New York Daily News Cover: October 20, 1987

A Stroll Down Memory Lane ...

October 21, 2019
Mike MorelandBy Mike Moreland
Vice President Investments

Remembering “Black Monday” and the 1987 Stock Market Crash

October 19 marked the 32nd anniversary of what became known as the ‘Crash of 1987’. Following a good start to the year, market momentum slowed. Inflation ticked up, the Federal Reserve nudged interest rates higher, and economic activity moderated. Stocks started to fall in earnest in early October.

Sounds like a typical economic and market cycle so far. Then the law of unintended consequences took over. The shiniest trinket of the day was a product called portfolio insurance. Pitched as a method to limit downside risk, it involved selling market-linked derivatives when real-world prices fell. Gains in the derivative positions offset losses in cash markets. Voilà! Low-risk investing was here.

Portfolio insurance, also called dynamic hedging, worked well…until it didn’t.  As the stock market selloff accelerated the week prior to the Crash, so did activity in futures. Selling begat more selling, until everything went over the cliff. The S&P 500 fell over 20% on the 19th, a record drop then – and now.

S&P 500 INDEX IN 1987

Source: Bloomberg

All of this is in the history books. What’s not is the uncertainty of that day. We’re used to instant communication, up-to-the-second information, and an ability to act. All of those functions broke down on the 19th. The ‘tape’ – the running summary of market activity – started running late as volumes overwhelmed the reporting technology. By early afternoon the tape was 3-4 hours behind. Trades being reported now were from mid-morning. Where were prices now? No one knew. 

What happens in the absence of current information and selling pressures all around? More selling, more volume, and growing panic. Finally, many trading desks simply stopped answering the phone. Even if you wanted to sell (or for a few brave souls, buy) you couldn’t.

But someone had to buy the stock others sold. In many cases, the buyers of last resort were the specialist firms on the floor of the NYSE. In exchange for exclusive market-making rights, specialists are charged with keeping an orderly market in the shares for which they have responsibility. This means they sell shares from their book when the public wants to buy, and vice versa. More than one specialist firm went out of business from the losses absorbed on the 19th.

The morning of the 20th started out much the same. Ultimately, the Federal Reserve stepped in to guarantee liquidity to the financial system. This stopped the panic. A slow, hesitant return to calm ensued. We were shaken, poorer, and distrustful of financial ‘experts’, but we lived to invest another day.

S&P 500 INDEX SINCE 1980

Source: Bloomberg

What Did We Learn from the Crash of 1987? 

But look at the Crash of 1987 through the lens of time. Investing is a long-run proposition, and in the long run, the Crash is barely visible. If you believe our economic system will build prosperity – and we do – we will participate in its good days and bad. We will work to minimize the risk in poor markets and ensure participation in the better times.  Ask us how consistency, prudence, and belief in the power of the U.S. economic engine will help you achieve your goals.

Photo source: New York Daily News Cover, Oct. 20, 1987

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About the Author

Michael Moreland

Mike Moreland is Vice President of Investment Services at Security National Bank. With more than 40 years of Wealth Management experience at SNB, and his Sioux City roots, Mike has a rich background in finance and Siouxland.