Hard lessons from a market meltdown
The crash of 1987 was my first experience with a violent correction in financial markets, and it taught me a few valuable lessons.
Share prices had been on a tear during the first half of the year. Year-over-year through August, the Dow Jones was up 44 per cent. The TSE, as it was called then, was up 34 per cent year-to-date. Good times were rolling.
In October, things fell apart. The psychology turned on hints that interest rates might rise and a sense that prices had galloped ahead too far, too fast. Markets trembled on Friday, Oct. 16. Monday, Oct. 19, saw a record 23-per-cent drop for the Dow Jones Industrial Average, and an 11-per-cent drop for the Toronto Stock Exchange.
The scale of the collapse was well beyond anyone’s ability to measure; the damage was the worst since 1929. Early forms of computer trading, which sold blocks of shares as prices fell, helped pile on the downward pressure.
That Monday, with panic everywhere, my editor sent me to interview Jim Pattison, the Vancouver tycoon who was visiting Toronto. The assignment was to ask him what he thought of the mayhem and what might happen next.
Our conversation was interrupted several times as he took calls from his stock broker. Each call ended with him buying shares, mostly in blue-chip U.S. companies. What brass. In the face of a cataclysmic collapse, he was diving in.
Pattison said opportunities like this didn’t come along very often — great companies with great businesses at a knock-down price. “If you’ve got cash, it’s a good time to buy,” he said.
It turned out he was right. Markets quickly recovered, confounding the pessimists. The Dow ended 1987 with a small gain, as did the TSX, which was up 3 per cent on the year. It turned out well for Pattison, too. He’s now the fourth-richest Canadi- an, worth $8 billion, according to the latest Canadian Business rankings.
It took a while for the lessons to sink in, but here’s how I look back on that experience:
Nobody can predict the future, though many claim they can. How long or lasting this year’s setback is will only in hindsight. In 1987 and in 2001, the corrections were short and sharp.
In 2008-09, it lingered. But when prices took off in mid-2009, it was a four-year spree. One reason was record low interest rates; the other was an expectation of a global recovery that would fuel profits.
But the recovery has been weak and share prices have run ahead of the profits behind them.
Nobel Prize-winning economist Robert Shiller warned as much last summer. He said the rise in share prices has not been supported by growth, with the average price-toearnings ratio of U.S. shares 30 to 50 per cent above historic averages at the time.
An extra issue for Canada is the rapid fall in commodity prices. Our resources are not all we have going for us, but the global war for oil dominance has caught us smack in the middle. The slowing demand for metals and minerals has hurt even more.
Pattison was buying the cream of the crop, knowing that shares in those companies might fall some more, but would fall the least and recover first. It’s what Jack Vogel, who founded the Vanguard fund family, calls “Buy right and hold tight.” Companies that are dominant with a history of profitability are good bets in good times and bad.
Sentiment can turn quickly. Irrational exuberance can give way to irrational pessimism, as David Rosenberg, chief economist at wealth management firm Gluskin Sheff and Associates, put it last week. Both lead to excesses in different directions. On Monday, the TSX was down again, as was the price of oil and the loonie. It may go on for a while yet. There’s no question it hurts, but where we are in the first week of January isn’t necessarily where we’ll be at the end of the year. Adam Mayers writes about investing and personal finance on Tuesdays and Thursdays. Have a question? Reach him at amayers@thestar.ca.