Beware of parallels with the 1987 crash

Whitney Houston and Madonna dominated the charts, Timothy Dalton made his debut as James Bond and Britain was run by a powerful female Tory Prime Minister who was crushing the opposition and dominated the global stage. Looking back, 1987 seems like a very different world from the one we live in today. But it had one thing in common with 2019. Equity markets got off to a roaring start.

The trouble is, the last time the markets started as strongly as this it ended up in the worst crash of modern times. Could it happen again? There are some worrying parallels.

The nervousness that gripped investors in the run-up to Christmas seems a long time ago now. From Britain’s on-off departure from the EU, to President Donald Trump’s crippling of the independence of the Federal Reserve, to Germany crashing into an industrial recession, the markets shrug it all off and keep on rising. Both the S&P 500 and the Dow Jones are just a whisker away from the all-time highs reached in September. According to a report this week from Bespoke Research, 2019 has seen one of the strongest starts to a calendar year ever. Since January, the S&P 500 is up by 15.1pc. Overall, it is the fifth best start to a trading year, and, significantly, the best since 1987, when the market rose by 22pc in the first 67 trading days.

The warning signal comes from October 1987, when the markets were crushed by Black Monday, with the

largest ever one day percentage fall in the Dow, and loses on some bourses as high as 60pc in that month alone. Could that repeat itself? In truth, there are three parallels with that year.

First, China looks wobbly. The Black Monday crash started in Hong Kong, and accelerated by the time trading opened in London. For Hong Kong then, look at the Shanghai index now.

It has been on a roll again, hitting a six month high, as China opens itself up to foreign investment and money floods into the country. And yet, the Chinese economy remains as precarious as ever, with growth still rapid by Western standards, but with massive debts, and the threat of punitive tariffs looming. A sudden crash in Shanghai would send shock waves through the global markets, with consequences just as unpredictable as the Hong Kong collapse that triggered the 1987 sell-off.

Next, the Fed had been trying to engineer a soft landing for the US economy. A rapid recovery fuelled by President Reagan’s tax cuts and deregulation had led to a series of interest rate rises as the central bank tried to stabilise an economy that looked to be overheating. That backfired spectacularly.

Now, as then, a Republican President has been dramatically cutting taxes, and the Fed had been searching for a way of cooling it down without damaging growth too much. It could back backfire just as badly. In the wake of the 1987 crash, the then relatively new Fed chairman Alan Greenspan cut interest rates to support the economy, and initiated an era of central bankers responding to market collapses with easier monetary policy. It would certainly be no great surprise to see that happen again.

Finally, equities were wildly overbought. In the 12 months running up to Black Monday, the S&P 500 rose by a massive 44pc as investors crowded into the market. Shares were expensive. True, we haven’t quite seen anything as exuberant as that this year. But by any historical measure, the US market is expensive, and the massive tech stocks that have driven the market are back on stratospheric ratings. Not every market is overvalued – the UK is still very cheap, for example – but the tech heavy American indices are trading at extraordinary levels, and if some of the hubris around technology is punctured they could fall spectacularly.

Investors will be hoping this turns into another 1991 or 1998, where a strong start to the year led to decent gains overall (the market ended up by 26pc in both those years). The trouble is, it could turn into another 1987. Of course, that wouldn’t be completely terrible. Equities actually ended up by 2pc overall, and it was a great buying opportunity for anyone brave enough to buy right after the crash. But there was a very scary bump along the way.

‘Black Monday saw the largest ever one day percentage fall in the Dow’