1987
Stock Market Crash Versus Today’s Market
by The Curmudgeon
Introduction:
In a long
forgotten (or never read) April 13, 1987 Barron's article, When
Stocks Trade Like Commodities, Anthony Delis warned of "big trouble
ahead" for the U.S. stock market based on a powerful advance in prices
that seemed to defy economic fundamentals.
Delis called
attention to the exponentially rising stock prices from 1986 through April 1987
and compared that with similar price patterns in commodities. He wrote: "It's quite clear that these
ascending curve (=exponential) patterns climb vertically, exhaust themselves,
and then drop just as quickly."
Of course, we
all know what happened in Oct 1987 as depicted by the chart below:
Is the stock
market headed for a 1987-like CRASH?
Recently, there
have been several on-line articles, blog posts, and archived interviews questioning
whether another 1987 like crash might occur soon (perhaps this October).
1. In an intriguing Zero Hedge blog post titled
1987 And
Market 'Accidents' Waiting to Happen, Tyler Durden wrote: "given
the current uncertainty of macro-economic data, high-leverage, fear of rising
interest rates, and instability of currency markets, all of the same conditions
that led to the 1987 crash are now present in financial markets. Does this mean
the markets are going to crash? Certainly not; but the conditions may be right
for another 'market accident' to happen."
The following
quotes from the Fed's research paper - "A Brief History of the 1987
Stock Market Crash With a Discussion of the Federal
Reserve Response" - were suggested as the primary causes of the 1987
stock market crash...
"During
the years prior to the crash, equity markets had been posting strong gains.
Price increases outpaced earnings growth and lifted price-earnings ratios; some
commentators warned that the market had become overvalued"
"Importantly,
financial markets had seen an increase in the use of “program trading”
strategies, where computers were set up to quickly trade particular amounts of
a large number of stocks, such as those in a particular stock index, when
certain conditions were met."
"The
macroeconomic outlook during the months leading up to the crash had become
somewhat less certain. Interest rates were rising globally."
Durden
concludes by asking the readers if the above commentary "Ring(s) any
bells?"
2. In a Yahoo Finance interview with Heritage
Capital's Paul Schatz on July 29th, Yahoo Breakout host Matt Nesto asks: Are
Stocks Heading for a 1987-Style Crash?
Schatz doesn't
think so, but believes we could experience a 10 to 20% correction very
soon. He said the drivers for the '87
crash -sharply rising (long term) interest rates, misplaced confidence in
portfolio insurance, and ill-advised remarks on the U.S. $ exchange rate by
Treasury Secretary James Baker- were not now present.
Schatz thinks a
new market top could be set in August or September, which would play into a
number of seasonal factors that have made the tenth month a tricky one, albeit
one that the Stock Trader's Almanac shows has averaged a 0.4% gains for the Dow
since 1950, which is better than five other months.
3. In a July 26th blog post on his Street
Smart Report website market timer Sy Harding
asserts that Stock
Market Bubbles Cannot Be Timed.
Harding opens
with several examples of "speculative bubbles, which burst with
devastating results for investors who believed there would be no end to their
rising prices." He continues:
"There are
several characteristics in the current market that were characteristics in
previous bubbles. In prior bubbles
prices were rising, as they seem to be now, based more on the excitement of the
price action itself (the continuing rising prices) and the surrounding hype,
with little thought given to the fundamentals. That is a worry."
"Then
there is the evidence that even as public investors are pouring money into the
market at a near record pace, institutional investors have been pulling money
out at a near record pace. That has also been evident near prior bubble
tops."
"A
convincing argument can also be made from the surge in investor confidence that
has margin debt (buying stocks with 50% discounts) at record levels last seen
at the 2000 and 2007 tops."
Harding offers
some very sound advice with this suggestion:
"By dialing back risk and preparing for the prospect of an
intermediate-term correction, one will also be on the right side of the market
if it turns out to be one of those fairly rare instances when it was not only
an overbought market, but a bubble market due for a sudden bursting of the
bubble."
Analysis and
Opinion:
While the
CURMUDGEON won't comment on whether another 1987-like crash is in the cards,
we'd like to point out some of the key differences between now and then.
·
In
percentage terms, to match the 508-point calamity that cracked the Dow (DJI) on
October 19, 1987, the blue chip benchmark would now have to shed more than
3,400 points in a single session. There
are circuit breakers in place now that would prevent that from re-occurring. However, there is the distinct possibility of
several "limit down" days, which were typical of commodity markets
(e.g. Gold and Silver) in early 1980.
·
Most
experts agree that the mistaken belief that "portfolio insurance"
would protect a stock portfolio played a huge role in the '87 crash. While that strategy is now passé, we strongly
believe that a combination of factors will cause liquidity to totally
evaporate. Those include: discounted
ETFs with APs failing to properly create/destroy ETF shares, various derivative strategies, unwinding of
leveraged stock positions (margin debt is at an all-time high), a buyers strike by HFTs and "dark
pools," etc. Few have called
attention to these dangers that will surely exacerbate any sharp stock market
downturn! We assert that trading will be
suspended when there are no bids, as market makers and HFTs won't take the buy
side in a sharply falling market.
·
With
the Funds rate at ZERO (as it has been for 4 1/2 years) and QE infinity in
place, the Fed has no real room to ease.
On Oct 19, 1987, the Fed Funds rate was 7.25% and was gradually lowered
by then new Fed Chairman Alan Greenspan to a cycle low of 6 1/2% in early
1988. Greenspan said immediately
following the '87 crash that the Fed "affirmed today its readiness to serve
as a source of liquidity to support the economic and financial
system." Current Fed head
Bernanke has been making that same statement for the past 4 1/2 years! But wait.... Maybe, he will have the Fed
buy all the Treasury securities at auction and on the open market. Wouldn't that be the ultimate test for
"Helicopter Ben" or his successor?
·
The
economic fundamentals are much different.
In the Fall of 1987, unemployment was lower,
the labor participation rate was significantly higher, wages were growing, and
U.S. manufacturing was still creating many factory jobs. Most importantly that 1987-88 economy was
very resilient. It did NOT enter
recession after the stock market crash, as many pundits predicted. [The CURMUDGEON had one of his best income producing years in 1988!]
·
Fast
forward to today and one can see the economy is considerably weaker. There's fiscal tightening through the U.S.
federal government sequester and tax increases (higher payroll tax &
increased income tax on the wealthy).
There's total gridlock/paralysis in Congress to pass any economic
stimulus legislation. Manufacturing and
much high tech engineering design and development have been outsourced and
offshored. Consumers are reluctant to
spend, as they are afraid of being laid off and becoming part of the "long
term unemployed."
·
In
short, there aren’t any "organic" drivers that could help the Main
Street economy in the event of another financial meltdown, even if Bernanke
does at some point temporarily stop a potential sharp market decline with more
QE and loans to the butcher, baker and candlestick maker. :-))
And on that
note, we ask readers to carefully consider the risk - reward tradeoff for any
new or existing investment(s), especially in light of the lurking dangers
described above.
Till next time.....................
The Curmudgeon
ajwdct@sbumail.com
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.