The Culprits of the 1987 Market Crash Remain a Mystery. What Lessons Can We Draw From It Now?
Black Monday didn’t come out of the blue. The red flags were there.
The crash of Oct. 19, 1987, was preceded by a bull market in stocks that began in August 1982 and drove the Dow industrials to 2722.42 from 776.91. The index’s price/earnings ratio hit a 25-year high, while interest rates reached their steepest levels in a decade.
The Dow had been trading sideways for six weeks when, on Wednesday, Oct. 14, it dropped 95.46 points, or 3.81%. It lost another 57.61 points the next day. Friday delivered the bull’s biggest reversal yet, a 108.36-point dive.
The question, according to Alan Abelson in Barron’s Up & Down Wall Street column that Monday, was whether the “blood in the Street” signaled a correction or a bear market. “In a correction, other people’s stocks go down,” he wrote. “In a bear market, your stocks go down.”
It was a bear market, and everybody’s stocks went down. The Dow on Monday dropped 507.99 points, a record single-day 22.61% decline, almost 10 percentage points worse than anything 1929 or Covid could deliver. The contagion crossed the globe; it’s known as Black Tuesday in Australia and New Zealand.
This crash seemed to come out of the blue, like most crashes, only because they are so rare and destructive. All things must end, yet when the end comes it’s usually a surprise. That’s worth remembering as today’s market leaves the pandemic trough behind and powers to new highs once more.
As for Black Monday’s warning signs, Merrill Lynch’s Bob Farrell got the timing right, if not the intensity, telling Abelson on Aug. 31 that he saw the bull continuing into October, setting “the stage for a true correction” of “15% or so.”
Shearson’s Elaine Garzarelli turned bearish in August, “in time to get her own mutual fund out ahead of the crash,” Floyd Norris noted. But there wasn’t a rush to the doors behind her. Most investors were blindsided. What happened?
“What set off the selling at the opening Monday is not completely clear,” Norris wrote on Oct. 26, echoing market watchers past and present.
One culprit Norris and others cite is portfolio insurance, a relatively new type of automated trading that bought index futures when stocks were going up and sold futures when stocks were going down. But while it certainly contributed to the declines, “that alone could not be the whole story,” Norris argued.
Shearson’s Garzarelli, months earlier, warned of other potential roadblocks for the bull. “Only when they see dramatic interest-rate rises, or the Federal Reserve tightens its credit policy, will investors lose confidence,” she told The Wall Street Journal on April 6. The Fed did tighten in 1987, amid hotter inflation. And the 30-year Treasury bond yield, at 8.5% in July, “slashed through the 10% barrier for the first time in almost 10 years” on Wednesday, according to Randall W. Forsyth on Oct. 19.
The “increase in interest rates can’t explain the upheavals” alone, Forsyth wrote, citing two other potential triggers for the previous week’s selloff: a disappointing trade-deficit report and what one economist called “a rather horrible tax proposal” in the House.
Looking back 10 years later, Forsyth wrote that the “root cause of the October 1987 crash remains monetary,” citing international efforts to control foreign-exchange rates.
Whatever sparked Monday’s selling, the result “was panic,” Norris wrote. A quick 200-point drop was followed by a 100-point gain, as some “nibbled at bargains,” but then came “free fall,” eclipsing even the then-record drop of Oct. 28, 1929, the original Black Monday.
And then it was over. No depression, not even recession, would follow. To be sure, fortunes were lost and companies ruined. But the bear market lasted just over three months and, in two years, the Dow recovered everything and was soaring again.
Fed Chair Alan Greenspan is credited with calming markets Tuesday by affirming the central bank’s “readiness to serve as a source of liquidity to support the economic and financial system.” Dubbed the “Greenspan put” or “Fed put,” that pledge continues to backstop the market.
Still, like the potential causes of the crash, this explanation for its recovery seems inadequate, and we are left with one of market history’s great mysteries.
The very inexplicability of Black Monday is, of course, the frightening part. Given the right conditions, a market—like a forest—needs just a tiny spark to go up in flames.