It’s the 35th anniversary of the 1987 stock-market crash: What investors can learn from ‘Black Monday’

Investors motion sick from October’s wild swings in stock markets probably don’t want to hear about it, but Wednesday marks the 35th anniversary of the ugliest day in stock market history.

On October 19, 1987, the Dow Jones Industrial Average DJIA,
-0.21%
plunged 508 points, a drop of nearly 23%, in a day-long selling spree that rebounded around the world and tested the limits of the financial system. The S&P 500 SPX,
-0.57%
decreased by more than 20%. At current levels, a similar percentage drop would result in a daily loss of over 7,000 points for the Dow.

Read: Wall Street pros recall the “sheer panic” of the October 1987 stock market crash

Could it happen again? There are some important differences between the market environments of 1987 and 2022.

Market-wide circuit breakers set up after the crash force 15-minute trading halts after 7% and 13% declines, then close the market for the day after a 20% decline.

“Is it possible to be 20% down in one day? Sure, but not before we do a couple of pre-assessments,” Liz Young, head of investment strategy at SoFi, told MarketWatch in a phone interview.

These circuit breakers were last tripped in March 2020 when stocks plummeted early in the COVID-19 pandemic.

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See: Here’s a key factor that compounded the 1987 stock market crash

“The other big difference is that we’re already down 20% this year,” Young said. While there may be more downsides, it’s hard to see what could trigger a comparable one-day downtrend.

Black Monday didn’t come out of the blue. The S&P 500 fell 3% on Oct. 14, 2.3% on Oct. 15, and 5.2% on Oct. 16, the Wednesday-Friday stretch before the fateful day, recalled Nicholas Colas, co-founder from DataTrek Research, in a note earlier this week.

But the S&P 500 was up 32.9% from January to September 1987, while stocks have been down this year since the large-cap benchmark posted record earnings on Jan. 3.

It’s also a reminder that stock market declines don’t have to happen all at once. 2008 was a “prolonged dip with bouts of bottom selling,” noted Ross Mayfield, Baird’s investment strategy analyst, in a phone interview.

And while the risk-reward dynamic looks more attractive for long-term investors, the market can still go down from here, he said.

The Dow and S&P 500 ended Friday at their lowest levels since 2020. They have rallied for the first two trading sessions this week, taking the S&P 500 up 22% year-to-date through Tuesday’s close, the Dow down 16% and the 20 Tech-heavy Nasdaq Composite COMP,
-0.65%
More than 30% discount. All three major indices are stuck in bear markets.

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Stock indices were mostly lower in choppy trading on Wednesday afternoon.

The Federal Reserve’s aggressive monetary tightening in an effort to stem persistently hot inflation has sparked a sharp rise in Treasury yields and unsettled equities as investors fear the effort will push the economy into recession.

Read: Why Stock Market Investors Should Wait for 10-Year Treasury Bonds to ‘Blink’

However, this October was certainly volatile. The S&P 500 ended the month up or down more than 1% on 8 of the 12 trading days. The Cboe volatility index VIX,
+1.31%,
an options-based measure of expected volatility over the next 30 days, remains elevated above 30, suggesting investors expect choppy trading to remain.

The 1987 crash remains a “relevant case study of extreme volatility,” Colas wrote.

The S&P 500 rallied 5.3% and 9.1% over the next two days after the Oct. 19 crash, but tumbled 8.3% the following Monday, leaving it essentially flat from its Black Monday near its Closing a week later, he observed. The S&P 500 didn’t bottom until December 4 and then rose 10.3% by the end of the year.

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That shows that buying at the bottom of an outsize “dip” can yield good short-term trading returns, but the market may need to retest the lows before making any sustained move higher, Colas said.

It’s also worth noting that the 1987 crash is often described as the origin of the so-called Fed “put,” he said. This is the idea that the Fed will respond to falling asset prices with extraordinary measures.

Amid rising inflation, the Fed is widely seen as unable or unwilling to bail out the market, with some arguing that the central bank may actually be hailing market-based pain to tighten financial conditions and bring inflation under control. The analyst noted that annual inflation, as measured by the consumer price index, was 4.4% in October 1987, about half of its 8.2% level in September 2022.

“To be clear, we don’t think another 1987-style crash is imminent, but the current economic environment certainly leaves the Fed with fewer options and less desire to support stock prices than it did 35 years ago,” Colas said.

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