20 Minus 2

October 17, 2007

It is almost twenty years since the largest one-day stock market plunge in history. In honor of the momentous anniversary of October 19, 1987, I am devoting this entire week of articles to what led up to the crash of 1987, my personal memory of the week and day itself and what lessons we might be able to draw twenty years later as the Dow Jones Industrial Average and the S&P 500 Index are making new highs.

Yesterday we left off in the month of October—at the ripe old age of 21, I had been trading gold options for a whopping three weeks. The first full week of October saw a bond rally fizzle, after which stock investors got spooked. On October 6, the Dow dropped 3.47% to 2548.63 on then-huge volume of 175.6 million shares. Waves of computerized selling made it difficult for the market to maintain equilibrium. Two days later long bond yields stood at 9.91%.

I received a flurry of calls as the trading week starting on October 12th began. Rumors swirled about massive Wall Street layoffs. We all assumed that the easiest people to let go were the newest – we were right. Some of my friends lost their months-old jobs as Salomon Brothers and Kidder Peabody, two of the more aggressive on-campus hiring outfits, were among the first investment banks to announce layoffs, primarily in their bond trading operations. With no available jobs on Wall Street, many started to send away for graduate school applications.

By mid-week, stocks continued to fall. On Wednesday, October 14, the Dow dropped a record 95.46 points to 2412.70, followed by another 58 point loss the next day, taking the index down more than 12% from its all-time high hit on August 25. The financial press blamed the weakening dollar, rising bond prices (both symptoms of the Federal deficit and the balance of trade) and computerized trading as the culprits for the losses. The first two were familiar to investors, but the advent of “portfolio insurance” was a mystifying development for most retail investors. The idea behind portfolio insurance was that institutional investors would sell stock-index futures via computer-driven programs during market declines to limit their losses. Unbeknown to the so-called “Masters of the Universe”, the strategy turned out to be one of the main causes of the unprecedented drop that would soon occur.

On Friday, October 16th, Iranian missiles hit a U.S.-flagged tanker off of the coast of Kuwait. Fears of heightened tensions as a result of the inevitable U.S. retaliation drove the Dow down 108.35 points to close at 2246.74 on record volume. By the close of the week, the yield on the 30-year bond was 10.12%, a level at which many investors were obviously tempted to abandon stocks altogether for a risk-free return. With stocks down over 10% on the week, portfolio-insurance triggers were about to be tripped. Only on Monday would we find out how damaging the “benign” portfolio insurance strategy would be. Over the weekend, my father’s partner called me to confirm the phone number at his hotel in Florence, Italy. I ask how things are going and he responds, “It’s not too good Jillie, but we’ll get through it.”