Black Monday 1987 – Could it happen again?

USA30, Daily

On the third Monday of October 1987, Black Monday, as it became known in the financial markets, happened. October 19 1987 saw the largest single-day fall in global stock markets, and the Dow Jones Industrial Average (USA30) also fell a record 23% in a single trading day. In Europe the UK FTSE100 (UK100) fell on the Monday too but worse was yet to come as the weeks wore on.

So what happened in 1987?

Throughout the year, share prices and the level of market activity took off. In January 1987 the FTSE 100 was at 1,680. Sharp rises in January and February took it to 1,980 (a rise of 18% in a few weeks). After a pause for breath in March the Index rose another 11% in April and May, nearly 3% in June and no less than 7.5% in the first two weeks of July, to peak at 2,443 at the close of business on July 16. In a little over 6 months the Index had risen by over 45%.

From then on it moved downwards during August, touching 2,185 – a fall of some 9% from its peak a month earlier. September and the first 11 trading days of October saw it recover to 2,302 by the close of business on Thursday October 15.

The night of October 15/16 1987 was also the night of the Great Storm for the South and South East of England. It all but closed the London markets on the Friday, the day the bubble burst on Wall Street. Feverish press speculation over the weekend caused prices to be marked sharply lower at Monday’s opening in both Tokyo and London. The FTSE fell to a low below 2,000 by mid-afternoon before recovering to close at 2,052, a fall of 250 points or 11% from Thursday night’s close.

There was worse to come. On Tuesday October 20, following the record-breaking 23% fall on the DOW the day before, the FTSE opened at 1,866. It fell to a low of 1,748 before staging a final hour recovery to close at 1,802. Wednesday saw a recovery of 140 points, but the fall began again, although less severe than on the Monday and Tuesday. Punctuated by the occasional rally, the market drifted lower and on November 9 closed at 1,565, a fall of 737 points or 32% from the close of business on October 15, just 15 business days earlier.

At that point the Index was 7% below its level at the beginning of the year, but it took over two years for the FTSE100 to breach its eve-of-crash level of 2,303.

In price terms the crash of 1987 was a rather nasty short term readjustment to a long term uptrend which had begun in the early 1980s. The froth or candy floss of the first nine months of the year was wiped out but it did not eliminate the serious long term investors who held their nerve. Psychologically however, especially in the UK, it had a major effect on the millions of small private investors who bought shares in the privatizations of the early and mid-1980s. In the ten years that followed only 250,000 of those small shareholders bought shares again.

So 31 years later could it happen again? YES is the clear answer, according to researchers from the Universities of New York and Boston.

A single-session drop as big as the one in 1987, for example, is predicted — over long periods of time — to occur once every 104 years, on average. So it’s possible we’ll get two 20% crashes in our lifetimes — or none.

Haven’t securities regulators figured out how to prevent crashes as big as 1987’s? After all, they’ve had decades to study why it occurred, as well as similar events like the infamous “Flash Crash” of 2010. Haven’t they instituted any number of structural changes designed to prevent future crashes?

The researchers believe such structural changes cannot prevent another crash. Every market, to a more or less similar degree, is dominated by its largest investors, and when something spooks those large investors into simultaneously selling, they will inevitably find ways of doing so, regardless of the regulators’ reforms.

The investment implication is clear: We should construct our portfolios so that declines like 1987’s won’t be fatal. If big drops are intolerable, then that probably means you are too exposed to the stock market in the first place. October is traditionally a highly volatile month on global stock markets and as indices turn away from all-time highs for now, the old adage remains as valid as ever “Trade what you see, not what you think”.

Today is the third Monday of October 2018 and last week the USA30 lost 4.2% and the UK100 lost 4.41%.