Happy 20th Anniversary

October 19, 2007

Happy 20th Anniversary to the stock market crash of 1987! It was on this day that the Dow Jones Industrial Average lost 22.6% and I learned lots of the great lessons that I carry with me to this day, including a true understanding and respect for risk and reward. I also learned that just because something has never happened, it does not mean that it can’t. Additionally, I don’t assume that just because something has happened, that it either will or will not recur.

On this day, many are commenting that they don’t believe that there could be another crash of the magnitude of 1987’s drubbing. While I do not foresee another 1987-like crash imminently, I would never be so bold to say that it could never happen again. In fact, there are some eerie similarities between 1987 and 2007. 1987 was the fifth year of a 5-year bull market, as well as the penultimate year of a two-term Republican President. Leading up to the day, there was pressure on the US dollar; the US was running deficits; oil was rising; stocks reached an all-time high in the summer; then sold off and recovered into October. Does any of this sound familiar?

Before you sell the farm, here are the differences: in 1987, the price to earnings ratio of stocks was higher than it is today; Fed policy makers were tightening interest rates in 1987, while today they have started to ease them; and most importantly, bonds were yielding over 10% in 1987 and today they are below 5%. In fact, in 1987, bond yields went from 7.28% to 10.22% in nine months, driven by fears of inflation, whereas today, bond yields have dropped from a high of 5.25% earlier in the year to nearly 4.5% yesterday. Crashes seem most likely after bond yields explode and confidence begins to waver, which probably puts the current chance of a crash at fairly low levels.

In returning to that period of time, it is also important to note that the stock market regained its footing after October 19th. The crash marked the low point for stocks in 1987 and by year-end, the Dow actually showed a gain for the year! Within nine months, stocks recovered all of the losses incurred on October 19th and the US economy never went into a recession as a result of the crash. This is not to say that it was an easy time. Many recall the 1987 crash as short and violent, but it is clear that the months leading up to the event itself could inform those who were paying attention and willing to see a different outcome. I never forgot what another trader said to me in November, 1987: “You do realize that we had all of the information that we needed to make the killer trade of a lifetime.”

I never made the trade of a lifetime, but I was able to use the buoyant commodities market to my advantage, ultimately leaving the firm and trading for myself, until I figured out that it was not the right career for me. My father and his partners sold their business in 1988 and he left the trading floor for good. He formed a new company with one of his former partners, trading from an office with a bunch of his old cronies, but always missed the action of the floor and retired from professional trading five years later. In the end, I would never trade the experience of participating in one of the most important events in the financial markets, so indeed the 20th anniversary is a happy one!