WHY BLACK MONDAY STILL MATTERS, 30 YEARS ON
1987 stock market crash offers lessons for investors today, Jonathan Ratner writes.
The 1987 stock market crash marks its 30th anniversary on Thursday, as U.S. equity markets continue to hit new all-time highs nearly every day.
Financial markets have remained resilient in the face of concerns related to historically high valuations, uncertainty in Washington, D.C., and geopolitical instability, yet many investors seem obsessed with the prospect of a stock market correction.
While the crash of 1987 was more about trading and portfolio insurance than economics or fundamentals, less attention is being paid these days to the events that may have prompted the more than 22-per-cent oneday sell-off in the Dow Jones Industrial Average, along with massive declines across the globe, on Black Monday.
Martin Roberge, portfolio strategist at Canaccord Genuity, explains that the 508-point rout had a lot to do with the consequences of the “monetary overkill” that led to a sharp decline in the U.S. dollar in the wake of the Plaza Accord in 1985. That intervention in global currency markets by several leading nations forced the U.S. Federal Reserve to act, and the Fed funds rate climbed 130 basis points between March and September 1987.
By September, market volatility started to creep up, and when the October crash arrived, Roberge noted that program trading and market overvaluation compounded the problem.
“Why remember 1987?” the strategist asked. “Because like back then, many market participants nowadays rely on computers to run quantitative and rules-based systems to manage money and mitigate risks.”
Roberge also pointed out that if the consensus of market strategists is right, equities will be overvalued far ahead of the next recession.
He’s not suggesting that computers will necessarily trigger the next crash or bear market without an impending recession lurking. But the strategist does believe investors should keep an eye on U.S. dollar-induced inflation, particularly if the U.S. Dollar Index (DXY) falls below 91. It’s currently hovering around 93.5, and hasn’t broken below the 91 mark since Jan. 1, 2015.
When it comes to monetary policy, it’s fair to say that the Fed’s tightening cycle is going rather smoothly, and markets are betting on the central bank’s fifth rate hike announcement on Dec. 13.
Disinflationary pressures have prompted the Fed to continually lower its expectations for the longer-term Fed funds rate, but Pavilion Global Markets believes U.S. inflation has begun a cyclical recovery that will push market pricing closer to a Fed funds rate of 2.5 per cent during the next two years.
“Fears over disinflation have led some FOMC members to take a more dovish view on the outlook for subsequent monetary policy normalization,” Pavilion said. “We believe a cyclical bottom has developed and the upcoming turn in inflation will bring on a more hawkish Fed than the fixed income markets are anticipating.”
Michael Hewson, chief market analyst at CMC Markets U.K., noted that during substantial corrections of the past, the rotation of capital always had an alternative destination — government bonds.
“These are nowhere near as attractive now,” Hewson said, adding that interest rates and bond yields were much higher in 2007, 1997 and 1987. “… Today they are anchored to the floor, which limits investor options in terms of returns.”
So while some investors are undoubtedly complacent, previous instances of stretched valuations have historically been frequently accompanied by a feeling of euphoria.
That sentiment, Hewson noted, is largely absent at this point in time.