30 Years On From Black Monday

19/10/2017

There has been much talk in the media about ‘The Great Storm of 1987′, 30 years ago – but this week also coincided with the biggest one day fall in stockmarket history. Schroders’ fund management team have looked at what happened and how today’s markets compare to 1987.

It was the biggest crash in living memory. In the US, the Dow Jones fell 22.6%, destroying the previous record one-day fall of 12.8% set during the Wall Street Crash of 28 October 1929.

Yet few could put their finger on the exact reasons why. In the years since, investors have blamed worries surrounding a turn in the fortunes of the global economy and rising inflation. Others have pointed to rumours of an interest rise in the US.

There has been much conjecture. What can’t be argued with is the fact that there was a collective panic across markets.

Losses were exacerbated by new computerised trading floors that were ill equipped, at the time, to prevent the collapse from spreading.

It came after a period of sustained gains. Most stockmarkets in developed countries had been growing at more than 30% a year in the five years up to Black Monday – gains that have not been repeated since. It took valuations to record highs.

As stockmarkets plunged and investors panicked, central bankers took action: interest rates were cut and the Federal Reserve “encouraged” banks to continue lending to ensure the flow of money wouldn’t dry up.

Those policies worked. In the five years following the crash, stockmarkets made a strong recovery.

 How stockmarket valuations compare: 1987 and 2017

While high stock valuations can contribute to a fall they are not necessarily the catalyst. As the table above illustrates, valuations in the US, UK and Europe are higher now than they were in 1987, yet stockmarkets continue to hit record highs.

Matthew Dobbs, an equities fund manager with Schroders said: “Stockmarkets continue to reach new highs and equity valuations are similar now to what they were in 1987. But there is big difference today: the risk-free rate is very different.

“What I mean is that the yields on bonds and interest rates in banks, where there are fewer risks to losing your investment, are now very low compared to the dividend yield on the stockmarket, which is about 4%.

“So, where would you put your money? If you don’t have it in stockmarkets then you’re not paid much for having it in the bank and not paid much for having it in the bond market.

Andrew Rose of Schroders, recalls the surreal atmosphere in London that surrounded Black Monday.

“It was an exceptional time for the stockmarket. We had not seen anything like the performance in stock prices before and we have not seen anything like it since.

With markets closed it meant that investors had to carry their positions throughout the weekend because they couldn’t close them on the Friday.

But traders had bought portfolio insurance – a mechanism that automatically sold investments into a market when the price hit a certain level. Investors thought losses would be limited. But everyone was a seller and no one was a buyer when markets went into freefall on Monday morning. The automated mechanism of selling at a certain price failed. In fact, it exacerbated the issue.

Ironically, if they had not taken out this sort of insurance, then markets might never have fallen as much as they did.

 At the time, you felt it was the end of the world. But looking back, it was just a blip. The UK and the US stockmarkets rebounded strongly in the late 1980s and throughout the 1990s.

Could it happen again? Procedures are now in place to prevent stockmarkets falling so far, so fast. There will always be market peaks and troughs. But over the long term, stocks have delivered superior returns.”

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Written by Colin Caulfield | Director

Colin is a Chartered Financial Planner & Pension Adviser Of the Year Read more >>

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