The lessons of Black Monday
Thirty years ago this week, the U.S. stock market suffered its single most disastrous day, said William Watts in MarketWatch.com. On Oct. 19, 1987, the Dow Jones industrial average plunged 508 points, or 22.6 percent, spurring “a chaotic, daylong selling frenzy that ricocheted around the world.” In today’s terms, “a percentage fall of that magnitude would knock more than 5,200 points off the Dow.” The Black Monday crash had many causes, but at its heart were overvalued stocks and the market’s growing complexity. Computerized trading was still in its infancy but growing quickly, and financial derivatives had only recently come into widespread use, rendering the market significantly more complex—and vulnerable. “It was the first significant instance of computer-driven trading run amok,” said Richard Dewey in Bloomberg .com. One popular financial product, called portfolio insurance, was designed to protect investors by automatically selling index futures when markets fell. But those sales triggered a vicious selloff cycle that lasted throughout the day. Investors and regulators all “learned the hard way that markets, left to their own devices, can and will break down into panic and chaos.”
Could it happen again? asked Nicole Bullock in the Financial Times. “The comparisons with today’s market are more than just a curiosity.” In October 1987, the stock market had been enjoying a remarkable five-year bull run; we’re now 8 ½ years into a market rally, with the Dow briefly topping a record 23,000 this week. The “biggest red flag” is that U.S. stocks today look even more overvalued than they did back then, with price-to-earnings ratios “at levels topped only by the peaks before the dotcom bubble burst in 2000 and the Great Crash in 1929.” And while controls like circuit breakers are now in place to halt trading in times of sharp decline, some analysts have warned that hedging strategies meant to limit risk could in fact “mimic the feedback loop that portfolio insurance caused” three decades ago. The fact that the 2008 financial crisis happened suggests we didn’t learn Black Monday’s lessons, said Diana Henriques in The Atlantic. The 1987 crash “allowed Wall Street and Washington to look into the future,” showing how a modern global market could cause panic on a scale never before seen. “And yet Black Monday didn’t lead to any meaningful reforms.” Thirty years later, regulators still “operate as separate fiefdoms,” with no agency empowered to act “whenever and wherever a systemic risk emerges.”
What makes 2017 feel different and unique is that “everything is crazy and the markets aren’t freaking out,” said Dani Burger in Bloomberg Businessweek. From hurricanes to the threat of nuclear war, “it seems nothing can unnerve investors bent on pushing the U.S. stock market higher.” The Dow is up 25 percent since President Trump was elected, and the S&P 500 “has hit records on nearly four dozen different occasions.” The fear of missing out on major gains is apparently enough to overcome any anxiety about the next crash. But with shares and bonds at record highs, “we must at least be due another correction,” said Simon English in the Evening Standard (U.K.). “History suggests that at some point, something will give.”