Lessons from Black Monday, 25 years on
It's a day that has became known as Black Monday and for good reason. A quarter century ago today - on Oct. 19, 1987 - the U.S. stock market suffered its biggest one-day drop in history.
The Dow Jones industrial average swooned 508 points, or 22.6 per cent, leaving investors stunned and shaken, while triggering a worldwide rout in equity prices.
Such a point drop might not seem so large now, with stock prices much higher, but in percentage terms it would be equivalent to a plunge of more than 3,000 points in today's Dow. U.S. stocks had also sagged 9 per cent the proceeding week, further unnerving investors who had lost nearly a third of their nest eggs in almost the blink of an eye.
At the time, the drop had an eerie resemblance to the beginning of the Great Depression. The stock market panic of October and November, 1929, was the opening act of the Dirty Thirties, and here was a one-day drop that exceeded even the worst daily decline back then.
Montreal money manager Stephen Takacsy remembers the day well. In 1987, he was working at Royal Bank of Canada and recalls the shell-shocked reaction as the stock market carnage unfolded.
"People were saying, 'Oh, our lives are forever changed,'" Mr. Takacsy says.
But markets like to confound people, and Black Monday was no exception. Stocks began recovering shortly after, and markets roared ahead for more than a decade before finally suffering another major blowout when technology shares cratered in early 2000.
Looking at a chart of market action, showing the long upward march of stock prices following the crash, Mr. Takacsy says the day's huge decline now "just looks like this tiny little blip."
There is no definitive answer as to why stocks crashed on Black Monday. Toronto stocks fell in sympathy, but only about 11 per cent, or half the decline seen on Wall Street.
In the weeks previous, the United States had been squabbling with Germany over monetary policy, setting the stage for investor nervousness. Stocks had roughly tripled from their lows earlier in the 1980s, suggesting markets were richly valued, never a good thing during monetary policy uncertainty.
Meanwhile, institutional investors had begun implementing trading strategies - common now, but novel back then - of simultaneously buying and selling baskets of stocks and hedging the transactions using stock futures and options.
Some of these strategies were known as "portfolio insurance" because they were designed to protect holdings against sharp losses, but in the avalanche of trading that day, these transactions may have inadvertently accentuated the decline.
As the day's swoon gathered momentum, margin calls on investors who had lost money led to a vicious circle of forced selling and even greater carnage. Exchanges couldn't keep up with the volume of trading, leaving investors in the dark as to their losses. As sell orders poured in, many were so-called market orders - or instructions to liquidate at any price - and stock values gapped downward.
After Black Monday, stock exchanges figured they had better find ways to curb such collapses and instituted circuit breakers, or trading pauses, when there are large declines. On the Dow, trading would now stop for up to an hour on a decline of 10 per cent.
Since 1987, investors have become more inured of crashes because they've experienced more of them. There have been two major market breaks, first the technology bubble in 2000, and then the recent 2008-09 panic that accompanied the collapse in the U.S. housing market. A flash crash also occurred in 2010, when the Dow dropped about 1,000 points in a matter of minutes, but then later in the day recovered most of the decline.
Some observers argue that panics are part of the inevitable architecture of markets. Investors consequently should be on alert for them, and the profitable trading opportunities they present.
"I think crashes will definitely happen," says Jason Donville, president of Donville Kent Asset Management Inc., although he hastened to add, "I don't think there is one imminent right now."
Mr. Donville says panics occur in investments that are experiencing bubbles, or dramatic increases in price not justified by fundamental factors. Among the present candidates for bubble status, in his view, are bonds, gold and Canadian real estate investment trusts. "If there is going to be a crash, that's likely where it is going to happen."
When the 1987 crash occurred, Mr. Donville was a naval officer in Halifax on HMCS Fraser. He was just starting his working career and didn't have money to invest, but his contrarian nature sensed that the panic had created more reasonable valuations.
"I saw that as, 'Oh great, a correction, there is a good chance for me to start investing,'" he said.
Remembering Black Monday
"I was sooo lucky. I was travelling and before I left, my broker had urged me to sell my positions as he would not be able to get in contact with me. Except for a few small holdings I missed the plunge by a day! He sure earned his commission. It was a cheap lesson [for me at least]. Thanks to him I lost only a few dollars that took only a month to recover."
-Bob, 61, Toronto