as 1987 in the sense that much is being driven by market psychology that is swayed by an omnipotent and overwhelmingly negative media, and Wall Street elites, who are willing to take losses to derail parts of the White House agenda. Individual investors are lulled into the idea markets go straight up, and they are supposed to never have paper losses.
It’s a perfect combination. While I’m not sure it’s equal to a Black Swan, its impact has resulted in a rolling capitulation that is beginning to mirror the short-term devastation of 1987.
Keep in mind that decline saw the Dow Jones Industrial Average -36.1%. From August 25 to October 19, all underlying economic fundamentals were very firm and sturdy. The next recession won't start for another three years.
Back then, professional investors and the market made a worst-case assumption, coupled with dangerous devices and exogenous events. The pain was immense but short-lived. The biggest question right now is whether the stock market will create a worst-case scenario that otherwise wouldn’t exist.
The answer is yes if the Federal Reserve aids and abets.
Obviously, we are in the throes of the same emotional panic, where the first spot of selling triggers massive intraday reversals and slides to the downside.
It’s easy to give up and take huge losses here, but individual investors with five, ten, twenty years time line should be careful. I’m not saying it’s not going to get worse, but I know that evening I walked back into my office on October 19, 1987, thinking it was the end, I found out not long afterward, it was really the beginning.
Continue to focus on the fundamentals of core holdings. Even names you may want to jettison from your portfolio might be oversold here. Using the Wilshire 5000, the total stock market value has been down $7.5 trillion since September - it’s complete carnage for sure and beyond excessive.
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