1987 Stock Market Crash Versus Today’s Market

by The Curmudgeon


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

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.