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Stock Market Checks 3 Out of 4 Boxes That Triggered The 1987 Crash

The stock market suffered its worst one-day loss in history on “Black Monday.” Today things look eerily like they did in October 1987.

Are we close to witnessing a dramatic stock market crash similar to what happened in 1987? 3 out of 4 boxes that explained the 1987 crash can now be checked.


  • In 2007, 20 years after the 1987 stock market crash, a Wall Street columnist for USA Today reviewed the four conditions that caused the storm.
  • The column ran within days of the Dow and NASDAQ peaks, just as the Great Recession and 2007 – 2009 bear market began.
  • Today we’re seeing three of the four stock market conditions that triggered the ’87 crash. When the fourth one happens, buckle up.

On “Black Monday” (Oct 19, 1987), stocks suddenly went into free fall.

The Dow Jones Industrial Average experienced a 22% drop, its worst intra-day loss in history. The S&P 500 lost 20% of its valuation (PDF).

On the 20th anniversary of the 1987 stock market crash, a pair of USA Today columnists asked a question that would soon get a resounding answer:


20 years later, could markets crash again?

 


The duo, a business reporter and a Wall Street and financial markets reporter, brought readers back to the fateful Monday in October 1987. And they scrutinized the four prevailing conditions that led to the stock market’s worst day in history.

Here is what happened just before the crash:

  1. The market makes huge gains beforehand
  2. Market euphoria reigns
  3. Sharp downturns precede the crash
  4. Financial innovation backfires

Check off 1, 2, and 4. Be aware of a sharp downturn..

Today’s stock market is unnervingly similar to the one that crashed in 1987.


1. Stock Market Makes Huge Gains Beforehand

In the lead up to Black Monday:


The Dow soared 44% from the start of 1987 through its Aug. 25, 1987, peak. The Standard & Poor’s 500 index had climbed 265% the five years ended August 1987, assuming reinvested dividends.


You could say the stock market made huge gains in 2019.


Dow Jones Industrial Average 1Y Chart | Source: TradingView


Recent growth hasn’t been as dramatic as the bull market before the 1987 crash. But the unprecedented duration of the expansion is cause for concern. It has been the longest bull run in history.

Over the last ten years, the S&P 500 grew 189%. Throughout 2019 and into the new decade, the major stock indexes continue racing to record highs.

2. Stock Market Euphoria Reigns

Because of the huge gains:


Market euphoria reigns. The public doesn’t usually focus on the stock market — unless it’s skyrocketing. The public’s attention was focused on Wall Street in 1987… Many argue that it is the swing from mass euphoria to despair that triggers crashes.


A decade of growth has led Wall Street to embrace a very dangerous notion: That it can’t lose. That this will last forever. That leads to greed.


Be fearful when others are greedy and greedy when others are fearful. Warren Buffet


In November, CNBC warned:

Wall Street is getting very bullish as stocks hit records. Here’s why that’s worrisome


Euphoria sweeps across Wall Street. How long will it last?


In the middle of the Dot Com crash, Warren Buffett summarized investing euphoria:


Nothing sedates rationality like large doses of effortless money. Normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party.

3. Financial Innovation Backfires

In 1987, computer-automated stop-loss orders turned a scare into a catastrophe:


Institutional investors touted “portfolio insurance” as a way to immunize themselves from huge losses… Instead, they acted as a trigger to sell when prices were in free fall, exacerbating the losses.


Today, markets could be more vulnerable to automated mayhem than ever before. 80% of the daily trading volume consists of trades executed by computers.

The incredible amount of algorithmic trading in the markets today has already precipitated more “flash crashes” since 1987.

On May 6, 2010, the Dow dropped over 9% in 36 minutes. A Chicago-area market intelligence firm said another flash crash is “absolutely certain” to happen again.


4. Sharp Downturns Precede The Crash

Here’s what makes that 9% flash crash absolutely terrifying— in 1987:


The market had been sliding since late August, but it fell a total of 10% the three days before the crash.. Says University of California at Berkeley finance professor Mark Rubinstein: When those declines happened, there were a lot of people who started to think about it over the weekend who concluded, This is not the kind of market I want to be in.


With all three other boxes checked, another event like the 2010 flash crash (or something else we aren’t expecting) could be enough to trigger a panic selloff.

A sharp downturn in the near future could cause a larger fall soon after.


 

(Sources Investopedia, Federal Reserve, CNBC, Berkshire Hathaway, ABC News, Kiplinger, The Conversation)

 


Make money in a Crash?

In the category Trading we issue a few trades every month, in line with the market. This can mean both Long and Short positions. This category is especially a very interesting one because a lot of money can be made here, both in economic prosperity and in bad economic times.

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