Black Monday 20 Years Later
Recently, several significant issues have been percolating beneath the surface of a buoyant stock market. Despite an otherwise sanguine investment outlook, I can’t help but continue to see parallels to the market environment of 1987: a buyout boom fueling stocks that are running up in the face of slowing profit growth, a weak dollar, bond yields backing up on inflation fears and even insider trading scandals.
The old saw on Wall Street is “When no one is worried, it’s exactly the time to worry.” But the fact of the matter is people are not overly bullish right now and the VIX index - one measure of investor worry - is in the middle of its recent range rather than at the very low level (which normally indicates too much complacency) at which it started the year. I don’t expect a 1987 style crash, but I don’t hear others drawing the obvious parallels. Pesky thing about big market moves:….No one expects them.
With the market making new highs and buyout deals happening daily, it could be a rocking summer on Wall Street and complacency might return. So I am going to take this time to inject a little worry into your mind. Why? As I have noted in a prior post, the strong New York City residential real estate market has very solid supply/demand underpinnings, but at the end of the day Wall Street employment is critical to this situation continuing. Additionally, the fact is most of the rest of the country is experiencing a residential real estate shellacking not seen in 15 years. So there is every reason to be very wary of the remaining strong markets like New York City.
So What’s to Worry About?
Weak Dollar - This is being driven by fundamental factors such as higher relative interest rates and expected rate increases in European countries (which attract bond buyers to these markets), the decision by the Chinese to “diversify” their foreign currency reserves (consisting largely of U.S. treasury securities) into higher yielding investments and efforts by petro dollar driven economies like Kuwait’s to diversify the pricing of oil into other currencies. Please note my prior post on China and concerns about that country making “trophy” investments in the U.S. One of China’s just announced diversification moves was to buy a stake in Blackstone Group, which is essentially a bet on the U.S. commercial real estate and buy out booms continuing (Yikes).
Corporate Profit Growth Slowing - dampened by a moribund housing market and consumer fatigue. The recently released revised GDP number of 0.6% for Q1 shows the economy barely growing. If things slow enough, companies could start laying people off, kicking off a nasty downward spiral.
Inflation Continues To Be A Potential Problem - soaring gasoline pricing, the weaker dollar, hard commodity price inflation (driven by Chinese demand) and soft commodity shortages driven by ethanol production from corn and lower planting of soybeans and other commodities.
Weak Bonds – reacting to the commodity inflation and weak dollar, bonds investors are getting un-nerved driving yields higher! Here is the 10YR bond yield chart over the past 3 months causing money to get more expensive to borrow.
Monday October 19, 1987, also known as “Black Monday” still lives in the minds of investors old enough to have experienced it. I for one am proud to say I am young enough to have been in my senior year in college when the crash hit.
A crash it was. It was the second largest percentage point decline in history at 22.68%. second only to the 24.39% decline in 1914 after the onset of WWI.
In 1986, the economy was in a similar position as it is today. It was having a “soft landing” whereby the Federal Reserve had ostensibly slowed the economy to a point where inflation was being kept at bay. The following summary of events leading up to the Black Monday panic borrows heavily from a 1997 piece by Motley Fool recollecting the events of 10 years prior.
# 1 - The year 1987 opened with bond yields near 10 year lows. The junk bond market was booming with good demand for these higher yielding, but lower quality (higher default risk) bonds. Demand for junk bonds was being met by an ever increasing supply as the leveraged buyout (LBO) boom roared. The acquisition of all of the outstanding stock of public companies by private investors (using large helpings of junk bond debt) was steadily removing stock from the market. Axiomatically, this reduced supply of available stock, coupled with good buying interest, resulted in higher prices for the remaining stocks available in the market.
# 2 - On January 8, 1987 the Dow Jones Industrial average broke the 2000 barrier for the first time, closing at 2002.25. Market participants were emboldened by the string of records in the market that followed and expectations built of increased public enthusiasm for stocks.
# 3 - On January 22, 1987 the Dow had its biggest single day rally in point terms and although it is not a record on a percentage basis, it is taken as another positive omen.
# 4 - In February 1987 a string of insider trading scandals surfaced including the now infamous Ivan Boesky case. (While the other parallels of 1987 and 2007 are obvious, some readers may not be aware of the multiple takeover deal related insider trading cases that have cropped up recently. As was the case with increased mortgage frauds associated with the end of the housing boom, these increases in crime tend to be related to too much of a good thing and tend to happen near the end of big trends.)
# 5 - The dollar declines steadily through the first quarter and after a huge run up the Dow Jones gets hit for a 57 point loss to close the quarter at 22781.41.
After another scandal is reported involving Treasury bond trading, bond prices tumble and yields increase to > 8% for the first time in 13 months.
# 6 - In April bond funds begin to see redemptions. As individuals pull money out of bond funds, it causes bond prices fall and yields rise. Some start to worry that the weak dollar could revive inflation.
# 7 - In late April the government passes legislation designed to reduce the trade surpluses of Asian nations. Investors begin to fear that in retaliation, the Japanese - a major funding source of the U.S. Federal Government - will stop buying our Treasuries, causing an even greater decline in prices and increase in yields (which would be required to attract investors to U.S. bonds).
During this period oil prices are rallying strongly with crude hitting a high of $22.39 per barrel in July, up from only $16.40 in March. The surge is another reason for inflation fears continuing to be stoked. By July, 30-year bond yields hit 8.79% and bond prices are beginning a dive that will carry rates to a peak of 10.5% by August 15, the highest levels since 1985.
# 8 - The stock market peaks at 2722.4 on August 25,1987. A September bond rally fizzles. Already down 5% from its peak, the Dow Jones gets hit for another 3.5% on October 6, 1987. Wall Street firms begin to lay off bond traders. An Iranian missile hits a U.S. flagged tanker in the Persian Gulf.
# 9 - October 16, 1987 the Dow Jones falls 108.35 points on record volume to 2246.74. Many economists worry that the bond market’s message is that the federal deficit and the trade deficit need to be addressed.
# 10 - October 19, 1987, the U.S. shells an Iranian oil platform in the Gulf. The Dow Jones falls 508 points, the worst 1 day decline since the start of WWI, down 22.6%. It makes the 12.8% decline of October 28, 1929 look like a minor dust up. The trading volume of 604MM shares hits twice the prior record; many people and systems are overwhelmed.
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Do you ever look at the South African Market?
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Posted by Rudi Scholtz | June 5, 2007 11:46 AM