Could market crash like ’87?
Most pros don’t see stocks as nearly as vulnerable as before
On the 30th anniversary of the biggest one-day stock market drop in Wall Street history, the Dow is trading at an alltime high and enjoying a bull run that began nearly nine years ago.
But memories of that dark day — Oct. 19, 1987 — when the blue-chip stock index was undone by panic and a deluge of sell orders that caused it to crater a record 22.6%, is a reminder that no market is crash-proof.
What would it take to spark a replay of the 1987 stock market crash, better known as “Black Monday”?
You can’t blame investors who fear another out-of-the blue shock — or Black Monday 2.0 — for wondering.
The historic meltdown followed a period of big gains for stocks. The selling intensity was worsened by instructions coming from a risk management trading strategy that was supposed to protect investors from falling prices but ended up causing the selling to feed on itself.
The general thinking on Wall Street is the next big meltdown likely will be caused by some sort of cataclysmic computer-driven event in a market dominated by machines.
And that fear will cast worry in traders’ minds as a similar decline to 1987 for today’s Dow would equate to a drop of more than 5,200 points from Wednesday’s close of 23,158.
Possible crash scenarios include a computer trading algorithm gone wild, a cyberattack against a stock exchange, bank or market pricing system or a trading systems malfunction that undermines investor confidence in the financial system.
“We have an electronic market today, and things can get out of control very quickly,” warns Joe Saluzzi, co-founder and cohead of equity trading at Themis Trading and co-author of Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence.
That said, while Wall Street is aware of tech-driven vulnerabilities in today’s market, most pros don’t see stocks as nearly as vulnerable from a business and economic standpoint as they were in the days leading up to the 1987 crash.
For one, this year’s gains of
14% are not nearly as turbocharged as the nearly 40% run-up back then. And the interest rate picture is far more favorable for stocks today, with the 10-year Treasury note yielding 2.34%, way lower than 30 years ago when yields jumped from 7% at the start of the year to around
10% by October.
And while today’s market price-to-earnings ratio — a key metric used to measure the frothiness of the market — is higher than historical norms at 18 times earnings, it’s not as richly priced as it appears given how low rates are.
“We believe that the stock market stands on a much stronger foundation than it did in October 1987, making another crash like 1987 appear unlikely,” LPL Financial and one of its strategists, Ryan Detrick, concluded in a recent report.
Still, while rare, stock market crashes, or steep price declines that seemingly come out of nowhere, can’t be ignored. Big drops do still happen.
“We believe that the stock market stands on a much stronger foundation, making another crash like 1987 appear unlikely.” Ryan Detrick, strategist for LPL Financial
“There was a palpable sense of market history,” Ed Yardeni said of the 1987 crash.
ED YARDENI, PRESIDENT AND CHIEF INVESTMENT STRATEGIST AT YARDENI RESEARCH:
Eight years into his Wall Street career and working as an economist for brokerage firm E.F. Hutton, Yardeni recalls a day in which he and the firm’s traders sensed “something horrible was happening.”
“Everyone was frantic, if not hysterical. I spent all day on the Hoot & Holler system, an old-fashioned communications system used to broadcast market updates to the firm’s thousands of brokers. I had been very bullish ... since the market bottom in 1982, so it was like a kick in the gut for my forecast.
“Everyone was alarmed. No one quite understood how the market could plunge so much in one day. Everybody was sort of in a frozen state of disbelief.
“I would run downstairs to the trading desk to try to get feedback. Everyone was scared. Usually when I got down to the desk the noise of the activity of buying and selling stocks was pretty loud. But on Black Monday there was an eerie quiet. Traders were just staring down at their quote screens, probably wondering if this was the end of their career.
“There was a palpable sense of market history. At the end of the day a lot of Wall Streeters went to Harry’s Bar to commiserate. I just went home.”