Twenty years ago the Dow plummeted 508 points, an unbelievable 22.6%. It was the biggest one-day percentage drop in the Dow’s 111-year history causing bedlam on Wall Street and economic panic around the world. Black Monday. October 19, 1987.
“You could feel, taste and touch the emotion,” confided veteran floor broker Ted Weisberg, in an interview with the Los Angeles Times. “That day clearly was different from any other day any of us had ever experienced.”
While most market analysts consider a repeat of that monstrous one-day plunge highly unlikely, they admit a recurrence is remotely possible. Similarities between the market in 1987 and 2007 worry market watchers and futures traders. As in 1987, today the dollar is weak, oil and commodities prices are rising, the market is increasingly volatile and we’re in the fifth year of a bull market. However, analysts point out important differences that they feel would prevent a catastrophic drop in the Dow from occurring today: enormous market growth since 1987, globalization, and the increasing speed and volume of trading made possible by tremendous advances in technology over the past 20 years. Interestingly, it is our present-day reliance on technology that concerns some market experts, prompting them to see parallels between 1987 and today.
As Spanish philosopher and essayist George Santayana (1863-1952) wisely said, “Those who cannot remember the past are condemned to repeat it.” With that in mind, it behooves futures traders to understand what led to Black Monday in 1987.
In the U.S., program trading took the brunt of the blame for the 1987 crash. In program trading, computers rapidly execute stock transactions based on previously determined external inputs, such as the relative price of one security to another. On Black Monday, large institutions using a portfolio insurance strategy to minimize losses fueled market slippage. As stocks slid further, their computers kicked in, program trading stock-index futures, sending the slide into free fall. Many blamed this blind computer selling for the depth of the market fall.
In a recent interview with The Wall Street Journal online, New York University Professor of Economics Richard Sylla discussed both the macroeconomic and internal causes that led to Black Monday. (Click the link to read the full interview.) Sylla included in the macroeconomic issues international disputes regarding foreign exchange and interest rates as well as fears about inflation.
“The internal reasons included innovations with index futures and portfolio insurance,” Sylla explained. “I’ve seen accounts that maybe roughly half the trading on that day was a small number of institutions with portfolio insurance. Big guys were dumping their stock. Also, the futures market in Chicago was even lower than the stock market, and people tried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in the New York cash market. It made it hard — the portfolio insurance people were also trying to sell their stock at the same time.”
Next time: Parallels Between Black Monday and Today.
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